Ropes & Gray: Considerations for the Buy Side on the ISDA 2018 U.S. Resolution Stay Protocol

ISDA recently published the ISDA 2018 U.S. Resolution Stay Protocol (the “Protocol”), which is now open for adherence. This Client Alert provides further information about the Protocol and considerations for buy-side entities in respect of the Protocol and the applicable rules to which the Protocol relates.

Rules Underlying the Protocol

U.S. federal banking regulators have adopted rules that represent a significant shift in the terms of “qualified financial contracts” (such as derivatives, repurchase and reverse repurchase transactions and securities lending transactions). These rules will require buy-side firms to relinquish certain termination rights that have long been part of bankruptcy “safe harbors” for these types of contracts under bankruptcy and insolvency regimes in order to continue trading with large financial institutions. The rules will apply to derivatives transactions, repurchase and reverse repurchase transactions and securities lending transactions with large financial institutions. As a result, institutional investors, hedge funds, mutual funds, sovereign wealth funds and other buy-side market participants who enter into these transactions after January 1, 2019 will need to bring their covered qualified financial contracts (including, but not limited to, ISDA Master Agreements, Master Repurchase Agreements, and securities lending agreements) with large covered financial institutions into compliance with the rules.

The rules are part of post-financial crisis efforts by regulators in various jurisdictions to create a framework for directing an orderly resolution of a distressed systemically important financial institution. These regimes, including Title II of the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), generally impose a one-or two-business day stay on the exercise of default rights (such as termination rights and rights to net collateral) by creditors of a distressed financial institution, to give the applicable receiver or regulatory body time to transfer the financial institution’s rights and obligations to another entity. Following such a transfer, the non-defaulting party’s right to exercise default rights as a result of its counterparty entering the proceedings is extinguished.

The cross-border enforceability of these special resolution regimes is unclear under current law. The rules seek to provide clarity with respect to the enforceability of the U.S. special resolution regimes by requiring parties to covered qualified financial contracts to “opt into” the applicability of these regimes by contract. In effect, parties to covered qualified financial contracts will agree to be bound by the U.S. special resolution regimes, even in situations where the regimes might not otherwise apply. Comparable regulations have been adopted in Germany, Japan, Switzerland and the United Kingdom, and are expected to be adopted in other jurisdictions.

In addition, the rules are designed to facilitate an insolvency proceeding of a failing or failed financial institution under the U.S. Bankruptcy Code by prohibiting a covered financial institution from entering into qualified financial contracts that allow a counterparty to exercise default remedies with respect to such financial institution because an affiliate of such financial institution – including, without limitation, an affiliate who has provided a guaranty with respect to such covered qualified financial contract – enters into resolution or bankruptcy proceedings. This restriction is in part designed to facilitate “single point of entry” resolutions of financial institutions, under which the parent holding company of a financial institution enters bankruptcy proceedings, with the intention that the subsidiaries of such parent company continue to operate outside of bankruptcy. The goal of these changes is to increase the likelihood of an orderly and controlled resolution of a troubled global financial institution and to limit the destabilizing effects on the global financial system as a whole.

The full client update is publicly available at

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