Firms holding swaps contracts with a bank filing for U.S.bankruptcy protection would have to wait at least 24 hours beforedemanding collateral under new practices that may be adopted by theindustry this month.

The revision could make it easier for banks to satisfygovernment requirements for the “living wills” they must produce toshow how they'd unwind their businesses in an orderly fashion ifthey veered toward collapse.

The International Swaps and Derivatives Association (ISDA), themain industry group for the $700 trillion global swaps market,included the language in a draft of a new standard contract underpressure from U.S. regulators, said three people with knowledge ofthe talks. Regulators and industry lawyers meeting in London arenearing agreement on the draft, a copy of which was reviewed byBloomberg News.

Those involved in the negotiations hope to be able to announcethe most recent developments at the annual meeting of theInternational Monetary Fund that begins Oct. 10 in Washington, saidthe people, who spoke on condition of anonymity because thediscussions aren't public.

The new protocols, which would initially cover only large banksincluding JPMorgan Chase & Co. and Goldman SachsGroup Inc., would be applied retroactively to contracts already inplace, according to the people.

The revision of the contracts should be finished “within thenext few weeks,” Nick Sawyer, a spokesman for ISDA, said in astatement. He declined to provide details.

Under the U.S. bankruptcy code, derivatives including swaps areamong the few financial instruments exempt from the “stay,” orpause, that keeps creditors of a failed firm from immediatelycollecting what they're owed. If a bank entered bankruptcy, itsswap counterparties could move to seize collateral.

Such a rush would make an orderly bankruptcy impossible,according to recent statements by the Federal Reserve and FederalDeposit Insurance Corp. The two regulators are responsible forsupervising the annual living-will plans that banks must developunder the 2010 Dodd-Frank Act. In August, the regulators rejectedliving wills from 11 of the largest U.S. and foreign banks, tellingthe firms to simplify their legal structures and address thebankruptcy exemption for swaps.

While any change in the bankruptcy code would need to be made byCongress, parties in swaps deals would have to abide by the termsof their private contracts.

Liquidation Process

Bloomberg News earlier reported the possible addition of a stayto standard swaps contracts in the event of a government-initiatedliquidation of a bank. How the stays would apply in U.S.bankruptcies had been unresolved, as swap dealers expressed concernabout losing their place at the front of the creditors' line.Regulators used the living-will process to press the industry tocome up with a solution on its own.

Regulators have said a pause in the collection of swapscollateral could give a firm enough time to re-capitalize and avoidthe kind of panic that followed the 2008 failure of Lehman BrothersHoldings Inc. They theorize that having a credible plan forunwinding failed banks would help end the perception by some marketparticipants that governments will bail out firms that are “too bigto fail.”

ISDA, backed by swaps dealers such as Goldman Sachs, JPMorgan,and Deutsche Bank AG, sets the worldwide standards forderivatives—complex financial instruments whose value is tied toanother asset, such as a loan or stock.

Regulators and central bankers from the U.S., U.K., and othercountries have been negotiating for months with the industry tofinish a deal before a mid-November Group of 20 summit in Brisbane,Australia.

Meanwhile, Congress has been exploring other options. Lastmonth, the House Judiciary Committee passed a bipartisan bill meantto revise bankruptcy laws to ease the winding-down of financialfirms. A similar bill has been introduced by Senate Republicans.Such efforts so far haven't gained much traction in a dividedCongress.

This week, House Financial Services Committee Chairman JebHensarling, a Texas Republican, said the U.S. banking agencies aredodging “both congressional deliberation and agency notice andcomment” by dealing directly with the industry.

Fiduciary Duty

Regulators in the U.S. and Europe have also been examining howthey can mandate use of the new contracts beyond the biggest banks,according to people familiar with the discussions.

“A consequence of this effort is that, in effect, regulatorswant hedge funds—and their investors—to lose rights that they havenegotiated under industry contracts to terminate such contractswith a defaulting counterparty,” said Stuart Kaswell, generalcounsel of the Managed Funds Association, a hedge-fund trade group,in an August statement.

Sawyer, the ISDA spokesman, said the industry expects regulatorsto “impose new regulations in their jurisdictions that will promotebroader adoption of the stay provisions.”

The Financial Stability Board, a global group of regulators,suggested as much in a statement on its website this week.

“Contractual solutions have limitations and therefore may not beconsidered a substitute for statutory regimes in the longer term,”the group said in the statement. “Any contractual solution bindsonly the parties that agree to it.”

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