Anyone who knows ISDA knows we care passionately about close-out netting. It’s one of the bedrocks of good risk management, and results in drastically lower credit exposures between counterparties. Being able to squash the positive and negative values of multiple trades between a pair of counterparties into a single net payment from one to the other means a default is likely to be less disruptive to the financial system.
We’ve long campaigned for netting certainty, and we’ve worked with authorities across the globe to help them draft legislation on the enforceability of close-out netting. Off the back of that work, we’ve so far commissioned netting opinions in more than 60 countries, with others in the pipeline.
That work continues, and we’re making progress in a number of areas – including in China, where we recently published a netting opinion for certain Chinese sovereign entities and an update to our China netting memorandum.
The netting opinion states that certain agencies that act on behalf of the government – the People’s Bank of China, the Ministry of Finance and the State Administration of Foreign Exchange – are not subject to any bankruptcy regime in China. That means the legal issues relating to bankruptcy stays, an administrator’s ‘cherry-picking’ right and statutory set-off under China’s Enterprise Bankruptcy Law are not applicable. They would therefore not affect the enforceability of contractual early termination and netting provisions in the ISDA Master Agreements held by these entities.
The updated netting memo, meanwhile, builds on an earlier release in 2014, and provides more detail on bankruptcy proceedings for China’s commercial banks, securities companies and insurance firms. It also includes an updated discussion on changes that should be made to the ISDA Master Agreement when ’automatic early termination’ is specified as applying to a Chinese counterparty, so all outstanding transactions under the agreement are terminated automatically if there’s a bankruptcy petition relating to that counterparty. Alongside a collateral memo we published in 2016, it goes a long way to helping firms build a picture about the state of play and the issues they need to consider when trading with Chinese entities that are subject to the Enterprise Bankruptcy Law.
These are all important steps to the ultimate goal: to have legislation in China that recognizes the enforceability of close-out netting. To that end, we’ll be taking the next step in June, when we host a seminar in Beijing on the benefits of close-out netting.
We believe the development of close-out netting legislation in China would create more certainty for financial institutions, and encourage more participation. Once these elements are introduced, the conditions will be in place for China’s derivatives markets to further develop and flourish, providing end users with a means of managing their interest rate and foreign currency exposures.