The Value of Insolvency Safe Harbours

Final version in the Oxford Journal of Legal Studies, Forthcoming

LSE Legal Studies Working Paper No. 9/2015.

33 Pages Posted: 27 Mar 2015 Last revised: 21 Sep 2015

See all articles by Philipp Paech

Philipp Paech

London School of Economics - Law Department

Date Written: March 25, 2015

Abstract

‘Safe harbour’ is shorthand for a bundle of privileges in insolvency which are typically afforded to financial institutions. They are remotely comparable to security interests as they provide a financial institution with a considerably better position as compared to other creditors should one of its counterparties fail or become insolvent. Safe harbours have been introduced widely and continue to be introduced in financial markets. The common rationale for such safe harbours is that the protection against the fallout of the counterparty’s insolvency contributes to systemic stability, as the feared ‘domino effect’ of insolvencies is not triggered from the outset. However, safe harbours are also criticised for accelerating contagion in the financial market in times of crisis and making the market more risky. This paper submits that the more important argument for the existence of safe harbours is liquidity in the financial market. Safe harbour rules do away with a number of legal concepts, notably those attached to traditional security, and thereby allow for an exponentiation of liquidity. Normative decisions of the legislator sanction safe harbours as modern markets could not exist without these high levels of liquidity. To the extent that safe harbours accelerate contagion in terms of crisis, which in principle is a valid argument, specific regulation is well suited to correct this situation, whereas a repeal or significant restriction of the safe harbours would be counterproductive.

Keywords: financial institutions, financial market, banks, insolvency, safe harbours, safe harbors, collateral, netting, set-off, close-out netting, Unidroit, FCD, Financial Collateral Directive, Insolvency, bank resolution, moral hazard, systemic risk, risk management, liquidity

JEL Classification: G15, G21, K22, K33

Suggested Citation

Paech, Philipp, The Value of Insolvency Safe Harbours (March 25, 2015). Final version in the Oxford Journal of Legal Studies, Forthcoming ; LSE Legal Studies Working Paper No. 9/2015. . Available at SSRN: https://ssrn.com/abstract=2578521 or http://dx.doi.org/10.2139/ssrn.2578521

Philipp Paech (Contact Author)

London School of Economics - Law Department ( email )

Houghton Street
London WC2A 2AE, WC2A 2AE
United Kingdom

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