On 16 March 2017, the Swiss Financial Market Supervisory Authority FINMA (FINMA) released final rules on stay recognition clauses in financial contracts that are governed by non-Swiss law and/or subject to the jurisdiction of non-Swiss courts. The new rules are set out in an amendment to the Ordinance of FINMA on the Insolvency of Banks and Securities Dealers (BIO-FINMA) and aim to implement and further specify the scope of the obligation for banks to include stay recognition clauses in financial contracts as provided for in article 12(2bis) of the Ordinance on Banks and Savings Institutions (FBO). The final rules took effect on 1 April 2017, with a 12 months implementation period for contracts with banks and securities dealers and an 18 months implementation period for contracts with all other counterparties.
By Stefan Kramer / Andreas Josuran (Reference: CapLaw-2017-18)
1) Background of the New Rules
The global financial crisis of 2007-2009 illustrated that contagion and interconnectedness among financial market participants may pose systemic risks and endanger the proper functioning of the financial markets in a crisis. Financial contracts providing for default clauses referring to external events (such as cross-default clauses or clauses referring to the exercise of resolution powers by the regulator) are one potential cause of such interconnectedness. Against this background, article 30a of the Act on Banks and Savings Institutions (FBA) introduced the power of FINMA to order a stay (a Stay) in connection with the exercise of its resolution powers for up to two business days. The Stay temporarily overrides termination and related contractual rights (e.g., close-out netting provisions) which would otherwise be triggered as a result of protective measures or restructuring proceedings being implemented with respect to an entity that is subject to FINMA’s resolution powers (the Resolution Entity).
On 1 January 2016, a new rule was introduced in the Swiss Banking Ordinance (article 12(2bis)) requiring banks and group companies to include stay recognition clauses in financial contracts. The main purpose of this obligation is to ensure enforceability of a Stay imposed by FINMA with respect to transactions governed by third-country law (e.g., derivatives and repo transactions under ISDA or GMRA master agreements, which are generally governed by English or New York law), thereby ensuring that resolution actions taken in relation to a Swiss Resolution Entity would not immediately lead to the early termination of its financial arrangements (or those of its subsidiaries).
The rules are part of a coordinated effort of the Financial Stability Board (FSB) to improve cross-border recognition of resolution stays by obliging firms to adopt contractual solutions where statutory recognition regimes are lacking. The Swiss rules closely track similar obligations that were recently introduced by the Prudential Regulation Authority (PRA) in the United Kingdom.
2) Scope of Obligation to Amend Financial Contracts
a) In-scope Contracts
The scope of the obligation to amend financial contracts is closely linked to the scope of a FINMA’s stay powers. If a Stay cannot apply to a specific contract, for instance because it does not contain termination provisions or related contractual rights (i.e., set-off, netting, collateral enforcement and porting rights) which would otherwise be triggered as a result of protective measures or resolution proceedings being imposed by FINMA (collectively, Relevant Termination Rights), there is no obligation to include a stay recognition clause into such contract.
Furthermore, the obligation to amend contracts only applies to newly concluded or amended contracts (see below under 3 a) “Newly concluded or amended contracts”).
Pursuant to article 56(1) BIO-FINMA, the following types of contracts are generally in scope (subject to the exemptions described below under 2 b) “Available Exemptions”):
- lit. a: contracts for the purchase, sale, lending or repurchase relating to securities and corresponding transactions with respect to indices containing these underlying assets, as well as options in relation to such underlying assets;
FINMA in its report of 9 March 2017 on the results of the consultation process (the Consultation Report) states that, in light of the general scope of the rules, spot transactions and similar transactions with a very short term (i.e., intraday and overnight transactions) do generally not need to be amended. This appears to be justified given that, firstly, such transactions typically do not provide for Relevant Termination Rights and do therefore not fall within the scope of application (see above) and, secondly, even if in specific cases they did contain Relevant Termination Rights, a Stay would in any case have little to no effect on such transactions. - lit. b: contracts for the purchase and sale with future delivery, lending or repurchase relating to commodities and corresponding transactions with respect to indices containing these underlying assets, as well as options in relation to such underlying assets;
- lit. c: contracts for the purchase, sale or transfer of commodities, services, rights or interest at a future date and at a predetermined price (futures contracts);
In the EU, the obligation to amend contracts is generally limited to financial contracts (see article 2 no. 100 of the Directive 2014/59/EU (BRRD)). With respect to the Swiss rules, it is not entirely clear from FINMA’s Consultation Report to what extent contracts that are unrelated to financial market transactions would be out of scope. However, contracts providing for the sale or purchase of services, IT, real estate etc. will in any way not need to be amended if they do not provide for Relevant Termination Rights. - lit. d: swaps, including credit derivatives and interest options;
- lit. e: inter-bank loans;
Contrary to the rules in the EU (see article 2 no. 100(e) BRRD), under which the obligation to amend contracts generally only applies to inter-bank loan agreements with a duration of up to three months, Swiss law does not make this distinction. - lit. f: other contracts with the same effect as the ones above;
In its Consultation Report, FINMA makes it clear that this “catch-all provision” is not intended to broaden the scope of application. Rather, it aims to prevent circumvention of the new rules and to avoid loopholes as regards future developments in the market. It would therefore in our view not be sufficient if a contract (e.g., an insurance contract) has a similar economic effect as an in-scope contract (e.g., a credit default swap). Rather, a transaction would have to be documented specifically with a view to circumvent the obligations under the BIO-FINMA in order to fall under the “catch-all” provision. - lit. g: contracts as the ones above in the form of a master agreement.
Contracts can be in scope irrespective of whether they are documented as a stand-alone transaction or entered into under a master agreement.
b) Available Exemptions
According to article 56(1)(h) BIO-FINMA, contracts of foreign affiliates do not need to be amended, unless performance of the affiliate’s obligations under the contract is secured by a Swiss bank or securities dealer.
If not the Resolution Entity itself but a foreign affiliate of the Resolution Entity is a party to a relevant contract that includes Relevant Termination Rights, a Stay imposed by FINMA will only be effective, and a stay recognition clause will only have to be included in the contract, if there is a sufficient connection to the Swiss resolution proceedings. As regards customary derivatives and repo master agreements, an obligation to amend a contract would therefore only exist if the Resolution Entity cumulatively (i) is named as “credit support provider” or “specified entity” (or an equivalent) in the relevant contract, and (ii) guarantees or otherwise secures the performance of the relevant foreign affiliate under such contract.
Furthermore, pursuant to article 56(2) BIO-FINMA, the following types of contracts are out of scope even if they would otherwise fall into one of the categories described above:
- lit. a: contracts that do not provide for Relevant Termination Rights;
This already follows from the general principle that an obligation to amend contracts only exists to the extent the relevant contract can potentially be subject to a Stay (see above under “In-scope Contracts”). Accordingly, contracts only providing for other termination rights (e.g., a right to terminate at will) do not need to be amended. - lit. b: contracts that are concluded or settled directly or indirectly via a financial market infrastructure or an organized trading facility (OTF);
This exemption captures contracts concluded or cleared via a financial market infrastructure pursuant to article 2(a) Act on Financial Market Infrastructures (FMIA) or an organized trading facility pursuant to article 42 FMIA. In addition, FINMA clarifies in its Consultation Report that the exemption also applies to contracts concluded on foreign trading platforms regardless of their qualification in the relevant home country jurisdiction (such as, for example, securities exchange facilities (SEFs) qualifying as “trading venues” within the meaning of Directive 2014/65/EU (MIFID II)). Not within the scope of this exemption are, however, contracts concluded via foreign facilities that only serve the purpose of bilateral trading (and do therefore not count as organized trading facilities under MIFID II), such as systematic internalizers. - lit. c: contracts with central banks;
- lit. d: contracts of group entities which are not active in the financial sector;
- lit. e: contracts with natural persons;
This exemption applies to contracts with individuals and other counterparties that are not enterprises within the meaning of article 77 of the Ordinance on Financial Market Infrastructures (FMIO). Requiring for such contracts to be amended to include a stay recognition clause would not be proportionate, given the significantly lower systemic relevance of such transactions. Pursuant to FINMA’s Consultation Report, contracts entered into by ultra-high net worth individuals may need to be amended if they are concluded through investment structures such as trusts or family offices. - lit. f: contracts relating to the placement of financial instruments in the market.
This exemption applies to subscription agreements, underwriting agreements and similar contracts for the purchase and/or placement of financial instruments in the market. Such contracts commonly include termination clauses, in particular upon the occurrence of a material adverse change of the financial or legal position of the issuer.
3) Further Conditions
a) Newly Concluded or Amended Contracts
Only contracts that are newly concluded or actively amended by the parties thereto are in scope. Existing contracts do therefore generally not need to be amended. Also, an obligation to include a stay recognition clause is not triggered in case an amendment is effected by operation of the contractual terms, such as, e.g., the resetting of interest rates (article 56(2)(g) BIO-FINMA).
According to the Consultation Report, the entering into a new transaction under an existing master agreement is also considered an amendment which would trigger the obligation to include a stay recognition clause. Moreover, contrary to the rules enacted by the PRA for banks in the UK, the Swiss rules do not provide for a general exemption for amendments that are not material. Rather, FINMA’s Consultation Report states that no distinction should be made between material and non-material amendments.
b) Non-Swiss Governing Law or Jurisdiction of Non-Swiss Courts
In line with the general goal to improve cross-border recognition of resolution stays by obliging firms to adopt contractual solutions where statutory recognition regimes are lacking, only contracts that are either governed by non-Swiss law and/or subject to the jurisdiction of non-Swiss courts are in scope. Conversely, contracts that are governed by Swiss law and subject to the jurisdiction of Swiss courts do not need to be amended (article 12(2bis) FBO).
4) Implementation
a) Timeline
The new rules took effect on 1 April 2017 with a 12 months implementation period for contracts with banks and securities dealers and an 18 months implementation period for contracts with all other counterparties. Accordingly, the regulation will apply to contracts with banks and securities dealers as of 1 April 2018 and it will apply to contracts with other counterparties as of 1 October 2018.
b) How to Implement
Compliance is expected to be established primarily by way of the ISDA Resolution Stay Jurisdictional Modular Protocol together with a specific Swiss Module which is in the course of being prepared by ISDA. Adherence to the Jurisdictional Modular Protocol results in counterparties to financial institutions consenting to “opt in” to stays on, or overrides of, certain termination rights under specific resolution regimes, notwithstanding the governing law of their agreements. Accordingly, if both parties to a contract adhere to the Jurisdictional Modular Protocol and the respective Swiss Module, in-scope contracts (including future contracts if a reference to the Jurisdictional Module is incorporated in the terms of the agreement) are automatically amended to include the relevant resolution stay recognition clauses.
Contracts that are not covered by a protocol will not automatically include a stay recognition clause. To the extent such contracts fall into the scope of the obligation to include stay recognition clauses, parties will have to include such a clause on a bilateral basis.
5) Conclusion and Outlook
Swiss banks will have to comply with the obligation to amend newly concluded or amended contracts (i) by 1 April 2018 for contracts with banks and securities dealers as counterparties and (ii) by 1 October 2018 for contracts with other counterparties. ISDA have communicated earlier that they expect the preparation of the aforementioned Swiss Module to take three to six months.
Stefan Kramer (stefan.kramer@homburger.ch)
Andreas Josuran (andreas.josuran@homburger.ch)