Netting and insolvency : a critical analysis

Abstract

Netting provides a means for market participants to manage their credit risk exposures. Netting and related collateral agreements have the effect of reducing the credit risk exposures of derivative market participants. The international adoption of dose-out netting protections (together with associated collateral protections) and the continued evolution of these protections has been concomitant with the rapid expansion of derivative markets themselves. These protections have undoubtedly contributed to the size, liquidity, pricing and risk management characteristics of the market. Thus, this thesis aims at providing those persons involved in the financial services sphere as well as the public in general, with information as far as the new legislation in force is concerned. The new law of Set-off and Netting on Insolvency was a long awaited measure in our legislation as will be examined further on. Chapter 1 explores the definition and fundamental general principles of set-off as delineated in our Civil Code. Local court judgments give a better understanding of the concept of set-off and what it entails by focusing on the circumstances of each particular case. Importance is also given to the problems which used to take place prior to the new legislation in force and which used to be encountered by creditors in case of insolvency proceedings. Among these problems, reference is made to the general rule of bankruptcy blocks all forms of set-off except for legal set-off and the pro-creditor and pro-debtor approaches to set-off by various jurisdictions. Chapter 2 starts off by mentioning Directive 98/26/EC and by tracing its historical origins. This is the central chapter on set-off and netting because apart from defining these terms in detail it focuses on other important terms such as close-out netting. Also, a thorough analysis of the provisions of the new legislation is made in this chapter to stress the relevance of having a netting agreement among the parties involved in financial transactions. It is named 'solution to the problem ' because it makes us understand how effective a netting mechanism can be and how significant it is for member states to ensure that netting of financial transactions is legally enforceable and binding on third parties, even in the event of insolvency proceedings. 1 Chapter 3 is somewhat different from the preceding chapters since it pays special attention to the economic implications of a netting agreement. The different types of economic sectors in our country are introduced in this chapter. It also analyses in detail the types of financial risk with special reference to systemic risk and the payment system. After identifying the risk element, this chapter gives us reasons why netting is essential to operate and why it is needed. The advantages of a netting arrangement are also discussed. I conclude by opining that a necessary change has been made within the financial legislation sphere and I argue whether netting is justifiable or not and whether it is acceptable or not.