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Abstract
U.S. bankruptcy law grants special rights and immunities to creditors in derivatives transactions, including virtually unlimited enforcement rights. This Article argues that these rights and immunities result from a form of path dependence, a sequence of industry-lobbied legislative steps, each incremental and in turn serving as apparent justification for the next step, without a rigorous and systematic vetting of the consequences. Because the resulting "safe harbor" has not been fully vetted, its significance and utility should not be taken for granted; thus, regulators, legislators, and other policymakers-whether in the United States or abroad-should not automatically assume, based on its existence, that the safe harbor necessarily reflects the most appropriate treatment of derivatives transactions under bankruptcy and insolvency law or the treatment most likely to minimize systemic risk.
Table of Contents
I. Introduction.......... 1716
II. Background.......... 1718
III. The Concept of Path Dependence.......... 1721
A. Defining Path Dependence.......... 1721
B. Legal Path Dependence.......... 1722
IV. Evolution of the Bankruptcy-Law Safe Harbor for Derivatives.......... 1724
A. The 1978 Bankruptcy Code.......... 1724
B. The 1982 Amendment.......... 1727
C. The 1984 Amendment.......... 1728
D. The 1990 Amendment.......... 1729
E. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005.......... 1731
F. The Financial Netting Improvements Act of 2006.......... 1736
V. Is the Derivatives Safe Harbor Path Dependent?.......... 1737
VI. Reassessing the Derivatives Safe Harbor.......... 1742
A. Does Market Concentration Justify the Safe Harbor?.......... 1743
B. Is the Safe Harbor Focused on the Right Parties?.......... 1746
C. Possible Unintended Consequences.......... 1747
VII. Conclusions.......... 1753
I. Introduction
Bankruptcy law in the United States, which serves as an important precedent for the treatment of derivatives under insolvency law worldwide,2 provides unique protections to creditors in derivatives transactions. Unlike other creditors of a debtor,3 derivatives counterparties have special rights and immunities in the bankruptcy process, including virtually unlimited enforcement rights against the debtor (hereinafter, the "safe harbor"). This Article shows that these rights and immunities accreted over time, primarily due to industry lobbying and without a systematic and rigorous vetting of the consequences.
This type of legislative accretion process is not uncommon. It is a form of path dependence-a process in which the outcome is shaped by its historical path. Because the resulting legislationin our case, the safe harbor-is not fully...