Netting is a crucial protection against default. Close out netting applies on the occurrence of an event of default. All transactions under single master agreement are accelerated and terminated and a single net sum payable by one party to the other. Accordingly, insolvency is a risk only in respect of the net amount due and not the gross amounts due.
The Netting of Financial Contracts Act in Ireland allows for a bilateral close-out netting. The legislation was extended by ministerial order and by the MiFID Act 2007.
The ISDA Master Agreement is a netting agreement and is commonly used. The European Directive on Settlement Finality 1998 seeks to reduce systematic risk in the context of payment on security settlement. It provides that insolvency proceedings shall not have retrospective effects on rights and obligations of participants. Such retrospectivity was a feature of many State’s insolvency proceedings.
The rights of a participant or Central Banks in payment and collateral security systems are not to be affected by the failure of the insolvency laws of the State to recognise the validity of the collateral security. Collateral security may be realised for the purpose of satisfying rights of other participants. Where securities are recorded in the register account of a centralised depository system in a state, the rights of the collateral taker in relation to the securities are governed by the law of that State. This seeks to resolve risks and problems regarding the law applicable.
The Directive provides for netting of payments on security settlements and protects collateral given. It seeks to limit systematic risk in payment. Payment orders and transfer orders for payment and securities may not be revoked or invalidated.
The Collateral Directive was adopted in 2002. It applies to a range of financial institutions, public banks, public authority, settlement agents and clearinghouses and to entities other than natural persons but including unincorporated firms and partnerships that are party to an arrangement with one of the above institutions.States may opt out in respect of the latter category (counterparties to transactions).
Formal requirements in relation to the creation of financial collateral are to be abolished. However, the provision of collateral may be required to be evidenced in writing.
Article 6 provides that title transfer, quasi-securities are not to be recategorised as securities. Title transfer involves purchase and repurchase by way of collateral so that it is obliged to return equivalent collateral but not the same collateral. In addition, it is free to use the securities as it wishes.
Many jurisdictions including common law jurisdictions recategorised situations that are in substance security as security transactions. This is not permissible in this context.
Close-out and netting arrangements are protected from insolvency law. The above mentioned opt out does not apply in Ireland. The regulations apply to financial collateral, arrangements evidenced in the writing. Registration of security requirements are removed.
The Finality Directive sought to deal with issues regarding the law of the place where the interest was registered. The law governing the proprietary aspects of the transfer is determined by the reference to the location of the relevant intermediary maintaining the account recording the securities.
The Hague Convention on certain rights in respect of securities held with an intermediary seeks to establish a method by which the location of the relevant intermediary can be determined for them. It sets out principles applicable. The law expressly agreed is the first point provided the intermediary has an office in the chosen State that regularly maintains security accounts.
If there is no choice of law clause but the agreement expressly and unambiguously states that the relevant intermediary entered into an account through a particular office, the law applicable is the law of the location of that office provided it regularly maintains security accounts. If this does not yield an answer, the place of incorporation or the organisation of the relevant intermediary is looked at.
Notwithstanding the opening of insolvency proceedings under another State, the law applicable under the Convention governs in relation to events that have occurred before the opening of those insolvency proceeding. The Convention has been accepted by a small number of States only. It has not yet been adopted by the EU.
Over-the-counter derivatives are those that are not traded in a regular market. They became increasingly the focus of regulators concerns following the financial crisis. The objectives of the major countries have been to secure that standardised OTC derivative contracts should be traded on the exchange or electronic trading platforms, where appropriate and cleared through central counter parties.
Derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements.
The European Market Infrastructure Regulation on OTC derivatives, central counterparties and trade repositories provides for improved transparency by way of mandatory reporting of all OTC derivatives to trade repositories to enable regulators and participants to assess the volume and risk of the derivatives market.
It provides for a reduction of counterparty risk and operational risk by clearing of standardised OTC derivatives through CCPS. There are risk management rules applicable to contracts that qualify for clearing.
There is increased standardisation of OTC derivatives. All clearing members are required to have margin requirements in the context of collateralisation of all OTC transactions through central counterparties. There are common rules for central counterparties including minimal capital requirements for CCPS, margin calls on a inter-daily basis, maintenance of margins in segregated accounts but not to be held in secured and liquid investments.
Certain risk mitigation techniques are to provide for all uncleared OTC derivatives. Financial and nonfinancial counterparties transacting over-the-counter derivatives which are not cleared through a CCPS are subject to new obligations including collateral requirements, timely confirmation and the risk management procedures.
The central counterparty clearing system seeks to protect market participants in the event of market default by a counterparty. It seeks to prevent parties in the event of market default by a counterparty. By trading through a central counterparty, parties are no longer exposed to each other’s credit risk. The counterparty requires margin to be posted in the event of default by a clearing member. Counterparties should be able to move trade positions and margin to another clearing member.
There are a number of different clearing houses, different jurisdictions including the Chicago Mercantile Exchange, ICE Clear Europe, ICE Trust, Eurex, L