THE BILATERAL NETTING OF THE QUALIFIED FINANCIAL CONTRACTS ACT, 2020

[Mr. M. GOVINDARAJAN]

Introduction

The Bilateral Netting of the Qualified Financial Contract Bill, 2020 was introduced in Lok Sabha on 14.09.2020.  The Bill seeks to provide a legal framework for bilateral netting of qualified financial contracts which are over the counter derivatives contracts.    The Bill became an Act and notified on 28.09.2020.  The Bilateral Netting of the Qualified Financial Contracts Act, 2020 (‘Act’ for short) is  to ensure financial stability and promote competitiveness in Indian financial markets by providing enforceability of bilateral netting of qualified financial contracts and for matters connected therewith or incidental thereto.  The Act came into effect from 01.10.2020.  The provisions of this Act shall have effect, notwithstanding anything inconsistent therewith contained in any other law for the time being in force or any instrument having effect by virtue of any such law.

Applicability of the Act

The provisions of this Act shall apply to a qualified financial contract entered into on a bilateral basis between qualified financial market participants, either under a netting agreement or otherwise, where at least one of such participants shall be an entity regulated by an authority specified in the First Schedule, as detailed below-

• The Reserve Bank of India;
• The Securities and Exchange Board of India;
• The Insurance Regulatory and Development Authority of India;
• The Pension Fund Regulatory and Development Authority of India;
• The International Financial Services Centres Authority.

Netting

Section 2(1)(j) of Act defines the term ‘netting’ as 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.

Netting agreement

 Section 2(1)(k) of the Act defines the expression ‘netting agreement’ as an agreement that provides for netting, and includes,--

•  an agreement that provides for the netting of amounts due under two or more netting agreements; and
• a collateral arrangement relating to or forming part of a netting agreement.

Close out netting

Section 2(1)(e) of the Act defines the expression ‘close out netting’ as a process involving termination of obligations under a qualified financial contract with a party in default and subsequent combining of positive and negative replacement values into a single net payable or receivable as set out in section 6.

Administration

Section 2(1)(a) defines the term ‘administration’ as proceedings of the nature of placing under administration and includes imposition of moratorium, reorganization, winding up, liquidation (including any compulsory winding up procedure or proceeding), insolvency, bankruptcy, composition with creditors, receivership, conservatorship or any proceedings of nature similar to or resulting in any of the foregoing, initiated or commenced under any law for the time being in force, against a qualified financial market participant.

Administration practitioner

Section 2(1)(b) defines the expression ‘administration practitioner’ as the liquidator, receiver, trustee, conservator, resolution professional or any other person or entity, by whatever name called, which administers the affairs of a party subject to administration under any law for the time being in force.

Qualified financial contracts

The International Financial Services Centres Authority designated, defines the qualified financial contracts vide Notification No. IFSCA/2020-21/GN/008, dated 02.02.2021.  The Qualified financial contract means any privately negotiated bilateral financial contract executed outside a stock exchange, including any terms and conditions incorporated by reference in any such financial contract, pursuant to which payment or delivery obligations that have a market price are due to be performed at a certain time or within a certain period of time and includes-

• a currency, cross-currency or interest rate swap;
• a basis swap;
• a spot, forward or other foreign exchange transaction;
• a cap, collar or floor transaction;
• a commodity swap;
• a forward rate agreement;
• a currency or interest rate option;
• a credit derivative, such as a credit default swap;
• a spot, forward or other securities or commodities transaction;
• a securities contract, including a margin loan and an agreement to buy, sell, borrow or lend securities, such as a securities repurchase or reverse repurchase agreement, a securities lending agreement or a securities buy/sell-back agreement, including any such contract or agreement relating to mortgage loans, interests in mortgage loans or mortgage-related securities, a money market instrument;
• a commodities contract, including an agreement to buy, sell, borrow or lend commodities, such as a commodities repurchase or reverse repurchase agreement, a commodities lending agreement or a commodities buy/sell-back agreement;
• a collateral arrangement;
• an agreement to clear or settle securities transactions or to act as a depository for securities;
• any other agreement, contract or transaction similar to any agreement, contract or transaction referred to in above paras with respect to one or more reference items or indices relating to, without limitation interest rates, currencies, commodities, interest, or precious metals; or
• any other facility or agreement, contract or transaction designated as a qualified financial agreement by the Authority from time to time in addition to those listed above.

Enforceability of netting

 Section 5(1) of the Act provides that netting of the qualified financial contract shall be enforceable-

• where such contract is entered into with a netting agreement, in accordance with the terms of the netting agreement;  the inclusion of any non-qualified financial contract in a netting agreement shall not invalidate the enforceability of netting of qualified financial contract under such agreement; or
• where such contract is entered into without a netting agreement, in accordance with the provisions of section 6.

Section 5(2) provides that a qualified financial contract shall not be void and shall be deemed never to have been void or unenforceable by reason of any law for the time being in force.

Section 5(3) provides that close-out netting of a qualified financial contract shall be enforceable against an insolvent party, and, wherever applicable, against a guarantor or other person providing collateral or security for a party and shall not be affected or stopped or otherwise limited by-

• the appointment of, or any application for the appointment of, an administration practitioner, or
• applicability of any provision of law relating to administration, or
• any other provision of law that may be applicable to an insolvent party.

Section 5(4) provides that where a qualified financial market participant is subject to administration, then notwithstanding,-

• any stay, injunction, avoidance, moratorium or similar proceedings or any other order of a court, tribunal or authority, or
• any order of adjudication or dissolution or winding up or resolution or insolvency, or
• any rule, regulation, scheme, direction, guideline, circular or order,

made or issued under any law for the time being in force, close-out netting shall be applicable and nothing contained therein shall affect the validity of close-out netting under this Act.

Section 5(5) provides that the amount payable or other claims to be made in accordance with the close-out netting under this Act shall be final, irrevocable and binding upon the parties to a qualified financial contract and upon the administration practitioner, of the party in administration.

Invocation of close of netting (Sec.6)

• 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;
• 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 parties to a qualified financial contract shall ensure that all obligations owed by one party to another party under a qualified financial contract are reduced to or replaced with single net amount which has the following effect,-

1. the termination, liquidation or acceleration of any present or future payment or delivery rights or obligations arising under or in connection with any one or more qualified financial contracts to which a netting agreement applies;
2. the calculation or estimation of a close-out value, market value, liquidation value or replacement value in respect of each right and obligation or group of rights and obligations terminated, liquidated or accelerated under clause (a) and the conversion of each such value into a single currency; and
3. the determination of the net balance of the values calculated under clause (b), whether by operation of set-off or otherwise, giving rise to the obligation of one party to pay an amount equal to the net balance to the other party.

• the realization, appropriation or liquidation of collateral, and unless otherwise agreed by the parties, the realization, appropriation or liquidation of collateral under a collateral arrangement shall take effect without any requirement of prior notice to, or consent from, any party, person or entity.

Applicability of close-out netting

Close-out netting shall be applicable to all qualified financial market participants who are parties to a qualified financial contract notwithstanding anything to the contrary contained in any law specified in the Second Schedule or any other law pursuant to which any qualified financial market participant has been incorporated, constituted or is regulated.  The laws specified in the second schedule are-

• The Reserve Bank of India Act, 1934;
• The Insurance Act, 1938;
• The Banking Regulation Act, 1949;
• The State Bank of India Act, 1955;
• The Securities Contracts (Regulation) Act, 1956;
• The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970.
• The Regional Rural Bank Act, 1976;
• The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980;
• The Securities and Exchange Board of India Act, 1992.
• The Foreign Exchange Management Act, 1999.
• The Insurance Regulatory and Development Authority Act, 1999;
• The Payment and Settlement Systems Act, 2007;
• The Companies Act, 2013;
• The Pension Fund Regulatory and Development Authority 23 of 2013. Act, 2013;
• The Insolvency and Bankruptcy Code, 2016.

Determination of net amount

Section 7 of the Act provides that where parties to the qualified financial contract enter into a netting agreement, the net amount payable under the close-out netting shall be determined in accordance with the terms of the netting agreement entered into by the parties.   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, such sum shall be determined through arbitration.

Limitation on powers of administration practitioner

The administration practitioner shall not render or seek to render ineffective,--

• 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; or
• any payment or delivery obligation incurred by the insolvent party and owing to the non-insolvent party under or in connection with a netting agreement on the grounds of it constituting a preference including a fraudulent preference or a transfer for undervalue, including during a suspect period by the insolvent party to the non-insolvent party.