Insolvency Arrangements and Contract Enforceability

December 2002

Report of the Contact group on the legal and institutional underpinnings of the international financial system

Recent episodes of financial stress (Enron, LTCM, LTCB) demonstrate the importance of having effective means to achieve the rapid, efficient and equitable resolution of troubled and insolvent companies with extensive financial operations. The challenge is made greater by the increasing global reach of ever larger and more complex financial institutions and non-financial firms with substantial financial activities. The rapid evolution of the environment in which insolvencies occur and the more measured evolution of insolvency regimes have created notable tensions and significant pressures for change. Effective resolution techniques are needed for financial institutions and other active financial market participants in order to contain systemic risk, limit moral hazard and reduce the distortions that arise from the existence of the safety net.

This report examines the objectives and operation of insolvency processes (particularly for financial institutions and non-financial firms with substantial financial activities) in countries with well developed economic, financial and legal infrastructures. It was prepared by the Underpinnings Contact Group. It is based on two comprehensive surveys: of insolvency arrangements for financial institutions and financially active non-financial firms and of the treatment of financial contracts under these insolvency arrangements. The contracts include closeout netting and offset provisions, finality rules in payment systems and collateral agreements to support financial transactions.

The report is exploratory in nature. It considers broad trends in financial markets and insolvency procedures and seeks to suggest perspectives and problems worthy of further investigation. Hence, it does not make concrete policy recommendations, but recognises the need for further analysis and research by academics, practitioners and the public sector.

Report Insolvency Arrangements and Contract Enforceability: