New Bankruptcy Act Impacts Derivatives Industry
Recent changes to U.S. bankruptcy and insolvency laws provide creditor protection from court stays and avoidance measures as to a broader class of derivatives trades and market participants in the financial contracts arena.
(PRWEB) June 14, 2005 -- Thirty bankers and derivatives counsel came to hear
Ellen H. Clark, a New York-based derivatives lawyer with Salans international
law firm, speak on Tuesday, June 7th, about the recently adopted Bankruptcy Act
of 2005 signed into law by President Bush on April 20, 2005. Although the Act
was meant in large part to curb abuses by profligate debtors, buried in its 185
pages is a long-awaited, change-making section called Title IX on "financial
contracts" which has turned the heads of derivatives specialists.
Title
IX provides the long sought-after holy grail of derivatives attorneys: legal
certainty in bankruptcy for netting, termination and collateral arrangements of
hybrid swaps.
"The new Financial Contract legislation under Title IX of
the Act has brought the U.S. Bankruptcy Code into the 21st Century," explains
Clark, "and more importantly for U.S. market participants, it provides a level
playing field to compete with many foreign counterparties for deals unhampered
by our legal tar-baby called the automatic stay."
Before the
International Swaps and Derivatives Association, the derivative industry trade
association leader (“ISDA”), along with a coterie of legal experts in the
derivatives area, petitioned for change in the existing U.S. bankruptcy
legislation more than 15 years ago, derivative contracts were treated like any
other payment obligation under the Bankruptcy Code. In order to provide a
bankrupt debtor with breathing room to start business afresh, certain provisions
of the Code, still in place today, were set up to stay actions by creditors
seeking to recover amounts due to them. Debtors' contracts with creditors could
be avoided altogether by the bankruptcy trustee. A bankruptcy court could also
postpone obligations for a period of time. Fair enough for the individual
debtor, but for creditors of an insolvent corporate entity involved in complex
swap or derivatives trades, the bankruptcy "automatic stay" or contract
avoidance measure meant market disaster.
In 1990, ISDA succeeded in
bringing about the first set of amendments to the Bankruptcy Code to exempt swap
contracts from the automatic stay provisions by creating a "safe harbor"
especially for these types of financial contracts. "But the solution was
short-lived," explains Clark. “By 2005, the world of derivatives trades had
developed beyond recognition, and bankruptcy legislation just hadn't kept
up."
That is where the Bankruptcy Act comes in. ISDA and its advisers
again took the lead, along with The Bond Market Association and government
officials at the FDIC, in proposing legislation that would amend not only the
Bankruptcy Code, but also the Federal Deposit Insurance Act and Federal Deposit
Insurance Corporation Improvement Act which govern the insolvency of banks. The
amendments, which took more than ten years to bring to fruition, have greatly
expanded the scope of the original Bankruptcy Code amendments that provided the
original safe harbor for swaps.
"Three major changes came about this
spring," Clark explained to her audience. "The scope of financial contracts
covered by the safe harbor was greatly expanded. Now everything from debt and
equity swaps to weather swaps are exempt from the automatic stay in bankruptcy.
Second, the scope of covered counterparties able to seek relief under the safe
harbor was extended to a broader category of market-makers. Third, the ability
to net payment amounts among different product types, from hybrid swaps to repos
and forwards to security arrangements, is expressly permitted under the
bankruptcy law to occur automatically without stay or avoidance or any other
court interference."
This last item, cross-product netting, is a
tremendous source of relief for derivatives market makers. "However, I don't
think the Bankruptcy Act went far enough", pointed out Drew Phillips, a
derivatives attorney at Bank of Tokyo - Mitsubishi. "Until netting is permitted
among affiliates of a bankrupt entity, a lot of the gaming that we have seen in
the pre-petition phase will continue to occur." Indeed, according to Kimberly
Summe, General Counsel at ISDA, there are many leading financial institutions
that would support further legislative refinements to include cross-affiliate
netting, but not all regulators agree. "The bottom line", says Clark, "is market
certainty, where the law is clear and the outcome known. Even if the new law is
not all things to all people, it has come a long way in the right direction."
Ellen H. Clark, Esq. is a derivatives and structured finance attorney in
New York. She currently practices at Salans law firm where she is head of their
structured products group representing international financial organizations and
private equity investors. Her offices are at 620 Fifth Avenue, New York, New
York, 10020. She can be reached by telephone at (212)
632-8375.
Contact:
Ellen H. Clark
212 632-8375
e-mail protected
from spam bots
# # #
Source : http://www.prweb.com/releases/2005/6/prweb250163.htm