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The Parliament clears the “Bilateral Netting of Qualified Financial Contracts Bill, 2020”, with an intent to guarantee financial stability as well as encourage competitiveness in Indian financial markets. A legal outline is provided in the Bill to facilitate two counterparties in a bilateral financial contract to counterbalance claims against each other to settle on a single net payment obligation, unpaid from one counterparty to other in the case of non-payment.
“In the absence of a legal framework for bilateral netting, banks are forced to measure credit exposure to the counterparty for over the counter derivative contracts based on a gross basis and not net basis.
This situation significantly increases credit risk exposure and systemic risk in the financial market in the event of default of counterparty, besides trapping a significant amount of capital unproductively by banks. An unambiguous legal framework for enforceability of close-out netting would reduce credit exposure of banks and other financial institutions,” said the MoS Finance, Anurag Thakur.
Significant Features of the Bill
What is netting?
Netting means “determination of net claim or obligations after setting off or adjusting all the claims or obligations based or arising from mutual dealings between the parties to qualified financial contracts and includes close-out netting”.
Qualified Financial Contracts are those which are notified by the relevant authorities that may be RBI, SEBI etc.).
The parties to a Qualified Financial Contracts shall make sure that all responsibilities possessed by one party to the other, under the contract, are reinstated through a single net sum.
Close-out netting may be commenced by a notice given by one party to the other party of a qualified financial contract upon the occurrence of an event of default with respect to the other party or a termination event that may, in certain circumstances, occur automatically as specified in the netting agreement.
Provided that where any one of the parties to a netting agreement is subject to administration, then no prior notice to or consent of the party in insolvency, winding up, liquidation, administration or resolution proceeding, or to the administration practitioner of such proceeding, shall be required.
The net amount claim under the close-out netting is determined:
- As per the netting agreement agreed by the parties, or
- By an agreement between the parties on the sum in respect to the net claim, or
- By arbitration
Applicability of the Bill
Bill’s provisions are applicable to Qualified Financial Contracts, between two qualified financial market participant, where, at least, one party is a body regulated by the particular authorities such as RBI, PFRDA, SEBI, IFSCA or the IRDAI.
Qualified financial market participant
The relevant authority may, by notification, specify any entity regulated by it, as a qualified financial market participant to deal in qualified financial contracts.
Enforceability of netting
Netting of qualified financial contracts shall be imposed by an agreement of netting, entered into by contract between the parties. In netting agreement inclusion of non-qualified financial contracts will not nullify the enforceability of netting of qualified financial contracts under the agreement.
Close-out netting: Enforceability
Enforceability of Close-out netting is against:
- An insolvent party
- Against the person providing collateral
- A party positioned under administration, notwithstanding any injunction, moratorium, insolvency, resolution, winding up or order of a court-issued under any law.
Limitations on powers of administration practitioner
The administration practitioner can’t deliver ineffectively, any transfer, substitution or exchange of cash, collateral or any other interests under or in connection with a netting agreement between the insolvent party and the non-insolvent party to a qualified financial contract