Expert Committee Submits its Report on Determining Methodology for Fixing National Minimum Wage, Ministry of Labour and Employment Click here

The Bilateral Netting of Qualified Financial Contracts Act, 2020

From Arthapedia
(Difference between revisions)
Jump to: navigation, search
(Created page with "<p>[http://www.ibbi.gov.in/Law/IBC%202016.pdf Insolvency and Bankruptcy Code] represents the legal and institutional mechanisms in India for dealing with debt defaultof companie...")
 
 
(One intermediate revision by one user not shown)
Line 1: Line 1:
<p>[http://www.ibbi.gov.in/Law/IBC%202016.pdf Insolvency and Bankruptcy Code] represents the legal and institutional mechanisms in India for dealing with debt defaultof companies  and limited liability entities, partnership firms and individuals.However, this does not automatically  cover default by financial service providers, unless notified by the Government.</p>
+
<p>Financial institutions and other financial intermediaries employ a number of risk mitigating mechanisms to reduce their risk exposure in their business transactions. The two most commonly used mechanisms are collateral arrangements and close-out netting<sup class="reference"> [[#ref1|[1]]]</sup>. These risk-mitigating mechanisms ensure that that risk arising from one party’s exposure to the solvency of the counterparty and to fluctuations in the value of the relevant assets are tightly controlled. Both mechanisms help the financial institutions to manage the counterparty risk as well as market risk. </p>
 +
 
 +
<p>There are two types of netting<sup class="reference"> [[#ref2|[2]]]</sup>. Payment netting refers to a process coalescing offsetting cash flow obligations between two parties into a single net payable or receivable in the usual course of business when both parties are solvent. [https://www.unidroit.org/overview-netting Close-out netting] is applicable to transactions between a defaulting firm and a non-defaulting firm. Close-out netting refers to a process involving termination of obligations with a defaulting party under a bilateral contract and subsequent merging of positive (receivable) and negative replacement values (payables) into a single net payable or receivable. The policymakers and international standard setting bodies have strongly recommended that legal framework for close-out netting must be established in the interest of [http://arthapedia.in/index.php?title=Financial_Stability financial stability]. The Financial Stability Board recommended as part its recommendations of the [https://www.fsb.org/work-of-the-fsb/policy-development/effective-resolution-regimes-and-policies/key-attributes-of-effective-resolution-regimes-for-financial-institutions/ Key Attributes of Effective Resolution Regimes for Financial Institutions]<sup class="reference"> [[#ref3|[3]]]</sup> that the legal framework governing set-off rights, contractual netting and collateralisation agreements should be clear, transparent and enforceable during a crisis or resolution of firms, and should not impede the effective implementation of resolution measures. Several global standards on insolvency law prescribe specific recommendations for the enactment of safeguards for financial contracts, particularly netting<sup class="reference"> [[#ref4|[4]]]</sup> and collateral arrangements to provide certainty to financial transactions and to maintain financial stability. The recommendations number 101-107 of the [https://uncitral.un.org/sites/uncitral.un.org/files/media-documents/uncitral/en/05-80722_ebook.pdf UNCITRAL Guide on Insolvency] emphasise<sup class="reference"> [[#ref5|[5]]]</sup> that netting and set-off may reduce the potential for systemic risk that could negatively affect the stability of financial markets by providing certainty with respect to the rights of parties to a financial contract when one of those parties defaults.</p>
 +
<p>Therefore, while there is a resounding support by the policymakers to close-out netting, the empirical evidence clearly indicates that there are solid reasons for this support. That is why most of the major countries for OTC derivatives market (50 countries) have established a legal framework for bilateral netting of financial agreements. The statistics published each year by the Bank for International Settlements (BIS) consistently show that close-out netting reduces the gross mark-to-market value of outstanding derivative transactions across all asset classes. For example, netting benefit, measured as the difference between gross mark-to-market value and credit exposure after netting, was over 79 per cent (USD 9.2 trillion) as of December 31, 2019<sup class="reference"> [[#ref6|[6]]]</sup>. The mark-to-market exposure of all OTC derivatives globally is reduced from USD 11.4 trillion to USD 2.4 trillion as a result of close-out netting. So, the netting benefit is not inconsequential.</p>
 +
 
 +
<p>The present legal framework in India does not allow netting of bilateral financial contracts {over-the-counter derivatives (OTC)}, while it is allowed for multilateral transactions. Therefore, the financial contracts intermediated through the central counter-parties, like clearing corporations, get the benefit of netting under the Payment and Settlement Systems Act, 2007 and under the securities laws. However, in the absence of any legally unambiguous basis for finality of bilateral netting for certain entities, the Reserve Bank of India (RBI) currently does not allow bilateral netting of mark-to-market values arising on account of OTC derivatives, forcing the banks to provide capital on gross basis for such derivatives, trapping large amount of capital unproductively with banks. However, calculating the regulatory capital on gross-exposure basis is inefficient over calculating that on net-exposure basis.</p>
 +
<p>Further, due to the emerging global consensus of imposition of margins for non-centrally cleared OTC derivatives, it has become necessary for India to implement exchange of margin system for OTC derivatives to improve stability and resilience of our financial system. However, imposition of margin on gross basis would make the OTC derivative market very costly and may cause serious disruption in its functioning, as such derivatives account for a significant part of the total derivatives market. Recognising that a law on bilateral netting would be a significant enabler for efficient margining, RBI has announced, in its Statement on Developmental and Regulatory Policies dated February 6, 2020, introduction of margin system for OTC derivatives in line with the emerging international norms to mitigate the systemic risk and strengthen the resilience of the financial sector. Allowing for the close-out netting could result in substantial savings for the banks and other financial institutions in two ways, i.e., (i) by decreasing the regulatory capital requirements for OTC derivatives; and (ii) by decreasing margin requirements for non-centrally cleared derivatives (NCCDs).</p>
 +
<p>Recognising that a legal framework for bilateral netting would provide substantial benefits to the financial sector, the Government announced in  [https://www.indiabudget.gov.in/ Budget 2020-21] that a legislation for bilateral Netting would be introduced in Parliament. Accordingly, the Bilateral Netting of Qualified Financial Contracts Bill, 2020 (“the Bill”) was introduced in the [http://loksabhaph.nic.in/Legislation/NewAdvsearch.aspx Lok Sabha] in the Monsoon Session of 2020 and was passed by both the Houses of Parliament. The Bill is based on the similar legal frameworks of other countries and global standard setting bodies. The Bill, inter alia, provides for,-</p>
 +
<p>1. designation of any bilateral agreement or contract or transaction, or type of contract, as qualified financial contract by the Central Government or any of the regulatory authorities as specified in the First Schedule;</p>
 +
<p>2. enforceability of netting of a qualified financial contract;</p>
 +
<p>3. invocation of close-out netting which 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;</p>
 +
<p>4. determination of the net amount payable under the close-out netting in accordance with the terms of the netting agreement entered into by the parties and in the absence of the netting agreement, where the parties to a qualified financial contract fail to agree on the sum with regard to the net amount payable under the close-out netting, determination of such sum through arbitration; and</p>
 +
<p>5. imposing of certain limitations on powers of administration practitioner such that the close-out netting would be final and irreversible and any insolvency proceedings would not affect the netting.</p>
 +
 
 
<p>&nbsp;</p>
 
<p>&nbsp;</p>
<p><strong>Background</strong></p>
+
<p>The law would permit bilateral netting of qualified financial contracts and would result in substantial benefits for the financial sector. These are as follows.</p>
<p>[http://pib.nic.in/newsite/PrintRelease.aspx?relid=110730 A Bankruptcy Law Reforms Committee] (BLRC) was set up on  22.8.2014 for providing an entrepreneur friendly legal bankruptcy framework for  India as announced in the [http://indiabudget.nic.in/ Budget Speech (2014-15)], Para 106 - &ldquo;Entrepreneur friendly legal bankruptcy  framework will also be developed for SMEs to enable easy exit…&rdquo;   Further, the Government identified  Bankruptcy Law Reform as a key priority for improving the ease of doing  business and had announced in the [http://indiabudget.nic.in/ Budget Speech 2015-16]that a comprehensive Bankruptcy Code, meeting global  standards and providing necessary judicial capacity, will be brought in fiscal  2015-16.</p>
+
<p>1. It is estimated that the capital savings and fund-saving by banks - post the enactment of the Bill and the imposition of margin system would be around Rs. 58000 crore for 2020. The reduction in counterparty credit risk exposure through netting will strengthen resilience of the financial sector. Considering that banks may face capital erosion due to stress in the real sector at times, any capital optimisation would enable them to discharge their financing function effectively for the productive sectors of the economy.</p>
<p>The BLRC[http://finmin.nic.in/reports/BLRCReportVol1_04112015.pdf submitted its Report and draft Bill] on 4.11.2015. Based on this, as well as  public/stakeholder consultation, the Insolvency and Bankruptcy Code, 2015 was finalized. The Bill was introduced in the Lok Sabha on 21.12.2015and referred to a Joint  Committee of Parliament. The Joint Committee of Parliamentsubmitted its report  on 28.4.2016.[http://www.ibbi.gov.in/Law/IBC%202016.pdf The Insolvency and Bankruptcy Code, 2016] was passed by Parliament on 11.5.2016  and published in the Official Gazette on 28.5.2016. </p>
+
<p>2. The law would help in rationalising prices of the derivative products on account of optimisation of capital use and would enable banks to increase credit limits for counterparties and clients.</p>
 +
<p>3. The law would further develop the corporate bond market by energising the credit-default swap market.</p>
 +
<p>4. The law would facilitate business exits by improving recovery mechanism for the qualified financial contract when counterparty to such a contract defaults. </p>
 +
 
 
<p>&nbsp;</p>
 
<p>&nbsp;</p>
<p><strong>Objective  of the Code</strong></p>
+
<p>In view of the above, it may be stated that this important legislative reform of the Government would not only provide substantial saving to the financial sector and strengthen the financial stability, it would also help in further developing the financial market. </p>
<p>The new law aims  to consolidate the laws relating to insolvency of companies and limited  liability entities (including limited liability partnerships and other entities  with limited liability), unlimited liability partnerships and individuals, contained in a number of legislations<sup class="reference"> [[#ref1|[1]]]</sup>,  into a single legislation and provide for their reorganisation and resolution  in a time bound manner for maximisation of value of their assets. Such  consolidation will provide for a greater clarity in law and facilitate the application of consistent and coherent provisions to different stakeholders  affected by business failure or inability to pay debt. </p>
+
 
 
<p>&nbsp;</p>
 
<p>&nbsp;</p>
<p><strong>Benefits of the Code</strong></p>
+
<p><strong>Status</strong></p>
<p>The law will  thus promote entrepreneurship, availability of credit and balance the interest  of all stakeholders. The vision of the new law  is to encourage entrepreneurship and innovation. It is true that some business  ventures will fail, but such failures will be handled rapidly and swiftly.  Entrepreneurs and lenders will be able to move on, instead of being bogged down  with decisions taken in the past. The Code empowers the operational creditors  (workmen, suppliers etc.) also to initiate the insolvency resolution process  upon non-payment of dues. In order to develop the credit market in India, in  case of liquidation, financial debts owed to unsecured creditors have been kept  above the Government&rsquo;s dues in the list of priorities (waterfall).</p>
+
<p>[http://egazette.nic.in/WriteReadData/2020/222064.pdf The Bilateral Netting of Qualified Financial Contracts Act, 2020]<sup class="reference"> [[#ref7|[7]]]</sup> has received the assent of the President on the September 28, 2020 and was published in the Gazette of India Extraordinary on the September 28, 2020. The Act has been [http://egazette.nic.in/WriteReadData/2020/222198.pdf brought into force on October 1, 2020]<sup class="reference"> [[#ref8|[8]]]</sup>.</p>
<p>Facilitating early resolution and exit is  as important as facilitating investment. The essential idea of the new law is  that when a corporate entity defaults on its debt, control shifts from the  shareholders / promoters to a committee of creditors, who have 180 days  (extendable by 90 days in deserving cases) to evaluate proposals from various  players about resuscitating the company or taking it into liquidation. When  decisions are taken in a time-bound manner, there is a greater chance that the  corporate entity can be saved as a going concern, and the productive resources  of the economy (labour and capital) can be put to the best use. This is in  complete departure from regime under the [http://lawmin.nic.in/ld/P-ACT/2004/The%20Sick%20Industrial%20Companies%20(Special%20Provisions)%20Repeal%20Act,%202003.pdf Sick Industrial Companies (Special Provisions) Act, 1985  (SICA)] where there were delays  leading to destruction of the value of the firm.  </p>
+
<p>The Insolvency and Bankruptcy Code is  thus a comprehensive and systemic reform, which will give a quantum leap to the  functioning of the credit market. It would take India from among relatively  weak insolvency regimes to becoming one of the world's best insolvency regimes.  It lays the foundations for the development of the corporate bond market, which  would finance the infrastructure projects of the future.  The passing of this Code and implementation of the same will give a big boost  to ease of doing business in India.</p>
+
<p>&nbsp;</p>
+
<p><strong>Salient Features of the Code</strong></p>
+
<p>The Code separates commercial aspects of  the insolvency proceedings from judicial aspects. While <strong>Insolvency Professionals</strong> (IPs)<sup class="reference"> [[#ref2|[2]]]</sup> will  deal with commercial aspects such as management of the affairs of the corporate  debtor, facilitating formation of committee of creditors, organising their  meetings, examination of the resolution plan, etc., judicial issues will be  handled by proposed Adjudicating Authorities (National Company Law Tribunal /  Debt Recovery Tribunal)<sup class="reference"> [[#ref3|[3]]]</sup>. One  more important institution created under the Code is the &lsquo;<strong>Information Utility&rsquo;</strong><sup class="reference"> [[#ref4|[4]]]</sup> which  would store financial information and data and terms of lending in electronic  databases. This would eliminate delays and disputes about facts when default  does take place. </p>
+
<p>The  Code also provides a fast track insolvency resolution process for corporates  and LLPs. This will be an enabler for start-ups and small and medium  enterprises (SMEs) to complete the resolution process in 90 days (extendable to  45 days in deserving cases). </p>
+
<p>The Code also addresses the important  issue relating to cross border insolvency by providing the enabling mechanism  on the subject. The Government, at an appropriate time, may come out with a  detailed framework for cross border insolvency.</p>
+
<p>The code proposes setting up a regulator to  register and regulate the functioning of insolvency professional agencies,  insolvency professionals and information utilities. </p>
+
<p>&nbsp;</p>
+
<p><strong>Present  Status of Implementation</strong></p>
+
<p>The Insolvency and  Bankruptcy code was spearheaded by Ministry of Finance. However, the  administration of the Insolvency and  Bankruptcy Code, 2016 has been transferred to the [http://www.mca.gov.in/ Ministry of  Corporate Affairs] w.e.f. 29th  July,2016 by amending the GoI (Allocation of Business) Rules, 1961. The  Ministry of Corporate Affairs has been taking necessary steps for  implementation of the Code in terms of creating the required institutional  architecture.[http://www.ibbi.gov.in/ The Insolvency and Bankruptcy Board of India]which regulates the IPs Insolvency professional  agencies and information utilities was established on 1.10.2016 and has started  issuing relevant Regulations. The institutional architecture of IPsand National Company Law  Tribunaland National Company Law Appellate Tribunalhas been created for starting the insolvency and  bankruptcy process. The regulations for corporate insolvency process have been  notified and came into force with effect from 1.12.2016. SICA has been repealed  and therefore the adjudicating authorities of [http://www.bifr.nic.in/ Board for  Industrial and Financial Reconstruction] and Appellate Authority for Industrial and Financial Reconstruction  have been abolished with effect from 1.12.2016 paving the way for starting the  resolution process under the Insolvency and Bankruptcy Code, 2016, starting  with corporate insolvency process.  </p>
+
  
  
 +
<span class="small_footernote" id="ref1"> 1. UNIDROIT.  2013. Principles on Close-Out Netting.  </span>
  
<span class="small_footernote" id="ref1"> 1. The recovery proceedings by  creditors, either through the Contract Act or through special laws such as the  Recovery of Debts due to Banks and Financial Institutions Act, 1993 and the  Securitization and Reconstruction of Financial Assets and Enforcement of  Security Interest Act, 2002, has not had desired outcomes. Similarly, action  through the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA) and  the winding up provisions of the Companies Act, 1956 have neither been able to  aid recovery for lenders nor restructuring of firms. Laws dealing with  individual insolvency, the Presidency Towns Insolvency Act, 1909 and the  Provincial Insolvency Act, 1920, were almost a century old. This has hampered  the confidence of the lender and development of the credit markets in India. Resultantly, credit by banks is the largest component of the credit market in  India and corporate bond market has not yet developed to the desired level.  </span>
+
<span class="small_footernote" id="ref2"> 2. Mengle, D. 2010. ISDA Research Notes: The Importance of Close-Out Netting. International Swaps and Derivatives Association.</span>
 
+
<span class="small_footernote" id="ref2"> 2. Insolvency professionals would  handle the commercial aspects of insolvency resolution process. Insolvency  professional agencies will develop professional standards, code of ethics and will  be the first level regulator for insolvency professionals members leading to  development of a competitive industry for such professionals. </span>
+
 
    
 
    
<span class="small_footernote" id="ref3"> 3. The [https://drt.gov.in/ Debt  Recovery Tribunal] (DRT) is  the Adjudicating Authority with jurisdiction over individuals and unlimited  liability partnership firms. Appeals from the order of DRT shall lie to the  Debt Recovery Appellate Tribunal (DRAT). [http://nclt.gov.in/ The National Company Law Tribunal  (NCLT)] shall be  the Adjudicating Authority with jurisdiction over companies, limited liability  entities. Appeals from the order of NCLT shall lie to the National Company Law  Appellate Tribunal (NCLAT).NCLAT shall be the appellate authority to hear  appeals arising out of the orders passed by the Regulator in respect of  insolvency professionals or information utilities.(The National Company Law Tribunal  has been constituted w.e.f. 1 June,2016 and by virtue of Section 466(1) of  Companies Act,2013, the [http://clb.nic.in/ Company Law Board] stands dissolved.) </span>
+
<span class="small_footernote" id="ref3"> 3. Financial Stability Board. 2014. Key Attributes of Effective Resolution Regimes for Financial Institutions.  </span>
 
    
 
    
<span class="small_footernote" id="ref4"> 4. The Act proposes for insolvency information utilities which would  collect, collate, authenticate and disseminate financial information from  listed companies and financial and operational creditors of companies. An  individual insolvency database is also proposed to be set up with the goal of providing information on insolvency status of individuals. </span>
+
<span class="small_footernote" id="ref4"> 4. Op.cit. 1. </span>
 +
 
 +
<span class="small_footernote" id="ref5"> 5. United Nations Commission on International Trade Law. 2005. UNCITRAL Legislative Guide on Insolvency Law. </span>
 +
 
 +
<span class="small_footernote" id="ref6"> 6. International Swaps and Derivatives Association. 2020. Key Trends in the Size and Composition of OTC Derivatives Markets in the Second Half of 2019. </span>
  
 +
<span class="small_footernote" id="ref7"> 7. The Bilateral Netting of Qualified Financial Contracts Act, 2020. Accessed on September 29, 2020 at [http://egazette.nic.in/WriteReadData/2020/222064.pdf egazette.nic.in/WriteReadData/2020/222064.pdf]. </span>
  
==References==
+
<span class="small_footernote" id="ref8"> 8. The commencement notification dated October 1, 2020.Accessed on October 8, 2020 at [http://egazette.nic.in/WriteReadData/2020/222198.pdf http://egazette.nic.in/WriteReadData/2020/222198.pdf]. </span>
*[http://finmin.nic.in/reports/BLRCReportVol1_04112015.pdf Report] of the [http://pib.nic.in/newsite/PrintRelease.aspx?relid=110730 The Bankruptcy Law Reforms Committee] (BLRC)
+
*Press release of Ministry  of Finance dated [http://pib.nic.in/newsite/PrintRelease.aspx?relid=145309 12  May 2016]
+
  
  
==Also  See==
 
*[http://arthapedia.in/index.php?title=Insolvency,_Resolution,_Bankruptcy_and_Liquidation Insolvency, Resolution, Bankruptcy  and Liquidation]
 
*[http://www.arthapedia.in/index.php?title=Resolution_of_Financial_Firms Resolution of Financial Firms]
 
  
 
==Contributed by==
 
==Contributed by==
Line 47: Line 51:
  
  
[[Category:concepts|InsolvencyandBankruptcyCode2016]]
+
[[Category:concepts|TheBilateralNettingofQualifiedFinancialContractsAct,2020]]

Latest revision as of 14:57, 13 October 2020

Financial institutions and other financial intermediaries employ a number of risk mitigating mechanisms to reduce their risk exposure in their business transactions. The two most commonly used mechanisms are collateral arrangements and close-out netting [1]. These risk-mitigating mechanisms ensure that that risk arising from one party’s exposure to the solvency of the counterparty and to fluctuations in the value of the relevant assets are tightly controlled. Both mechanisms help the financial institutions to manage the counterparty risk as well as market risk.

There are two types of netting [2]. Payment netting refers to a process coalescing offsetting cash flow obligations between two parties into a single net payable or receivable in the usual course of business when both parties are solvent. Close-out netting is applicable to transactions between a defaulting firm and a non-defaulting firm. Close-out netting refers to a process involving termination of obligations with a defaulting party under a bilateral contract and subsequent merging of positive (receivable) and negative replacement values (payables) into a single net payable or receivable. The policymakers and international standard setting bodies have strongly recommended that legal framework for close-out netting must be established in the interest of financial stability. The Financial Stability Board recommended as part its recommendations of the Key Attributes of Effective Resolution Regimes for Financial Institutions [3] that the legal framework governing set-off rights, contractual netting and collateralisation agreements should be clear, transparent and enforceable during a crisis or resolution of firms, and should not impede the effective implementation of resolution measures. Several global standards on insolvency law prescribe specific recommendations for the enactment of safeguards for financial contracts, particularly netting [4] and collateral arrangements to provide certainty to financial transactions and to maintain financial stability. The recommendations number 101-107 of the UNCITRAL Guide on Insolvency emphasise [5] that netting and set-off may reduce the potential for systemic risk that could negatively affect the stability of financial markets by providing certainty with respect to the rights of parties to a financial contract when one of those parties defaults.

Therefore, while there is a resounding support by the policymakers to close-out netting, the empirical evidence clearly indicates that there are solid reasons for this support. That is why most of the major countries for OTC derivatives market (50 countries) have established a legal framework for bilateral netting of financial agreements. The statistics published each year by the Bank for International Settlements (BIS) consistently show that close-out netting reduces the gross mark-to-market value of outstanding derivative transactions across all asset classes. For example, netting benefit, measured as the difference between gross mark-to-market value and credit exposure after netting, was over 79 per cent (USD 9.2 trillion) as of December 31, 2019 [6]. The mark-to-market exposure of all OTC derivatives globally is reduced from USD 11.4 trillion to USD 2.4 trillion as a result of close-out netting. So, the netting benefit is not inconsequential.

The present legal framework in India does not allow netting of bilateral financial contracts {over-the-counter derivatives (OTC)}, while it is allowed for multilateral transactions. Therefore, the financial contracts intermediated through the central counter-parties, like clearing corporations, get the benefit of netting under the Payment and Settlement Systems Act, 2007 and under the securities laws. However, in the absence of any legally unambiguous basis for finality of bilateral netting for certain entities, the Reserve Bank of India (RBI) currently does not allow bilateral netting of mark-to-market values arising on account of OTC derivatives, forcing the banks to provide capital on gross basis for such derivatives, trapping large amount of capital unproductively with banks. However, calculating the regulatory capital on gross-exposure basis is inefficient over calculating that on net-exposure basis.

Further, due to the emerging global consensus of imposition of margins for non-centrally cleared OTC derivatives, it has become necessary for India to implement exchange of margin system for OTC derivatives to improve stability and resilience of our financial system. However, imposition of margin on gross basis would make the OTC derivative market very costly and may cause serious disruption in its functioning, as such derivatives account for a significant part of the total derivatives market. Recognising that a law on bilateral netting would be a significant enabler for efficient margining, RBI has announced, in its Statement on Developmental and Regulatory Policies dated February 6, 2020, introduction of margin system for OTC derivatives in line with the emerging international norms to mitigate the systemic risk and strengthen the resilience of the financial sector. Allowing for the close-out netting could result in substantial savings for the banks and other financial institutions in two ways, i.e., (i) by decreasing the regulatory capital requirements for OTC derivatives; and (ii) by decreasing margin requirements for non-centrally cleared derivatives (NCCDs).

Recognising that a legal framework for bilateral netting would provide substantial benefits to the financial sector, the Government announced in Budget 2020-21 that a legislation for bilateral Netting would be introduced in Parliament. Accordingly, the Bilateral Netting of Qualified Financial Contracts Bill, 2020 (“the Bill”) was introduced in the Lok Sabha in the Monsoon Session of 2020 and was passed by both the Houses of Parliament. The Bill is based on the similar legal frameworks of other countries and global standard setting bodies. The Bill, inter alia, provides for,-

1. designation of any bilateral agreement or contract or transaction, or type of contract, as qualified financial contract by the Central Government or any of the regulatory authorities as specified in the First Schedule;

2. enforceability of netting of a qualified financial contract;

3. invocation of close-out netting which 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;

4. determination of the net amount payable under the close-out netting in accordance with the terms of the netting agreement entered into by the parties and in the absence of the netting agreement, where the parties to a qualified financial contract fail to agree on the sum with regard to the net amount payable under the close-out netting, determination of such sum through arbitration; and

5. imposing of certain limitations on powers of administration practitioner such that the close-out netting would be final and irreversible and any insolvency proceedings would not affect the netting.

 

The law would permit bilateral netting of qualified financial contracts and would result in substantial benefits for the financial sector. These are as follows.

1. It is estimated that the capital savings and fund-saving by banks - post the enactment of the Bill and the imposition of margin system would be around Rs. 58000 crore for 2020. The reduction in counterparty credit risk exposure through netting will strengthen resilience of the financial sector. Considering that banks may face capital erosion due to stress in the real sector at times, any capital optimisation would enable them to discharge their financing function effectively for the productive sectors of the economy.

2. The law would help in rationalising prices of the derivative products on account of optimisation of capital use and would enable banks to increase credit limits for counterparties and clients.

3. The law would further develop the corporate bond market by energising the credit-default swap market.

4. The law would facilitate business exits by improving recovery mechanism for the qualified financial contract when counterparty to such a contract defaults.

 

In view of the above, it may be stated that this important legislative reform of the Government would not only provide substantial saving to the financial sector and strengthen the financial stability, it would also help in further developing the financial market.

 

Status

The Bilateral Netting of Qualified Financial Contracts Act, 2020 [7] has received the assent of the President on the September 28, 2020 and was published in the Gazette of India Extraordinary on the September 28, 2020. The Act has been brought into force on October 1, 2020 [8].


1. UNIDROIT. 2013. Principles on Close-Out Netting.

2. Mengle, D. 2010. ISDA Research Notes: The Importance of Close-Out Netting. International Swaps and Derivatives Association.

3. Financial Stability Board. 2014. Key Attributes of Effective Resolution Regimes for Financial Institutions.

4. Op.cit. 1.

5. United Nations Commission on International Trade Law. 2005. UNCITRAL Legislative Guide on Insolvency Law.

6. International Swaps and Derivatives Association. 2020. Key Trends in the Size and Composition of OTC Derivatives Markets in the Second Half of 2019.

7. The Bilateral Netting of Qualified Financial Contracts Act, 2020. Accessed on September 29, 2020 at egazette.nic.in/WriteReadData/2020/222064.pdf.

8. The commencement notification dated October 1, 2020.Accessed on October 8, 2020 at http://egazette.nic.in/WriteReadData/2020/222198.pdf.


Contributed by

Dr. Shashank Saksena (IES 1987)

Personal tools
Variants
Actions
Navigation
Concepts
Share Tools
Toolbox
Translate