Close-out Netting Can Be Guaranteed in Resolution: CBIRC

Recent bankruptcies by FIs have “fully proved” that close-out netting can be guaranteed in the resolution stage, a CBIRC official said at ASIFMA’s China Capital Markets Week.

The CBIRC (China Banking and Insurance Regulatory Commission) has said it has made considerable progress in addressing legal and regulatory ambiguities relating to close-out netting.

Close-out netting is the process of terminating obligations under a contract with a defaulting party and combining their obligations into a single net payable or receivable.  It enables parties to mitigate the credit risk associated with derivatives and means a default is less likely to be disruptive to the financial system, while also enabling more efficient use of capital by financial institutions.

Foreign financial institutions have long sought clarity on the lack of legal certainty and judicial recognition on close-out netting in China. The issue is said to have impeded capital market development in the country.

Speaking at ASIFMA’s China Capital Markets Week on Wednesday (21 April), senior CBIRC official Li Lixia pointed to revisions made to China’s enterprise bankruptcy law, the commercial bank law, and the banking supervision law in recent years – saying each has strengthened the validity of close-out netting in bankruptcy proceedings.

In addition, the draft futures law submitted to the NPC (National People’s Congress) for deliberation has clear provisions on close-out netting, and the Supreme Court is also in favour of closed-out netting, she said.

Li noted the release of a revised draft of the commercial bank law by the PBOC (People’s Bank of China) in October 2020 – which included a new chapter on bank resolution, indicating that bankruptcy applications by financial institutions must be approved by regulatory authorities.

According to Li, such bankruptcy and resolution cases approved by regulators in recent years – including those of Baoshang Bank and Anbang Group  – have “fully proved” that close-out netting can be guaranteed in the resolution stage.

“In the process of resolution, the outstanding contracts cleared by the central counterparty were terminated in advance, and netted in accordance with the clearing agreement,” she said, adding that “there is no possibility that … a counterparty may not be able to exercise the right to close out netting” and that “the contractual rights of a non-defaulting party are fully protected.”

Still, Li said regulators will follow up with legislative progress, and in due course consider releasing “policy interpretation” on the issue of close-out netting.

She urged foreign banks and other financial institutions operating in China to communicate with their overseas parent banks, home authorities and legal industry to promote the concept of close-out netting between Chinese and foreign banks.

“We have learned from international markets to establish and improve the market mechanism and derivatives trading framework, including close-out netting, which could cut transaction costs, improve transaction efficiency and reduce systemic risk,” Li said.

“Our goal is not only to promote market prosperity, but also to improve the market infrastructure, and ensure the market is developing with compliance and reasonableness.”

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