‘Bilateral Netting of Qualified Financial Contracts Bill, 2020’

In a latest development, Parliament passed Bilateral Netting of Qualified Financial Contracts Bill, 2020 that seeks to provide a legal framework for bilateral netting of qualified financial contracts.

Key-provisions of the Bill

• The bill covers trades that are negotiated bilaterally including cross-currency or interest rate or commodity swaps, currency or interest rate futures or options and spot, future or forward foreign exchange transactions.
  • These include credit derivatives such as the credit default swaps and commodity derivatives such as electricity derivatives, oil derivatives, coal derivatives or gas derivatives.
• The Bill covers financial contracts entered into on bilateral basis outside clearing system.
• Bilateral contracts constitute 40 per cent of total financial contracts while multilateral contracts constitute 60 per cent.
• Applicability:The provisions of the Bill will apply to QFCs between two qualified financial market participants, where at least one party is an entity regulated by the specified authorities (RBI, SEBI, IRDAI, PFRDA or the IFSCA).

Bilateral netting: 

• Netting refers to offsetting of all claims arising from dealings between two parties, to determine a net amount payable or receivable from one party to other.

Qualified financial contracts (QFC): 

• QFC means any bilateral contract notified as a QFC by the relevant authority.
  • The authority can be Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Insurance Regulatory and Development Authority of India (IRDAI), Pension Fund Regulatory and Development Authority (PFRDA) or International Financial Services Centres Authority (IFSCA).
• Qualified financial market participant:The relevant authority may, by notification, designate an entity regulated by it as a qualified financial market participant to deal in QFCs. This would include entities such as non-banking finance companies (NBFCs), insurance companies and pension funds.

Close-out netting arrangement: 

• Close-out netting refers to the termination of all obligations arising out of relevant QFCs.  
• The process may be initiated by a party to the QFC in the case of:
  • a default (failure to honour the obligations of a QFC) by the other party
  • a termination event, as specified in the netting agreement that gives one or both parties the right to terminate transactions under the agreement.  

The need

• Under existing laws, banks have to make higher provisions for such bilateral contracts which are outside the Clearing Corporation of India’s framework since calculations are done on a gross basis rather than a net basis.
• This bilateral netting legislation will help us in evaluating risks far more in real-time basis and actual risk assessment will happen rather than a notional risk assessment based on the gross figures.