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October 9, 2014

Expected change in derivatives aims to curb damage from bank failure

“Six years ago, the $700 trillion derivatives market helped turn Lehman Brothers’ collapse into a full-blown global financial crisis.

“But this weekend, regulators and large banks expect to agree on a change to derivatives that is intended to contain the damage caused by the crash of a large bank, several people briefed on the negotiations said.

“Many in the industry are promoting the change as evidence that banks and regulators are substantially reducing the threat that large banks pose to the financial system and the wider economy. While consumer advocates say that they support the change, they also contend that it does not do enough to dislodge the privileged, and potentially precarious, position that they say derivatives still occupy in the financial system.”

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“Some critics of the banking industry say more must be done.

“There is no question that this potentially very important change could, if done right, dramatically improve the ability to stop a crisis spreading,” said Dennis M. Kelleher, president of Better Markets, a group that has pressed for a more stringent overhaul of banks, “But the other pieces are critical, too.”

“Even after the change, derivatives will enjoy superior rights. The new provision would still allow a derivative to be terminated early if the entity directly on the other side of a derivatives trade went into a bankruptcy proceeding like Chapter 11.

“It is indefensible that derivatives get preferential treatment over all other creditors,” Mr. Kelleher said. “That becomes a key accelerant in spreading a financial crisis.”

“The banks may have secured an important concession in the negotiations. Some regulators wanted to reserve the right to stop meeting contractual obligations, like margin payments, on a derivatives trade during a stay. But the banks have not given that up, according to a person briefed on the talks.”

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Read the full New York Times article by Peter Eavis here.

 

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