Too Big To Default: Restricting End-Users’ Default Rights Against Big Banks by Managed Funds Association

Executive Summary

Managed Funds Association has prepared this white paper to present the views of its members on stays of early termination rights for consideration by public policymakers and regulators. MFA represents the global alternative investment industry and its investors by advocating for public policies that foster efficient, transparent, and fair capital markets.

As a general matter, MFA supports public and private sector efforts to facilitate the orderly liquidation of troubled financial institutions and improve the stability of the financial markets. Given that many MFA members’ investors incurred significant losses resulting from the collapse of Lehman Brothers, MFA has been a strong supporter of legislative and regulatory efforts to strengthen the financial system.

However, MFA members have serious objections to the rapidly advancing initiatives of certain bank regulators to restrict or “stay” the Default Rights of end-users against a distressed financial institution (the Regulators’ Stay Initiatives). As explained further in this white paper, bank regulators in the United States, Europe, and Asia are seeking to require end-users to relinquish several of their contractual Default Rights against big banks in response to recommendations made by the Financial Stability Board (the FSB), an organization that is dominated by central bankers and finance ministers.

Although the FSB’s decisions are not legally binding on members’ jurisdictions, several of the world’s most important bank regulators (G-20 bank regulators), including the U.S. Federal Deposit Insurance Corporation (FDIC) and the U.S. Board of Governors of the Federal Reserve System (Federal Reserve, and together with the FDIC, the U.S. Regulators), are seeking to implement the FSB’s recommendations (and the Regulators’ Stay Initiatives more specifically). MFA believes that the G-20 bank regulators are attempting to implement these initiatives without adequately consulting with relevant policymakers regarding their merits and potential consequences for the world’s leading financial markets. In addition, while the G-20 bank regulators will solicit public comment from industry stakeholders on proposed rules to implement the Regulators’ Stay Initiatives, it appears that the G-20 bank regulators have pre-determined to proceed with the Regulators’ Stay Initiatives. Therefore, MFA is concerned that issuance of such proposals will not constitute a meaningful opportunity for stakeholders to provide input on the initiatives.

Such an unexamined and global “taking” of end-user Default Rights ? under the auspices of the opaque FSB ? is troubling enough by itself. Moreover, it appears that U.S. Regulators are taking this FSB-led initiative a significant step further. Specifically, U.S. Regulators are proposing to require end-users to waive additional “cross-default” rights that are, and for decades have been, legally enforceable under U.S. law ? something even the FSB has not recommended.

In addition to our legal and process objections to such actions, MFA believes that forcing end-users to waive their Default Rights would be harmful for the markets and the global economy. Contractual Default Rights are critically important to end-users, particularly during stressed market conditions. Such rights not only allow them to protect their investors and other stakeholders from significant Lehman-like losses of their assets but also preserve the integrity and stability of the world’s leading financial markets. Therefore, placing any restrictions on these Default Rights as part of yet untested resolution strategies would be highly detrimental to the financial markets during stressed market conditions. Even if there were empirical evidence that waiver of such Default Rights would be beneficial to bank regulators’ efforts to resolve a distressed systemically important financial institution (SIFI), policymakers and regulators need to assess properly the impact of such waivers on non-defaulting market participants and financial market integrity more broadly before requiring such waivers, whether by regulation or legislation.

In this white paper, MFA: (i) highlights concerns about key aspects of these Regulators’ Stay Initiatives; and (ii) proposes recommendations that would facilitate an impartial and complete analysis of the relevant issues and a fair balancing of all relevant policy concerns by taking into account the implications for affected constituents. Specifically, in this white paper, MFA identifies the following concerns with the Regulators’ Stay Initiatives:

  • The FSB and G-20 bank regulators are advancing the Regulators’ Stay Initiatives without a mandate from public policymakers;
  • The G-20 bank regulators’ new resolution strategies have potential flaws and unintended consequences;
  • The contractual approach to imposing the Regulators’ Stay Initiatives is inherently flawed; and
  • The U.S. Regulators’ Cross-Default Stay Initiative is not a G-20 objective and is inconsistent with congressional intent.

End-Users' Default Rights

End-Users' Default Rights

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