Legislation establishing a legal scheme to handle the failure of a counterparty to a derivatives transaction will likely be introduced as part of a new bankruptcy bill in the House this week, a move that could ease mortgage lenders’ ability to hedge interest-rate risk and to securitize assets.

Washington sources said the bill is expected to contain a provision that would better isolate the special purpose vehicle in a securitization from bankruptcies via a safe harbor. The provision would clarify that asset-backed and mortgage-backed securities structured with junior tranches do not give a debtor the right to take the whole asset, disrupting the cash flow to the investor. The Bond Market Association enthusiastically endorses this provision.

But despite a consensus that the legislation is necessary and bipartisan support, its chances for passage, either promptly or even later this year, remain cloudy. Insiders said the credit card industry and its supporters in Congress, realizing the importance of the provision, want to link it to the omnibus bankruptcy legislation they are pushing.

The bill is driven by potential problems to the financial system posed by the near failure last fall of Long-Term Capital Management, a hedge fund, according to sources. LTCM was involved in all types of complex derivatives transactions, and market players worried that its failure would have created a domino effect stemming from the inability of mortgage lenders and other financial institutions to close derivatives transactions, and so disrupted the market.

Sources said the bill would impose a means-test on those filing for bankruptcy, a concept opposed by liberals in Congress and the Clinton administration.

The primary provisions of the bill would strengthen language in the bankruptcy code and the Federal Deposit Insurance Act, protecting the enforceability of termination and close-out netting, and relative provisions of certain financial agreements and transactions under the two laws.