Understanding: Significance and Provisions of Bilateral Netting of Qualified Financial Contracts Act, 2020.
Author: Saloni Jain
The Ministry of Finance in its notification dated 1st October 2020 rationalized all the provisions of the Bilateral Netting of Qualified Financial Contracts Act, 2020, to ensure the financial sector with stability and to promote competitiveness in the Indian market. The act had been bought by keeping the question of how non-centrally cleared derivative contracts underline the risk from the various lessons learned in the 2008 global financial crisis.
The act was drafted considering ‘International Swaps and Derivative Associations’ and nearly 50 countries are using this legal framework. The act covers trades which are negotiated bilaterally, credit derivatives, commodity derivatives.
- The act would reduce the capital burden and credit exposure of banks with other financial institutions from gross to net exposure which ultimately lowers the cost of the transaction and overall systematic risk.
- The act passes the way to develop a corporate default swap market and provides the corporate bond market to get energized with the buoyant bond market.
- The money locked up in banks not available for the starved economy will get liquidated and lubricated resulting reduction in hedging cost thereby encouraging over-the-counter derivatives.
- It identifies the right to consider a margin exchanged under credit documents like title transfer arrangement.
- This legislation supersedes the Insolvency and Bankruptcy Code (IBC) which gives a better recovery mechanism for the existing business for their financial contract.
- Domino effect- the bilateral netting act comes as a domino effect in the Indian Derivative market and similar. This effect is witnessed in the draft of the variation margin direction released by the Reserve Bank of India relating to public consultation.
Bilateral netting- Netting refers to two counterparties dealing in a bilateral financial contract to offset claims against each other to get a net amount payable or receivable from one party to another.
Qualified Financial Contract (QFC)- means a qualified financial contract notified by the relevant authority (Reserve Bank of India, Securities, and Exchange Board of India, Insurance Regulatory and Development Authority of India, Pension Fund Regulatory and Development Authority, or International Financial Services Centers Authority). Central government may, by the notification shall not include; a)contracts between certain parties or containing certain terms from being designated as QFCs, b)contract having a multilateral basis with the provisions of the Payment and Settlement Systems Act, 2007 the Securities Contracts (Regulation) Act, 1956.
Qualified financial market participant: The relevant authority may, by notification, designate an entity regulated by it as qualified financial market participants to deal with QFCs. This would include entities such as non-banking finance companies (NBFCs), insurance companies and pension funds.
The act will apply between two the qualified financial market participants having a financial qualified contract where one or the other party is an entity regulated by RBI, SEBI, IRDAI, PFRDA, or IFSCA.
Enforceability of Bilateral Netting
The act is enforceable when there is a contract between parties including a netting agreement of one or more QFC. The inclusion of non-financial contract will not invalidate the enforceability.
Close-Out Netting Arrangement (termination of the obligations arising out of QFC)
Invocation can be initiated when there is a default by either of the party or the netting agreement gives the right to one or more the parties to terminate the transaction.
Enforceability of Close-Out Netting
- against an insolvent party
- against a guarantor or the person providing collateral security
- against a party placed under administration, notwithstanding any injunction, moratorium, insolvency, resolution, winding up, or order of a court-issued under any law.
Net Amount for Close-Out Netting
The amount payable at the time of closeout netting will be according to the netting agreement and in case of absence of netting agreement then sum shall be followed by arbitration.
Limitations on Powers of Administration Practitioner
The administrative practitioner cannot render ineffective;
- Any transfer, substitution, or exchange of cash, collateral, or any other interests in connection with a netting agreement between the insolvent party and the non-insolvent party to a QFC.
- Any payment or delivery obligation constituting fraudulent preference or a transfer for undervaluing, including during a suspect period by the insolvent party to the non-insolvent party.
Power to amend Schedules
The Central Government by notification can amend the list of authorities and acts.
Power to Remove Difficulties
The Central Government may, by order, published in the Official Gazette may remove difficulties not inconsistent with the provisions within three years from the date of commencement of the act.