G-SIFIs to jump first, then who?

It is increasingly certain that G-SIFIs will relinquish their early termination rights against each other via an ISDA Protocol this autumn. Adherence to the Protocol, which is yet to be released, would only be open for adherence by G-SIFIs.

G-SIFIs first

In the FSB’s view, early termination rights linked to entry into resolution of G-SIFIs seriously impedes the resolution process and causes systemic risk, as counterparties rush to terminate a large number of transactions.

The resolution argument is based on the belief that important financial institutions such as Lehman Brothers would have been in a better position had it been allowed to hold on to its derivatives transactions. Harvey R. Miller, Lehman`s bankruptcy attorney, widely espouses this view. The systemic risk argument is based on the perception that the derivatives market would remain more stable in time of crisis should counterparties of the G-SIFIs be prevented from terminating their transactions.

As currently envisioned, the changes would only apply to G-SIFIs to G-SIFIs transactions.

Non G-SIFIs, next in line?

The regulators would eventually seek to restrict early termination rights for non G-SIFIs as well. In parallel, ISDA will have the option to extend the scope of G-SIFIs` Protocol or publish a separate one. The extended scope has not yet been ascertained, but considering the main impetus behind the changes relates to G-SIFIs resolution regimes, only the non G-SIFIs to G-SIFIs transactions may be added.

Assuming that regulators and ISDA orchestrate these major changes across the market, the risk management of transactions with G-SIFIs will be much more complex than the risk management of non G-SIFIs to non G-SIFIs transactions.

The suspension of early termination right is a sensitive issue, and the buy-side has shown strong reserves against waiving such rights. Perhaps transacting only with non G-SIFIs will be the path to salvation.

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