The new protocols, which would initially cover only large banks including JPMorgan Chase & Co. and Goldman Sachs Group Inc., would be applied retroactively to contracts already in place, according to the people.

The revision of the contracts should be finished “within the next few weeks,” Nick Sawyer, a spokesman for ISDA, said in a statement. He declined to provide details.

Under the U.S. bankruptcy code, derivatives including swaps are among the few financial instruments exempt from the “stay,” or pause, that keeps creditors of a failed firm from immediately collecting what they're owed. If a bank entered bankruptcy, its swap counterparties could move to seize collateral.

Such a rush would make an orderly bankruptcy impossible, according to recent statements by the Federal Reserve and Federal Deposit Insurance Corp. The two regulators are responsible for supervising the annual living-will plans that banks must develop under the 2010 Dodd-Frank Act. In August, the regulators rejected living wills from 11 of the largest U.S. and foreign banks, telling the firms to simplify their legal structures and address the bankruptcy exemption for swaps.

While any change in the bankruptcy code would need to be made by Congress, parties in swaps deals would have to abide by the terms of their private contracts.

Liquidation Process

Bloomberg News earlier reported the possible addition of a stay to standard swaps contracts in the event of a government-initiated liquidation of a bank. How the stays would apply in U.S. bankruptcies had been unresolved, as swap dealers expressed concern about losing their place at the front of the creditors' line. Regulators used the living-will process to press the industry to come up with a solution on its own.

Regulators have said a pause in the collection of swaps collateral could give a firm enough time to re-capitalize and avoid the kind of panic that followed the 2008 failure of Lehman Brothers Holdings Inc. They theorize that having a credible plan for unwinding failed banks would help end the perception by some market participants that governments will bail out firms that are “too big to fail.”

ISDA, backed by swaps dealers such as Goldman Sachs, JPMorgan, and Deutsche Bank AG, sets the worldwide standards for derivatives—complex financial instruments whose value is tied to another asset, such as a loan or stock.

Regulators and central bankers from the U.S., U.K., and other countries have been negotiating for months with the industry to finish a deal before a mid-November Group of 20 summit in Brisbane, Australia.

Meanwhile, Congress has been exploring other options. Last month, the House Judiciary Committee passed a bipartisan bill meant to revise bankruptcy laws to ease the winding-down of financial firms. A similar bill has been introduced by Senate Republicans. Such efforts so far haven't gained much traction in a divided Congress.

This week, House Financial Services Committee Chairman Jeb Hensarling, a Texas Republican, said the U.S. banking agencies are dodging “both congressional deliberation and agency notice and comment” by dealing directly with the industry.

Fiduciary Duty

Regulators in the U.S. and Europe have also been examining how they can mandate use of the new contracts beyond the biggest banks, according to people familiar with the discussions.

“A consequence of this effort is that, in effect, regulators want hedge funds—and their investors—to lose rights that they have negotiated under industry contracts to terminate such contracts with a defaulting counterparty,” said Stuart Kaswell, general counsel of the Managed Funds Association, a hedge-fund trade group, in an August statement.

Sawyer, the ISDA spokesman, said the industry expects regulators to “impose new regulations in their jurisdictions that will promote broader adoption of the stay provisions.”

The Financial Stability Board, a global group of regulators, suggested as much in a statement on its website this week.

“Contractual solutions have limitations and therefore may not be considered a substitute for statutory regimes in the longer term,” the group said in the statement. “Any contractual solution binds only the parties that agree to it.”

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