5th Meeting of the CESAME2 Group European Commission, DG Internal Market and Services Tuesday, 2 March 2010, Centre Borschette, Brussels Focus on Barrier 16 : Netting Edward Murray, Partner, Allen & Overy LLP
Netting overview ISDA and the development of netting legislation 2006 ISDA Model Netting Act ISDA s proposal for a European netting instrument Joint EFMLG/ISDA proposal for a European Netting Directive Proposal to UNIDROIT for a Convention on Netting in Financial Services Netting and resolution of banks and investment firms
Risk reduction through close-out netting Bank for International Settlements, November 2009 As of June 30, 2009, total notional amount of all outstanding OTC derivatives was $604.6 trillion The total mark-to-market value of outstanding OTC derivatives was $25.4 trillion (4.2% of notional amount) After applying close-out netting, total credit exposure was $3.7 trillion (0.6% of notional amount), a reduction of 85.2% from mark-to-market value U.S. Office of the Comptroller of the Currency, 3 rd Quarter 2009 As of September 30, 2009, close-out netting reduced counterparty credit exposure at U.S. banks by 89.7% 64% of the credit exposure that remained after netting was covered by collateral All banks, 1998-2009 US banks, 1996-2009
ISDA netting legislation initiatives ISDA promotion of netting legislation since 1987 in various jurisdictions Status of Netting Legislation monitor on the ISDA website at: http://www.isda.org/docproj/stat_of_net_leg.html 2006 ISDA Model Netting Act Recent and current initiatives in: Russia, Kazakhstan, Ukraine, Poland, Czech Republic, Slovakia, Slovenia, Hungary, Romania, Croatia, Pakistan, UAE, Bahrain, Qatar, Colombia, Peru, Mauritius, South Africa, South Korea, China, Indonesia, Malaysia, Nigeria UK impact of the Banking Act 2009 on netting against UK banks and building societies ISDA work co-ordinated through the ISDA Financial Law Reform Committee (staff contact: Peter Werner)
2006 ISDA Model Netting Act A model netting statute, prepared and published by ISDA - available from the ISDA website at http://www.isda.org/docproj/model_netting.html Originally published in 1996, a revised version was published in 2002 2006 Model Netting Act published in March 2006 and republished with slight revisions in October 2007 Sets out core principles and includes provisions relating to gaming laws, financial collateral and multibranch netting Accompanied by a Memorandum on Netting Legislation (March 2006) Influence on, and use by, national legislators and regulators in various countries
ISDA proposal for a European instrument on close-out netting On-going dialogue with European Commission in formal and informal contacts on desirability of Europe-wide strengthening of netting Contractual Netting Directive (1994) and Financial Collateral Arrangements Directive (2002) dealt with netting but did not set out core principles ISDA proposal (2004) to the Commission s Securities Experts Group for a European instrument on close-out netting Securities Experts Group Report (May 2004) referred to need for minimum standards in this area ISDA comment letter (August 2005) on the Commission Green Paper on Financial Services Policy Renewed impetus in the context of the Commission s review of the Collateral Directive: ISDA comment letters of April and September 2006 Commission s Evaluation Report (December 2006) acknowledged desirability of action to strengthen close-out netting
Joint EFMLG-ISDA netting initiative European Financial Markets Lawyers Group (www.efmlg.org) raised strengthening close-out netting in Europe in its own responses to the Collateral Directive review in April 2006 Joint proposal for a European directive on netting: to promote convergence of netting regimes in Europe to provide guidance to newer and potential future Member States on core principles to support netting Was not included in recent amendment of Collateral Directive Could be a stand-alone Directive Current status of Close-out Netting in the EU (see separate handout)
Possible elements of a European netting directive Scope: all legal and natural persons broad and flexible scope of transactions, to encompass foreseeable market developments bilateral close-out netting and multilateral netting, for example, under multilateral trading facilities inclusion of non-netting transaction should not affect netting as to the nettable transactions multibranch netting should be addressed Definitions should be consistent, where possible, with the Collateral Directive No formalities for creation or enforcement of a netting arrangement
Possible elements of a European netting directive (2) Close-out netting should be unaffected by commencement of insolvency proceedings Covered transactions should not be void or voidable under gaming, wagering or gambling laws Payments and deliveries under a netting agreement should not be vulnerable to insolvency avoidance if the netting agreement as a whole is otherwise valid Close-out netting should not be subject to stay or freeze Conflict of laws: party autonomy should be respected as far as possible
Proposal to UNIDROIT for a netting convention International Institute for the Unification of Private Law (UNIDROIT) treaty organisation based in Rome, founded in 1926 63 member states develops conventions and other instruments to promote harmonisation of substantive private law proposed UNIDROIT Convention on intermediated securities, with optional collateral chapter www.unidroit.org Triennial Work Programme 2009-2011
ISDA netting proposal to UNIDROIT 21 April 2009: Governing Council meeting Development of an international convention on close-out netting Core rules for netting and related issues Should not be limited to derivatives but should cover financial exposures more broadly (eg spot forex, securities trading etc) Potential benefits: increase number of countries where netting works common set of international norms for netting extend benefits of netting to emerging markets create a level playing field improve financial market efficiency and reduce system risk Importance of coordination with regional efforts, such as the possible development of a European netting directive 10-12 May 2010: Governing Council meeting
Netting and resolution of banks and investment firms Financial crisis has intensified interest in and development of special resolution regimes for banks and investment firms UK experience Banking Act 2009 and partial property transfer power Safeguards Order to protect netting, set-off, title transfer collateral, security, financial market infrastructure (clearing and settlement) Current consultation on investment firm resolution (post-lehman) Dunfermline Building Society Basel Committee Cross-Border Bank Resolution Group consultative document (September 2009) Recognition of systemic importance of netting (see, e.g., para 104) Proposal for temporary suspension of right to close out Commission Communication on Cross-Border Crisis Management in the Banking Sector (October 2009) Recognises systemic importance of credit risk mitigation techniques, including close-out netting, and related financial market infrastructure Recognises need to protect such techniques and infrastructure from effect of early intervention or resolution powers
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