Asset managers such as Pacific Investment Management Co. look set to lose hard-fought protections against the cost of a bank failure, when the Federal Reserve on Tuesday proposes yet another rule aimed at preventing taxpayer bailouts for financial firms.

The draft regulation to be voted on by the central bank's governing board would force changes to derivatives and other esoteric financial contracts of the type that destabilized broader financial markets after the 2008 collapse of Lehman Brothers Holdings Inc.

The proposal, if adopted, would see investment firms lose certain contractual rights to terminate financial deals with big banks—rights that essentially have allowed them to claim payments in the event of a bankruptcy filing without having to stand in line with other creditors. Big banks already agreed to waive such rights in 2014, but asset managers and hedge funds have resisted the change because it threatened to put them in a weaker contractual position.

While the broad outlines have been under discussion for years, key details were announced for the first time Tuesday. One potentially controversial provision could make the rules retroactive by requiring changes to existing contracts as soon as a bank and its counterparties enter into any new contracts..

"Pimco believes that this retroactive removal of a client's existing rights in exchange for the ability to continue to trade is an overreach and removes a very valuable protection designed to help reduce risk," William De Leon, global head of portfolio risk management at Pimco, said before the rule proposal was released publicly.

Tuesday's rule would govern contracts between banks and hedge funds as well as large asset managers, a rare example of the central bank indirectly regulating investment firms that don't fall under its direct authority.

Officially, the rule is voluntary, and firms would have the choice not to rewrite their contracts. However, fund managers and their clients are likely to sign on because they have few alternatives. The big U.S. banks overseen by the Fed are the largest providers of some derivatives. Big banks are also considered to be safer and less likely to fail than non-banks or smaller firms.

The proposal would effectively ask the investment firms to waive their rights to terminate derivatives and other relevant contracts for at least 48 hours after a bank bankruptcy filing.

Regulators have said the move will help ensure a big bank bankruptcy won't get so messy that it destabilizes the whole financial system. When Lehman filed for bankruptcy, regulators were scrambling to contain the damage in part because the firm's trading partners had the right to terminate certain financial contracts and receive payments instantly from the firm after it had failed.

Lehman's trading partners terminated thousands of derivatives known as swaps, effectively sending money—in the form of cash and collateral such as bonds—flying out Lehman's door to counterparties who were owed money by the failed investment bank. That complicated matters for authorities, who were simultaneously trying to unwind the firm's financial obligations in an orderly way.

Regulators also worry that similar early-termination provisions in other types of financial contracts, such as repurchase agreements, would allow a failing bank's counterparties to seize bonds and sell them at fire-sale prices to raise cash, which can drive down prices across financial markets and spread a panic. Fire sales spread contagion after the Lehman bankruptcy.

In pushing for the freeze in derivatives termination rights, U.S. authorities are moving to prevent a replay of that 2008 meltdown.

The two-day delay is aimed at giving regulators time to stabilize the remaining, healthy parts of a cratering firm using other bailout-prevention tools. These include new requirements that banks issue debt that could be converted to capital in a crisis. Fed officials on Tuesday told reporters that by allowing regulators time to stabilize the bank, the new rule would help bank counterparties who otherwise might be exposed to a failing firm.

Regulators in other countries, including the U.K. and Germany, have already set out their versions of the rule. The International Swaps and Derivatives Association, a trade association, has created a protocol for investment firms to adhere to the changes.

The changes are likely to be opposed by some in the asset management industry. The Managed Funds Association, a hedge fund trade group, published a paper last fall suggesting the rules would actually harm financial stability by encouraging investors to exit trades at the first sign of trouble, lest they be hemmed in by the termination restrictions after a bankruptcy filing.

Investment firms see the rule as a backdoor way to rewrite how derivatives are treated under the bankruptcy code—a policy change that they say should be left to Congress, the paper said.

Fed officials said they envisioned the rule as a sort of new normal that would make big-bank counterparties subject to the same delay, and therefore less likely to panic. They noted that under the rule, a hedge fund could still terminate its contract if its direct counterparty went bankrupt. The rule applies to scenarios like Lehman, where the parent company files for bankruptcy but subsidiaries that deal with clients remain open. Asset managers also would retain the right to terminate the contract in the event that the bank failed to make a required payment or delivery of collateral, officials said.

Asset managers have also said they have a duty to their clients not to give up any legal protections.

Before drafting the rule, regulators first asked asset managers and hedge funds to follow banks in waiving voluntarily their contractual rights to make it easier to work through the failure of a large bank, according to people familiar with those talks. MFA, the hedge fund trade group, met with the Fed to discuss the ramifications of early termination rights on Oct. 20, 2015.

The rule applies to the eight U.S. banks considered by regulators to be "systemically important" to the global economy, as well as the U.S. operations of foreign banks that have that label. The Fed is taking comments on the proposal before finalizing it, and the rule would take effect more than a year after it becomes final.

Write to Ryan Tracy at ryan.tracy@wsj.com and Katy Burne at katy.burne@wsj.com

(END) Dow Jones Newswires

May 03, 2016 14:15 ET (18:15 GMT)