Parliament passes much awaited amendments to Netting Act

What you need to know

• In a move to reduce systemic risk in the derivatives markets, the Federal Government has passed the Financial System Legislation Amendment (Resilience and Collateral Protection) Bill 2016. The legislation makes important amendments to the Payment Systems and Netting Act 1998 (Cth) (Netting Act) and provisions in other legislation.
• The legislation allows for the enforcement of security-based margin arrangements in connection with close-out netting contracts.
• The legislation addresses potential inconsistencies between the Netting Act and other industry legislation by providing certainty in relation to the application of stays on close-out rights.

The Federal Government yesterday passed the Financial System Legislation Amendment (Resilience and Collateral Protection) Bill 2016, and the Act received Royal Assent on the same day (the Act). The amendments in the Act will commence on 1 June 2016, being the 28th day after the date of Royal Assent.

The Act makes some crucial amendments to the Payment Systems and Netting Act 1998 (Cth) (Netting Act). Among other things, the Act allows counterparties to enforce rights in respect of margin that has been provided under a security-based arrangement and provides certainty around the application of stays on close-out rights. Consequential amendments are made to other associated "Industry Acts" such as the Banking Act 1959 (Cth) (Banking Act), the Insurance Act 1973 (Cth) and the Life Insurance Act 1995 (Cth).

Security over financial property

Participants in non-cleared derivatives markets in Australia have traditionally transferred margin by way of title transfer rather than by way of security. This is partly due to the potential uncertainties in relation to the enforcement of security if a counterparty goes into external administration. The Netting Act does not currently protect actions taken to enforce security in connection with close-out netting contracts.

It is expected that under the international reform framework relating to margin requirements for non-cleared derivatives (to be implemented by national regulators), at least initial margin will need to be provided by way of security.

The Act is designed to ensure that security-based margin arrangements may be enforced by removing some of the uncertainties around the enforcement of security. Under the legislation, security in financial property that is taken to comply with margin requirements will, subject to certain safeguards, generally be enforceable.

Stays on close-out rights

Certain Industry Acts contain provisions which are potentially inconsistent with the protections afforded by the Netting Act. For example, under the Banking Act, a party is not entitled to close-out a transaction related to a contract because a statutory manager has been appointed to an ADI, whereas the Netting Act provides that a counterparty to a close-out netting contract may close-out if a party has gone into external administration. Similar provisions apply in relation to other regulated entities, such as life insurers and general insurers. The Act seeks to address the uncertainty arising from these potential inconsistencies by providing certainty as to when a counterparty to a close-out netting contract is stayed from exercising close-out rights on the appointment of a statutory or judicial manager and also that the stays under the Industry Acts do not apply to market netting contracts. The temporary period during which the stay applies (referred to as the "resolution period") is, generally, the time period ending at midnight (by legal time in the Australian Capital Territory) at the end of the first business day after the day on which the trigger event happens e.g. the appointment of a statutory or judicial manager.

Other changes

The provisions of the Act are complex. Some other changes dealt with in the Act include:

• the definition of "external administration";
• "non-terminal administration" and participants in Real Time Gross Settlement systems; and
• cash market settlement activities in approved netting arrangements.