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FRM Part II · FRM Exam Part II · The Failure Mechanics of Dealer Banks

In Duffie's analysis of dealer bank failures, which feature of the U.S. Bankruptcy Code most directly lets a defaulted dealer's derivatives and repo counterparties terminate and seize collateral immediately, thereby accelerating a liquidity run?

Safe-harbor exemptions from the automatic stay let repo and derivatives counterparties terminate contracts and sell collateral immediately after a dealer defaults. This speeds up the loss of funding and can force fire sales, whereas ordinary creditors remain stayed.

  1. AThe automatic stay applied to all unsecured creditors
  2. BSafe-harbor exemptions from the automatic stay for derivatives and repo counterpartiesCorrect
  3. CThe requirement of court approval before any asset sale
  4. DThe priority of equity holders over senior creditors

Explanation

Qualified financial contracts such as repos and derivatives are exempt from the automatic stay, so counterparties can terminate, net and liquidate collateral at once. This removes the pause that other creditors face and can trigger fire sales. The automatic stay itself applies to ordinary creditors, not to these contracts.

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