Close-out netting and safe harbours increase systemic risk

28 September 2016/No Comments
By Nick Dunbar

The banking industry has long argued that close-out netting provisions in derivative contracts reduce systemic risk, and successfully lobbied to have ‘safe harbour’ provisions to protect counterparties from bankruptcy claims. This is embedded in US Generally Accepted Accounting Principles, resulting in trillions of derivatives exposures not being counted on bank balance sheets. However the Lehman Brothers bankruptcy in 2008 highlighted the tension between derivative counterparties and other creditors. In a paper, Stephen Lubben says that close-out netting cost Lehman creditors $75 billion, and argues that safe harbours amount to a subsidy provided to the derivatives market by the bankruptcy system.

Read the paper here

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