Derivatives — Several Developments of Note

BANKRUPTCY COURT IN NEW YORK RULES SUBORDINATION CLAUSES IN SYNTHETIC CDOs ARE INVALID AND NOT SUBJECT TO DERIVATIVES SAFE HARBOR

In a widely anticipated ruling, the Bankruptcy Court for the Southern District of New York has ruled that subordination clauses relating to defaulting swap counterparties in synthetic collateralized debt obligation (CDO) transactions are invalid ipso facto clause which are not enforceable under the U.S. Bankruptcy Code. In synthetic CDO transactions, the payment priority of a swap counterparty is deeply subordinated if the swap counterparty defaults under the swap transaction. The events of default include the bankruptcy of a swap counterparty. The court found no justification for this substantial payment penalty placed on a swap counterparty due to its bankruptcy and viewed it as unenforceable in U.S. bankruptcy proceedings. The court further ruled that the safe harbor for derivative transactions under the Bankruptcy Code does not extent to these subordination clauses. In this case, the synthetic CDO at issue was governed by New York law. However, in a similar case involving a synthetic CDO governed by English law, the U.K. Supreme Court recently ruled that such subordination clauses are valid in U.K. insolvency proceedings. A copy of the U.S. case can be accessed here.

CFTC ISSUES AGRICULTURAL SWAPS FINAL RULE

The Commodities Futures Trading Commission (CFTC) has issued a final rule relating to agricultural swaps. Under the final rule, agricultural swaps will be treated in a similar manner to other swap agreements. Prior to the Dodd-Frank Act (Dodd-Frank), certain agricultural swaps, for a variety of historical reasons, were treated in a different manner than other swap agreements. Given the new regulatory regime for swap agreements under Dodd-Frank, the CFTC concluded that there was no longer any valid reason for treating agricultural swaps differently than other swap agreements. This new rule will be effective on December 31, 2011. A copy of this new rule can be obtained at the CFTC’s Web site here.

CFTC AND SEC STAFFS HOST PUBLIC ROUNDTABLE ADDRESSING INTERNATIONAL ISSUES ON DERIVATIVES REGULATION UNDER DODD-FRANK

On August 1, 2011, the CFTC and SEC staffs held a joint public roundtable discussing various international issues pertaining to the implementation of derivatives regulation and addressing the considerable industry and public concerns relating to the extra territorial application of the Dodd-Frank derivatives rules. Among other things, a number of swap market participants reportedly expressed their concerns regarding potential discrepancies in international swaps regulations and possible disadvantages for U.S. entities, availability of reciprocity principle in international swaps regulations, the extent of end-users and other exemptions in U.S. and foreign swaps rules, and a range of other issues. The list of participants in the meeting, roundtable video and other relevant information can be found here.