Derivatives contracts are exempt from normal bankruptcy law

More or less (there are complex details).  Here is one account:

…in a series of amendments through the 1980s US bankruptcy law was
altered to provide extraordinary protection to over the counter (OTC)
derivatives. This favorable treatment under the law is undoubtedly one
of the reasons that markets in these derivatives did not follow the
historical pattern and move onto centralized exchanges. [TC: heterogeneity of contracts is an issue as well]

By providing over the counter derivatives extraordinary protection
under the law, the bankruptcy amendments dramatically reduced the need
for market participants to monitor the financial health of their
counterparties. One of the principal reasons that financial market
participants choose to establish cooperatively run exchanges (recall
that the NYSE is to this day a private organization) is to protect
themselves from counterparty risk. The exchange is the counterparty to
every trade, so the only concern is whether the exchange itself is
well-capitalized and well-run.

Here is more detail.  Here is again more detail, with this as the bottom line:

…counterparties to derivatives contracts are free to terminate the contracts and then seize collateral to the extent that they are owed money…

In other words, there is no bankruptcy stay.  That’s not obviously a good arrangement and it can lead to hair trigger failures (sound familiar?) by implicitly subsidizing these transactions.  I first heard of this reading the excellent Felix Salmon.  Here is yet further detail.  Here is how some of it came from the 2005 Bankruptcy AmendmentsCongress thought, at the time, that this would limit systemic risk. 


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