Shadow banking – legal issues regarding collateral and insolvency law

In many financial markets repurchase agreements (repos) and securities lending agreements benefit from special insolvency treatment which - broadly speaking consists of an exemption from a number of insolvency law mechanisms. In line with FSB Recommendation 13 on repos and securities lending, insolvency treatment of these transactions should not be changed. Instead, the regulators should be given the power to temporarily stay close-out netting, as in bank resolution proceedings. Regulatory haircuts (FSB Recommendations 6 and 7) may buffer systemic consequences but are unable to act as a circuit breaker. Repo and securities lending collateral assets face increased enforcement difficulties in cross-border settings, stemming from different national rules regarding good-faith acquisition and close-out netting. Haircuts are not an appropriate solution. Instead, only harmonisation of securities law and of the relevant insolvency rules can guarantee a consistent cross-border framework.