A Dialogue on the Costs and Benefits of Automatic Stays for Derivatives and Repurchase Agreements

Abstract

For nearly two years, the two of us have had a running discussion of the costs and benefits of automatic stays in bankruptcy for qualified financial contracts (QFCs) such as derivatives and repurchase agreements, particularly those held by systemically important major dealer banks. Under current U.S. bankruptcy law, these contracts are exempted from the automatic stay. The advantages and disadvantages of this treatment have been a matter of significant debate for the past decade, particularly since the 2008 crisis.

After some background on QFCs and automatic stays, we provide our joint analysis of the costs and benefits of stays on the QFCs, with a focus on systemically important financial institutions, including the special case of central market utilities. Following this, we state our respective policy conclusions. Briefly speaking, we both believe that repos (and certain closely related QFCs) that are backed by liquid securities should be exempt from automatic stays, or receive an effectively similar treatment. Repos backed by illiquid assets, on the other hand, should not be given this safe harbor. We both believe that derivatives that have not been centrally cleared should be subject to automatic stays. One of us believes that stays should also apply to cleared derivatives. The other author favors an exemption of cleared derivatives from stays, except in the case of a failure of a regulated central clearing party.

Keywords: qualified financial contract, OTC derivative, swap, repurchase agreement, automatic stay, clearinghouse, Dodd-Frank Act, financial regulation, finance, bankruptcy

JEL Classification: G20, G21, G30, G32, G33, K22, K23