The world’s biggest banks agreed to rewrite trillions of dollars of financial contracts as the industry responds to pressure from regulators to help make sure lenders can fail without bringing down the global economy.

The contracts help lubricate the workings of the global financial system, governing securities financing transactions and derivatives trades. The new protocol, drawn up by the International Swaps and Derivatives Association and three other industry groups, will allow agreements between the signatory banks to remain intact for a period after a bank fails, ISDA said in a statement today.

The goal is to prevent a recurrence of the messy bankruptcy of Lehman Brothers Holdings Inc. in 2008, which helped trigger a global economic slump. The protocol will complement regulators’ efforts to solve the problem of too-big-to-fail banks, including the total loss-absorbing capacity rules announced by the Financial Stability Board this week. Group of 20 leaders are set to endorse the TLAC rules at a summit next week.

The new protocol “captures a wider universe of financial contracts, further reducing the risk that a bank resolution triggers a chaotic unwind of financial contracts,” ISDA Chief Executive Officer Scott O’Malia said in a statement. “ISDA has worked hand in hand with other trade associations and market participants to meet the regulatory objective of broadening contractual stays to support cross-border resolution and strengthen systemic stability.”

Banks across Europe declined, with Barclays Plc declining as much as 1 percent. UBS Group AG dropped 0.7 percent, while Deutsche Bank AG slipped 0.3 percent. Royal Bank of Scotland Group Plc and BNP Paribas SA also decreased. The Bloomberg Europe Banks and Financial Services Index dropped as much as 0.6 percent and was down 0.4 percent at 9:11 a.m. in London.

The signatories to the revised protocol agreed to abide by the resolution regimes adopted in their counterparties’ home jurisdictions. Lehman’s collapse was accelerated and the costs of the failure increased as counterparties ended derivative transactions early.

The extension of the protocol to securities financing transactions by the global banks means that “more than $560 billion of cross-border securities-financing activity that could previously have been terminated at the point of resolution will be subject to the stay regimes” of the lenders’ home jurisdictions, the FSB said.

Bank of England Governor Mark Carney, who heads the FSB, said the financial crisis “exposed critical obstacles to cross-border resolution that complicated authorities’ ability to stem contagion across the global financial system.” The new protocol “closes off much of the cross-border close-out risk that statutory stays have not been able to eliminate because their reach is limited to national borders,” he said.

 

Bloomberg

 

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