The Too Big To Fail regulatory resolution schemes have revealed a significant problem with swap documentation: the early termination provision. According to speakers at last month’s International Swaps and Derivatives Association Annual General Meeting in Singapore, for a TBTF resolution program to work, derivatives users must give up their early termination rights.
These rights allow the swap user to jump to the front of the liquidation preference line, ahead of senior secured creditors, when a counterparty goes bust. Wilson Ervin, vice chairman of Credit Suisse, told the AGM audience that the losses on the Lehman Brothers early termination totaled $40 billion – more than the $25 billion lost on Lehman’s real estate and private equity holdings.
Early termination is, for many swap users, crucial to their comfort in working with various counterparties. Having it taken away would force swap users – including corporations – to take a dynamically analytic approach to assessing the credit risk of their counterparty broker dealer, much like that broker dealer assesses them.
ISDA has formed a working group on the issue and may consider an amendment to its documentation. It is too early to tell how any resolution will resolve itself, but without one, regulators around the world may be just whistling in the dark about TBTF resolutions.