Bankruptcy Treatment of Financial Derivatives

Intro

The Mexican Insolvency Law provides a comprehensive framework for managing financial derivatives in the event of bankruptcy. The law aims to preserve businesses while protecting creditors during insolvency proceedings. Its treatment of financial derivatives is particularly noteworthy, offering a balance between financial stability and creditor rights.

Termination and Netting

At the core of the law's approach to financial derivatives is the concept of automatic termination and netting. All derivative transactions, whether they be individual transactions or multiple transactions under framework contracts, are immediately terminated once a company enters bankruptcy. These terminated transactions are then netted out, with the value determined based on market prices at the time of the bankruptcy declaration. This mechanism serves to mitigate netting risk, a primary concern in derivative markets.

Treatment of Collateral

The treatment of collateral under the law is another crucial aspect. While the bankruptcy declaration generally triggers a stay on asset foreclosures, there's a significant exception for derivatives: collateral provided through security devices where title is transferred to the pledgee can be automatically applied to settle the closed-out amounts of derivative transactions. This provision offers additional protection to debtor’s counterparties in derivative contracts.

Ranking

In terms of claim recognition and ranking, the post-netting balance of derivative transactions will be treated as either a payable to the debtor or a claim against the debtor, depending on which party the balance favors. Claims against the debtor are recognized as pre-commencement claims, subject to bankruptcy impairment, and may be classified as secured or unsecured depending on their collateral.

Avoidance Powers

The law also addresses the court's avoidance powers, which allow for the setting aside of certain pre-commencement transactions. However, it provides a safe harbor for the netting of derivative transactions carried out during the retroactive period, offering further stability to financial instruments.

Areas of Legislative Improvement

While the Mexican Insolvency Law provides a clear framework for handling financial derivatives in insolvency scenarios, some areas remain unclear or potentially problematic. The treatment of costs and expenses beyond the fair market value of transactions, the process of re-couponing, and the complexities of multibranch netting, especially involving non-Mexican debtors with branches in Mexico, are identified as areas that may require further legislative attention or clarification.

Conclusions

The Mexican Insolvency Law provides a comprehensive and largely effective framework for managing financial derivatives in insolvency proceedings. By allowing for automatic termination and netting, providing protections for collateral, and offering safe harbors from avoidance actions, the law strikes a balance between financial market stability and equal treatment of creditors. However, as with any complex financial regulation, there remain areas for potential refinement and clarification as markets evolve and new challenges emerge.

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