Asset owners that use swaps could ultimately face losses and added risk as a result of an agreement among 18 major global banks.
The Oct. 11 agreement to a protocol introduced by the International Swaps and Derivatives Association allows the banks to delay the wind-down of swaps when one of the parties is in financial stress. It will apply to new and existing cross-border agreements among the 18 banks, which together have more than 90% of outstanding notional derivatives worldwide
The goal is to help reduce systemic risk in the overall market by giving regulators time to facilitate an orderly resolution of a troubled bank before its counterparties seek to terminate swaps contracts and collect associated payments, according to details on the ISDA's website.
Sources said the ISDA protocol, effective Jan. 1, is the blueprint for ultimate final cross-border regulations applied to all swaps participants. In the U.S., delays in domestic swap wind-downs already are in force through the Dodd-Frank Wall Street Reform and Consumer Protection Act. This agreement would extend to the largest banks in Europe and Asia as well, once their regulators adopt the protocols
The intent of reducing systemic risk was lauded by sources interviewed for this story. But some also said asset owners that use swaps will be hurt by any delay, also called a stay, in liquidating the derivatives. (Most existing contracts allow asset owners to withdraw their money from counterparties immediately upon request.)
“It's the stay, not the protocol, that introduces business risk to us,” said David Long, senior vice president and chief investment officer, asset-liability modeling and derivatives and fixed income, at the C$51.6 billion (US$45.9 billion) Healthcare of Ontario Pension Plan, Toronto. As of Dec. 31, HOOPP had total derivatives with a notional value of C$200.03 billion, of which C$135.5 billion were in swaps, according to the pension plan's 2013 annual report.
Mr. Long is concerned about how the protocol would affect contractual agreements already in place for swaps. “If we take away the contractual protections in these contracts, risks go up and we have to look at how to mitigate those risks, including being much more selective with counterparties,” he said.