Close-out netting (ISDA) and its consequences on the principle of parity of creditors in Insolvency proceedings

Abstract

The ISDA framework agreement and its important risk mitigation tool, known as close-out netting, is an element of vital importance for the international derivatives market, without which, it would not exist in its current size and volume.

This circumstance implies that regulators around the world find it necessary to adjust their private law and insolvency regime, to provide certainty regarding that this model agreement is achievable and valid in the event of insolvency of one of the parties. These regulatory adjustments are the “safe harbor rules.”

However, the form and design of these rules, most of the time aimed only to shelter the financial market, can generate serious distortions and differences with the general insolvency regime, thus breaking the traditional principle of equality between creditors (pari passu or par conditio creditorum) which is essential to this type of process.

From the regulatory point of view, the breach of equality between creditors in the insolvency process must be justified by a constitutionally acceptable value or reason.

This text seeks to make a critique about the ideologies or values that traditionally inspire these safe harbor regulations, to show that the mitigation of systemic risk as the reason that inspires them, is not a solid argument to defend the breakdown of equality between creditors.