Q'EST-CE QUE C'EST "NETTING"?

Outline of Bank Supervisory Netting Issues

by Ernest T. Patrikis, First Vice President

Joyce M. Hansen, Deputy General Counsel and Senior Vice President

Nikki M. Poulos, Attorney

September 25, 1996

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I. INTERNATIONAL USE

A. Since the publication of the Lamfalussy Report in 1990, the legal status of netting has noticeably improved in most of the G-10 countries, in particular due to new legislation. Specifically, Belgium, Canada, France, Germany, the Netherlands, Sweden, Switzerland, the United Kingdom, and the U.S. have enacted new legislation to ensure the enforceability of netting arrangements or close-out mechanisms. New legislation on netting is envisaged in Luxembourg. In Japan, no change in legislation is envisaged for the time being since netting under existing rules for set-off is considered to have a sufficient legal basis.

B. The bankruptcy law of some G-10 countries includes a "zero hour" rule, prohibiting payments of an insolvent entity with retroactive effects as from "zero hour" on the day of commencement of an insolvency proceeding. The effect of such a retroactive rule is that the receiver is either permitted or required to seek reimbursement of any payment made on that day by the insolvent debtor and, therefore, may or must challenge the results of netting arrangements through which such payments have been made. Some of these countries, such as Belgium and France, have enacted specific provisions to overcome the zero hour rule as far as interbank payments are concerned.

C. Outside of the G-10 there are other efforts underway in the area of netting. For example, this month (August 1996) the Reserve Bank of New Zealand released a discussion paper on netting, where it has proposed changes to the bankruptcy law to ensure that netting agreements are enforceable in the event of bankruptcy. The Reserve Bank of New Zealand has also released a discussion paper on payments finality in insolvency, where it has proposed amendments to their insolvency laws to overcome their zero-hour rule.

D. U.S. Netting Legislation -- Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")

1. Title IV of FDICIA: Netting contracts are enforceable, even in the event of the bankruptcy or insolvency of one of the parties.

2. FDICIA netting provisions apply to bilateral netting contracts between financial institutions and multilateral netting contracts among clearing organization members.

3. "Netting contract" -- any netting agreement between or among financial institutions governed by Federal or State law that provides for netting present or future payment obligations or payment entitlement (including liquidation or close-out values). The term covers agreements to net payments as well as to net and close out over-the-counter and other transactions.

4. "Netting contract" also includes the rules of a clearing organization. "Clearing organization" is an organization that

(i) provides clearing, netting, or settlement services for its members and either

(a) limits its membership to financial institutions and other clearing organizations or

(b) is a registered clearing agency under the Securities and Exchange Act of 1934) or

(ii) performs clearing functions for a contract market designated pursuant to the Commodity Exchange Act.

5. "Financial institution" is a depository institution, a securities broker or dealer, a futures commission merchant, and any other institution as determined by the Board. The Board of Governors has expanded this definition by Regulation EE to include a broader range of financial market participants. Regulation EE provides that any entity, domestic or foreign, that meets certain tests based on market activity would qualify as a financial institution under FDICIA.

6. Regulation EE "financial institution" definition:

a. entity will engage in financial contracts as a counterparty on both sides of one or more financial markets

b. must have had one or more financial contracts of a total gross dollar value of at least $1 billion in notional principal amount outstanding, or have had total gross mark-to-market positions of at least $100 million (aggregated across counterparties) in one or more financial contracts, on any day during the previous 15-month period with counterparties that are not its affiliates.

7. Most, if not all, dealers in the over-the-counter derivative and foreign exchange markets would qualify as financial institutions under either the statutory or regulatory definition.

8. Netting between dealers and their end-user customers, however, would not be covered by FDICIA unless the customers qualify as financial institutions under the statute or because of market activity as defined under Regulation EE.

9. In the event an entity does not meet the statutory or regulatory definition, the Board of Governors is authorized to make a case-by-case determination as to whether the entity is a financial institution under FDICIA. The Farm Credit System Banks, Sallie Mae, Fannie Mae, and certain participants of CHIPS have sought and received determinations from the Board of Governors that they qualify as financial institutions for purposes of the FDICIA netting provisions.

10. Recent Regulation EE amendment: Regulation EE was amended on January 19, 1996 to clarify that, for purposes of qualifying as a financial institution under Regulation EE, a person may represent that it is a financial market intermediary either orally or in writing. This amendment was intended to remove uncertainty in the financial markets as to the form of such representations.

E. BOARD OF GOVERNORS POLICY STATEMENT ON PAYMENT SYSTEM RISK REDUCTION

1. On December 21, 1994, the Board of Governors issued a policy statement on "Privately Operated Large Dollar Multilateral Netting Systems."

2. The scope of the policy statement is limited to multilateral netting systems that:

a. have 3 or more participants that net payments or foreign exchange contracts involving the U.S. dollar, and either

b. have, or are likely to have, on any day, settlements with a system-wide aggregate value of net settlement credits (or debits) larger than $500 million (in U.S. dollars and any foreign currencies combined); or

c. process payments or foreign exchange contracts, with a daily average stated dollar value, calculated over a twelve month period corresponding to the most recent fiscal year for the netting system, larger than $100,000.

3. A multilateral netting system which meets the above criteria is subject to the policy if

a. it is a State-chartered member of the Federal Reserve System;

b. any of its agent(s) or participants are State-chartered members of the System;

c. its participants' net positions are settled through a Federal Reserve settlement account;

d. its participants settle their net positions in the multilateral netting system through their individual Federal Reserve funds accounts or the Federal Reserve funds account of the settlement agent(s); or

e. one or more bank holding companies have an investment in the multilateral netting system.

4. The Board of Governors also reserves the right to apply the elements of this policy to any non-dollar system based, or operated, in the United States that engages in multilateral clearing or netting of non-dollar payments among financial institutions and that would otherwise be subject to this policy.

5. This policy does not apply to exchange-traded futures and options arrangements.

6. The Board's approach to privately operated large-dollar multilateral netting systems will be guided by the following minimum standards for such systems. These standards are identical to those set forth in the Lamfalussy Report with certain minor exceptions.

a. Netting systems should have a well-founded legal basis under all relevant jurisdictions.

b. Netting system participants should have a clear understanding of the impact of the particular system on each of the financial risks affected by the netting process.

c. Multilateral systems should have clearly-defined procedures for the management of credit risks and liquidity risks which specify the respective responsibilities of the netting provider and the participants. These procedures should also ensure that all parties have both the incentives and the capabilities to manage and contain each of the risks they bear and that limits are placed on the maximum level of credit exposure that can be produced by each participant.

d. Multilateral netting systems should, at a minimum, be capable of ensuring the timely completion of daily settlements in the event of an inability to settle by the participant with the largest single net debit position.

e. Multilateral netting systems should have objective and publicly-disclosed criteria for admission which permit fair and open access.

f. All netting systems should ensure the operational reliability of technical systems and the availability of backup facilities capable of completing daily processing requirements.

7. In order to satisfy the Lamfalussy Standards, the Board of Governors expects that individual large-dollar multilateral netting systems will utilize the following risk management measures or their equivalent:

a. require each participant to establish bilateral net-credit limits vis-a-vis each other participant in the system;

b. establish and monitor in real-time system-specific net debit limits for each participant;

c. establish real-time controls to reject or hold any payment or foreign exchange contract that would cause a participant's position to exceed the relevant bilateral and net debit limits;

d. establish liquidity resources, such as cash, committed lines of credit secured by collateral, or a combination thereof, at least equal to the largest single net debit position; and

e. establish rules and procedures for the sharing of credit losses among the participants in the netting system.

8. The Board of Governors will consider on a case-by-case basis alternative risk-management measures that provide for risk-management systems and controls that are equivalent to the five measures listed above.

9. Systems that were operating on December 21, 1994 are expected to comply fully with the policy statement by June 21, 1996. Systems established subsequent to December 21, 1994 are expected to comply fully with the policy statement without the benefit of a transition period.

F. Federal Deposit Insurance Corporation -- Definition of QFCs

1. The Federal Deposit Insurance Act ("FDI Act") provides special rules for the treatment of QFCs held by an insured depository institution in default for which the FDIC is appointed conservator or receiver. The FDI Act protects QFC counterparties by allowing for liquidation, termination, and netting of their agreements and trades. The FDI Act granted the FDIC rulemaking authority to determine whether any financial contracts not specifically included in the FDI Act should be so included and defined as qualified financial contracts ("QFCs").

2. In December 1995, the FDIC exercised this authority to add certain repurchase and swap agreements as QFCs.

3. This regulation expressly adds spot foreign exchange agreements as QFCs. The regulation also expressly adds as QFCs repurchase agreements that provide for the transfer of securities that are direct obligations of, or are fully guaranteed by, the central governments of the Organization for Economic Cooperation and Development ("OECD") countries.

II. CREDIT RISK AND USE IN CALCULATING CAPITAL REQUIREMENTS

A. Board of Governors -- capital adequacy --current exposure

1. On December 7, 1994, the Board of Governors amended its risk-based capital guidelines to recognize the risk-reducing benefits of qualifying bilateral netting contracts. Specifically, the effect of this final rule was to permit State-member banks and bank holding companies to net positive and negative mark-to-market values of interest- and exchange-rate contracts in determining the current exposure portion of the credit equivalent amount of such contracts to be included in risk-weighted assets. (The FDIC, OCC, and OTS adopted similar rules on December 28, 1994.) Exchange rate contracts with an original maturity of fourteen days or less and instruments traded on exchanges that require daily payment of variation margin are excluded from the risk-based ratio calculation.

2. The Basle Accord established a risk-based capital framework which was implemented for State-member banks and bank holding companies by the Board of Governors in 1989.

a. Under this framework, off-balance sheet interest-rate and exchange-rate contracts are incorporated into risk weighted assets by converting each contract into a credit equivalent amount. The amount is then assigned to the appropriate credit risk category according to the identity of the obligor or counterparty or, if relevant, the guarantor or the nature of the collateral.

b. The credit equivalent amount of an interest- or exchange-rate contract can be assigned to a maximum credit risk category of 50 percent.

c. The credit equivalent amount of a rate contract is determined by adding together the current replacement cost (current exposure) and an estimate of the possible increase in future replacement cost in view of the volatility of the current exposure over the remaining life of the contract (potential future exposure, also referred to as the add-on).

d. For risk-based capital purposes, a rate contract with a positive mark-to-market value has a current exposure equal to that market value. If the mark-to-market value of a rate contract is zero or negative, then there is no replacement cost associated with the contract and the current exposure is zero.

e. The original Basle Accord and the Board's guidelines provided that current exposure would be determined individually for each rate contract entered into by a banking organization; institutions generally were not permitted to offset, i.e., net, positive and negative market values of multiple rate contracts with a single counterparty to determine one current exposure relative to that counterparty.

3. For capital adequacy purposes, institutions can now net the positive and negative market values of interest- and exchange-rate contracts subject to a qualifying, legally enforceable, bilateral netting contract to calculate one current exposure for that netting contract. The net current exposure is determined by adding together all positive and negative market values of individual contracts subject to the netting contract. The net current exposure equals the sum of the market values if that sum is a positive value, or zero, if the sum of the market values is zero or a negative value.

4. To be able to net, institutions must have:

a. A written bilateral netting contract that creates a single legal obligation covering all included individual rate contracts and does not contain a walkaway clause (this is a provision in a netting agreement that permits a non-defaulting counterparty to make lower payments than it would make otherwise under the contract, or no payment at all, to a defaulter or to the estate of a defaulter, even if the defaulter or the estate of the defaulter is a net creditor under the contract);

b. Written and reasoned legal opinions stating that under the master netting contract the institution would have a claim to receive, or an obligation to pay, only the net amount of the sum of the positive and negative market values of included individual contracts if a counterparty failed to perform due to default, insolvency, bankruptcy, liquidation, or similar circumstances.

5. A legal opinion as generally recognized by the legal community in the United States can provide the necessary legal basis. A memorandum of law may be an acceptable alternative as long as it addresses all of the relevant issues in a credible manner. May be prepared by either an outside law firm or an institution's in-house counsel. Requirements are that it:

a. Must address all relevant jurisdictions; and

b. Must conclude with a high degree of certainty that, in the event of a legal challenge, the banking organization's claim or obligation would be determined by the relevant court or administrative authority to be the net sum of the positive and negative mark-to-market values of all individual contracts subject to the bilateral netting contract.

c. Must address netting contract's enforceability in (i) the law of the jurisdiction in which the counterparty is chartered, and if a branch is involved, the law of the jurisdiction in which the branch is located; (ii) the law that governs the individual contracts subject to the bilateral netting contracts; and (iii) the law that governs the bilateral netting contract.

6. Severability: Banking institutions may use bilateral netting contracts that include contracts with branches in jurisdictions that do not recognize netting. The Board of Governors does not endorse any specific method of calculating the net current exposures of such contracts. Instead, the Board maintains the position that banking institutions must obtain legal opinions supporting the result of the calculation they choose (i.e., the net). It is conceivable that illegality in one jurisdiction could unravel the whole contract. A legal opinion must address this issue.

7. The final rule permits, subject to certain conditions, institutions to take into account qualifying collateral when assigning the credit equivalent amount of a netting contract to the appropriate risk weight category in accordance with the procedures and requirements currently set forth in the Board's risk-based capital guidelines. The collateral must be legally available to cover the credit exposure of the netting contract in the event of default.

8. Banking organizations must maintain in their files appropriate documentation to support any particular capital treatment including netting of rate contracts. Appropriate documentation would include a copy of the bilateral netting contract, supporting legal opinions, and any related translations.

B. Board, OCC, FDIC -- risk-based capital -- future exposure

1. On September 5, 1995, the Federal bank supervisors issued a final rule amending their respective risk-based capital standards for banks and bank holding companies. This final rule implements a recent revision to the Basle Accord revising and expanding the set of conversion factors used to calculate the potential future exposure of derivatives contracts and recognizes the effects of netting arrangements in the calculation of potential future exposure for derivatives contracts subject to qualifying bilateral netting arrangements.

2. Future exposure:

a. The potential future exposure portion of the credit equivalent amount for rate contracts is an estimate of the additional credit exposure that may arise as a result of fluctuations in prices or rates.

b. The add-on for potential future exposure is estimated by multiplying the notional principal amount of the contract by a credit conversion factor that is determined by the remaining maturity of the contract and the type of contract. The credit conversion factors are set forth in a matrix.

c. Before this change, the add-on was calculated separately for each individual contract subject to a qualifying bilateral netting arrangement. These individual potential future exposures were added together to arrive at a gross add-on amount. The gross add-on amount was added to the net current exposure to determine one credit equivalent amount for the contracts subject to the qualifying bilateral netting arrangement.

3. The agencies' final rule amends the matrix of conversion factors used to calculate potential future exposure and permits institutions to recognize the effects of qualifying bilateral netting arrangements in the calculation of potential future exposure.

a. Higher conversion factors have been added to the matrix to address contracts with remaining maturities over five years and new conversion factors have been added to cover commodity-, precious metal- and equity-linked derivative transactions.

b. The agencies have adopted a methodology for calculating a reduction in the add-on amount for contracts subject to qualifying bilateral netting arrangements. Institutions should apply the following formula to adjust the amount of the add-on for potential future exposure:

ANET = (0.4 x AGROSS) + 0.6 (NGR x AGROSS)

where ANET is the adjusted add-on for all contracts subject to the netting arrangement, AGROSS is the amount of the add-on as calculated under the current agency standards, and NGR is the ratio of the net current exposure of the set of contracts included in the netting arrangement to the gross current exposure of those contracts.

c. Institutions with equity, precious metal, and other commodity contracts included in bilateral netting contracts can now include those types of transactions when determining the net current exposure for the bilateral netting contract and when determining potential future exposure.

d. Subject to certain conditions, institutions are permitted to take into account qualifying collateral when assigning the credit equivalent amount of a netting arrangement to the appropriate risk category.

C. Risk-based Capital Guidelines for Collateralized Transactions

1. On August 16, 1996, the Board of Governors, in conjunction with the OCC, the FDIC, and the OTS, issued a proposal to amend their respective risk-based capital standards to make uniform their treatments for transactions supported by qualifying collateral. The proposal would implement part of Section 303 of the Riegle Community Development and Regulatory Improvement Act of 1994 which directs Federal bank supervisors to make uniform their regulations and guidelines implementing common statutory and supervisory policies. The comment period ends on October 15, 1996.

2. Currently, the four agencies have had three different rules for the capital treatment of transactions that are supported by qualifying collateral.

a. The FDIC's and OTS's standards provide that the portion of a transaction collateralized by cash on deposit in the lending institution or by the market value of central government securities of the OECD-based group of countries may be assigned to the 20 percent risk category.

b. The Board's general rule is similar to the FDIC' and OTS's, but there is a limited exception: Transactions fully collateralized with cash or OECD securities with a positive margin may be eligible for a zero percent risk weight. The positive margin must be maintained on a daily basis and must take into account any change in the institution's exposure to the obligor or counterparty.

c. The OCC's rule permits the portion of a transaction that is collateralized with a positive margin by cash or OECD securities, which must be marked-to-market daily, to receive a zero percent risk weight.

3. The bank supervisors' proposal would permit portions of claims (including repurchase agreements) collateralized by cash on deposit with the lending institution or by securities issued or guaranteed by the U.S. Treasury, U.S. Government agencies, or the central governments in other OECD countries to be eligible for a zero percent risk weight.

a. To qualify, the collateralized arrangement would have to specify the portion of the claim that will be continuously collateralized either in terms of an identified dollar amount or a percentage of the claim. In the case of off-balance-sheet derivative contracts, the collateralized portion could be specified in terms of an identified dollar amount or a percentage of the current or potential future exposure.

b. The arrangement must also require maintenance on a daily basis of a positive margin of collateral on the specified collateralized portion, taking into account daily changes in the value of the institution's credit exposure and the market value of the collateral. Certain claims with fixed market values and little fluctuation in value, such as loans collateralized by CDs, may not actually require daily mark-to-market calculations.

c. When only a portion of a collateralized claim qualifies for the zero percent risk category, the remaining portion should be assigned to the appropriate risk category.

d. The collateralized arrangement should ensure that institutions maintain control over the collateral. The proposal has an accommodation for instances where an institution is acting as a customer's agent involving the lending or sale of the customer's securities that is collateralized by cash delivered to the institution. In this situation, the transactions would be deemed to be collateralized by cash on deposit with the lending institution provided that (a) any indemnification provided by the institution to the customer is limited to no more than the difference between the market value of the securities lent or sold and the cash collateral received and (b) any reinvestment risk associated with that cash collateral is borne by the customer.

III. RING-FENCING

A. U.S. Federal law and New York State law¹ take the "territoriality" approach of cross-border insolvencies for insolvent banks chartered outside the United States that operate Federally chartered or New York chartered branches in the United States. The territoriality approach dictates that the assets of the non-U.S. bank that are located in the United States are collected and applied to satisfy in the first instance creditors with claims against the Federal or New York branch. The collection and distribution of local assets independent from the global assets of the entire banking organization is referred to as "ring-fencing." The ring-fencing approach permits the relevant insolvency official to control the assets of the bank located in the U.S., thereby maximizing the possibility of satisfying the claims of the creditors of the local branch.

B. The New York State Banking Law ("NYBL") has been amended to incorporate specific statutory protections for multibranch close-out netting in an insolvency proceeding for a New York branch or agency of a non-U.S. bank.

1. Under the NYBL, following termination of a multibranch master agreement that is a QFC, the single net termination amount shall be calculated on both a global and New York-only basis. The global net amount is the amount owed by or to the non-U.S. bank as a whole if all transactions across all branches subject to the multibranch netting agreement are considered (the "Global Net Payment Obligation" or the "Global Net Payment Entitlement"). The New York or local net amount is the amount owed by or to the non-U.S. bank after netting only the transactions entered into by the New York branch or agency (the "Branch/Agency Net Payment Obligation" or "Branch/Agency Net Payment Entitlement"). The Superintendent of Banks, as receiver of the branch, is only liable to pay to a non-defaulting party the lesser of the "Global Net Payment Obligation and the Branch/Agency Net Payment Obligation. Likewise, when a counterparty owes a net amount pursuant to a repudiated or terminated QFC, the Superintendent may demand from the counterparty a payment for the lesser of the Global Net Payment Entitlement and the Branch/Agency Net Payment Entitlement.

2. These amendments to the NYBL represent a constructive departure from New York's generally applicable ring-fencing approach.

IV. INSOLVENCY AND BANKRUPTCY REVISION PROJECTS

A. The Bankruptcy Code ("Code") offers protection from its automatic stay and set-off and termination provisions for specific types of financial contracts with specific types of counterparties. For example, the Code allows close-out netting for securities contracts by stockbrokers, financial institutions, or securities clearing agencies; repurchase agreements by repo participants; swap agreements by swap participants, including foreign exchange agreements; commodity contracts by commodity brokers; and forward contracts by forward contract merchants. The FDI Act also preserves termination, closeout, and netting of these QFCs in the event of depository institution insolvency. However, counterparties must wait a day to execute these rights to enable the FDIC to transfer the contracts.

B. The public and private sectors are participating in efforts aimed to clarify and address certain inconsistencies which exist under insolvency laws in the United States relating to the treatment of certain financial transactions following the insolvency of a party to such transactions. In the private sector, the Public Securities Association and the International Swaps and Derivatives Association, Inc² have issued a legislative proposal in this respect. Their proposal sets forth amendments to (i) the Federal Deposit Insurance Act, as amended ("FDI Act"), (ii) the Code, (iii) the International Banking Act of 1978 ("IBA"), and (iv) the Securities Investor Protection Act of 1971 ("SIPA").

C. The proposed amendments are as follows:

1. FDI Act Amendments

a. Amending the FDI Act's definitions of securities contract, commodity contract, forward contract, repurchase agreement, and swap agreement to make those definitions consistent with the definitions in the Code.

b. Adding "federal funds agreement" to the definition of qualified financial contract ("QFC"), which includes any nondeposit interbank liability.

c. Making clarifying technical changes to conform the receivership and conservatorship provisions of the FDI Act.

d. Clarifying that the FDI Act expressly protects rights under security agreements or arrangements (such as a right of setoff) or other credit enhancements (such as a letter of credit or a guarantee) related to one or more QFCs.

e. Limiting the disaffirmance and repudiation authority of the Federal Deposit Insurance Corporation ("FDIC") with respect to QFCs so that such authority is consistent with the FDIC's transfer authority.

f. Clarifying that no provision of Federal or State law relating to the avoidance of preferential or fraudulent transfers can be invoked to avoid a transfer made in connection with any QFC of an insured depository institution, absent actual fraudulent intent. Clarifying that the Federal Deposit Insurance Corporation Improvement Act ("FDICIA") would not overcome the transfer powers of the FDIC with respect to QFCs.

g. Denying enforcement to walkaway clauses in QFCs. The definition of walkaway clause is not intended to encompass (i) any provisions relating to the manner of valuing a position or calculating amounts due under a QFC, (ii) setoff or netting provisions (between parties or their affiliates), or (iii) any provisions that make payment obligations conditional upon satisfaction of other payment obligations under QFCs or any other agreements or arrangements between the parties.

h. Expanding the transfer authority of the FDIC to permit transfers of QFCs to "financial institutions" as defined in FDICIA.

i. Requiring the FDIC to transfer QFCs that must settle through a particular clearing organization to a financial institution that is a member of such clearing organization.

j. Permitting transfers to an eligible financial institution that is a branch or agency of a non-United States ("U.S.") person if the depository institution in default is a branch or agency of a non-U.S. person organized under the same law and with its principal place of business in the same jurisdiction as the institution in default.

k. Amending the definition of "person" to clarify that governmental entities that are parties to QFCs benefit fully from the protections of the FDI Act.

l. Modifying the notification requirement following a transfer of QFCs of a failed depository institution so that it is consistent with the existing FDIC policy statement on QFCs issued on December 12, 1989.

m. Providing that a party may not terminate QFCs based solely on the appointment of the FDIC as receiver until 5:00 p.m. (Eastern Time) on the business day following the appointment of the receiver or after the person has received notice of a transfer under the FDI Act, or based solely on the appointment of the FDIC as conservator, notwithstanding the provisions of FDICIA.

n. Prohibiting the enforcement of rights of termination or liquidation that are based solely on the "financial condition" of the depository institution in receivership or conservatorship.

o. Allowing the FDIC to meet its obligation to provide notice in a manner consistent with the existing FDIC policy statement issued on December 12, 1989.

p. Permitting the FDIC to transfer QFCs of a failed depository institution to a bridge bank or a depository institution organized by the FDIC for which a conservator is appointed either (i) immediately upon the organization of such institution or (ii) at the time of a purchase and assumption transaction between the FDIC and the institution.

q. Providing that a master agreement for one or more securities contracts, forward contracts, repurchase agreements, or swap agreements will be treated as a single QFC under the FDI Act.

r. Expressly permitting the enforcement of offset or netting provisions related to claims under QFCs between (i) the depository institution in default and (ii) any person and any affiliate of such person. A new section is added to the Code to reach the same result.

2. FDICIA Amendments

a. Amending the definition of "netting contract" to eliminate the requirement that the contract be governed by the laws of the U.S., any State, or any political subdivision of any State and to include within the definition any security agreement or arrangement or other credit enhancement related to one or more netting contracts.

b. Modifying FDICIA so that it expressly protects all provisions of a netting contract (including the termination, liquidation or acceleration provisions, and provisions related to foreclosure in collateral and setoff against obligations to return collateral) notwithstanding any other provision of Federal or State law.

c. Providing that the termination provisions of netting contracts will not be enforceable based solely on the appointment of a conservator for such institution under the FDI Act or the appointment of a receiver for such institution under the FDI Act, if such receiver transfers QFCs in accordance with the FDI Act and gives notice of the transfer by 5:00 p.m. on the business day following the appointment of the receiver.

d. Providing that FDICIA does not override a stay order under SIPA with respect to foreclosure in securities (but not cash) collateral of a debtor.

e. Providing that two or more clearing organizations that enter into a netting contract are considered members of each other.

3. Code Amendments

a. Clarifying the definition of "swap agreement" to include equity or equity index swaps, equity or equity index options, bond or bond index swaps, bond or bond index options, credit spread swaps, credit spread options, interest rate futures, and currency futures.

b. Defining "other similar agreement" (which is a phrase contained in the definition of "swap agreement") to encompass any agreement which is presently, or in the future becomes, regu-larly entered into in the swap market that is a forward, swap, or option on one or more rates, currencies, commodities, equity or debt securities or instruments, economic indices, or measures of economic risk or value.

c. Clarifying that a swap agreement that documents many swap transactions will be a swap agreement to the same extent that each constituent transaction itself is a swap agreement within the definition.

d. Amending the definition of "securities con-tracts" to make it consistent with the current definition in the FDI Act and also to include any security agreements or arrangements and credit enhancements related to one or more such contracts.

e. Modifying the definition of repurchase agree-ment to eliminate the term limitation and certain asset limitations contained in the current definition.

f. Adding new definitions of "master netting agreement" and "master netting agreement participation" to the Code and protects the enforcement, free from automatic stay, of set-off or netting provisions in master netting agreements and security agreements or arrange-ments related to one or more master netting agreements. A master netting agreement parti-cipant may enforce any rights of termination, liquidation, acceleration, offset, or netting under a master netting agreement.

g. Clarifying that all Code provisions relating to securities contracts, commodity contracts, forward contracts, repurchase agreements, swap agreements, and master netting agreements (the "protected contracts") will apply in a Chapter 9 proceeding for a municipality.

h. Eliminating the entity restrictions that cur-rently limit the enforceability of rights under commodity contracts, forward contracts, and securities contracts. Adding a new definition of "financial participant," defined as (i) any commodity broker, forward contract merchant, stockbroker, financial institution, or securities clearing agency, or (ii) any entity that has an outstanding commodity contract, forward contract, or securities contract with a debtor at the time of filing of a bankruptcy petition.

i. Clarifying that the provisions of the Code related to the protected contracts will apply in a Section 304 proceeding.

j. Clarifying that the exercise of termination and netting rights will not affect customer property or distributions by the trustee of an insolvent commodity broker or stockbroker after the exercise of such rights.

k. Clarifying that the acquisition by a creditor of setoff rights in connection with the protected contracts cannot be avoided as a preference.

l. Clarifying that the provisions protecting set-off and foreclosure in relation to the protected contracts free from the automatic stay apply to collateral pledged by the debtor that is under the control of the creditor but which cannot technically be "held by" the creditor, such as receivables and book-entry securities, and to collateral that has been repledged by the creditor.

m. Clarifying that transfers made under or in connection with a master netting agreement may not be avoided by a trustee except where such transfer is made with actual intent to hinder, delay, or defraud.

n. Clarifying that provisions of the Code protecting rights of liquidation under the protected contracts in all cases also protect any rights of termination or acceleration under such contracts.

o. Providing that damages under any of the pro-tected contracts will be calculated as of the earlier of (i) the date of rejection of such contract by a trustee and (ii) the date of liquidation, termination, or acceleration of such contract.

4. Amendments relating to certain types of collateral

a. Providing that an agreement for the collateralization of government deposits, bankruptcy estate funds, Federal Reserve Bank or Federal Home Loan Bank extensions of credit, or one or more QFCs will not be deemed invalid solely because such agreement was not entered into contemporaneously with the acquisition of the collateral or because of pledges, delivery, or substitution of the collateral made in accordance with such agreement.

5. IBA amendments

a. Adding provisions dealing with QFCs of a branch or agency of a foreign bank located in any State, which do the following:

i. Authorize a receiver to take possession of all the property and assets of the foreign bank located in the U.S. and to use those assets to satisfy creditors whose claims arise out of transactions with any branch or agency of the foreign bank in any State.

ii. Generally apply the provisions of the FDI Act relating to QFCs, with certain modifications.

iii. Grant the receiver the authority to deal only with QFCs that appear on the books and records of any branch or agency of a foreign bank in any State.

iv. Limit a receiver's authority to disaffirm or repudiate multibranch QFCs, which are defined as QFCs that contain netting or setoff provisions relating to transactions between a party and a branch or agency of a foreign bank located in any State and at least one other branch or agency of that foreign bank or the home office of that foreign bank.

v. Provide for specific limits on amounts that may be owed by or to the receiver.

6. SIPA amendments

a. Providing that an order or decree issued pursuant to SIPA shall not operate as a stay of any right of liquidation, termination, acceleration, offset or netting under one or more securities contracts, commodity contracts, forward contracts, repurchase agreements, swap agreements, or master netting agreements (as defined by the Code), except that such order or decree may stay any right to foreclose on securities (but not cash) collateral pledged by the debtor or sold by the debtor under a repurchase agreement.

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¹ California and Illinois also have ring-fencing statutes.
² The proposal was issued on April 8, 1996.