BIPRU 13.7 Contractual netting

Scope

BIPRU 13.7.1R

Types of netting recognised

BIPRU 13.7.2R

For the purpose of BIPRU 13.7:

  1. (1)

    counterparty means any entity (including natural persons) that has the power to conclude a contractual netting agreement; and

  2. (2)

    contractual cross product netting agreement means a written bilateral agreement between a firm and a counterparty which creates a single legal obligation covering all included bilateral master agreements and transactions belonging to different product categories.

    [Note: BCD Annex III Part 7 point (a) (part)]

BIPRU 13.7.3R

Contractual cross product netting agreements do not cover netting other than on a bilateral basis.

[Note: BCD Annex III Part 7 point (a) (part)]

BIPRU 13.7.4R

For the purposes of cross product netting, the following are considered different product categories:

  1. (1)

    repurchase transactions, reverse repurchase transactions, securities or commodities lending or borrowing transactions;

  2. (2)

    margin lending transactions; and

  3. (3)

    financial derivative instruments.

    [Note: BCD Annex III Part 7 point (a) (part)]

BIPRU 13.7.5R

A firm may recognise as risk-reducing the following types of contractual netting:

  1. (1)

    bilateral contracts for novation between a firm and its counterparty under which mutual claims and obligations are automatically amalgamated in such a way that this novation fixes one single net amount each time novation applies and thus creates a legally binding, single new contract extinguishing former contracts;

  2. (2)

    other bilateral agreements between a firm and its counterparty; and

  3. (3)

    a firm that has a CCR internal model method permission may recognise Contractual cross product netting agreements for transactions falling within the scope of its CCR internal model method permission; netting across transactions entered by members of a group is not recognised for the purposes of calculating capital requirements.

    [Note: BCD Annex III Part 7 point (a) (part)]

Conditions for recognition

BIPRU 13.7.6R

A firm may treat contractual netting as risk-reducing only under the following conditions:

  1. (1)

    the firm must have a contractual netting agreement with its counterparty which creates a single legal obligation, covering all included transactions, such that, in the event of a counterparty's failure to perform owing to default, bankruptcy, liquidation or any other similar circumstance, the firm would have a claim to receive or an obligation to pay only the net sum of the positive and negative mark-to-market values of included individual transactions;

  2. (2)

    the firm must be in a position to provide to the appropriate regulator, if requested, written and reasoned legal opinions to the effect that, in the event of a legal challenge, the relevant courts and administrative authorities would, in the cases described under (1), find that the firm's claims and obligations would be limited to the net sum, as described in (1), under:

    1. (a)

      the law of the jurisdiction in which the counterparty is incorporated and, if a foreign branch of an undertaking is involved, also under the law of the jurisdiction in which the branch is located;

      1
    2. (b)

      the law that governs the individual transactions included; and1

      1
    3. (c)

      the law that governs any contract or agreement necessary to effect the contractual netting;

  3. (3)

    the firm must have procedures in place to ensure that the legal validity of its contractual netting is kept under review in the light of possible changes in the relevant laws;

  4. (4)

    the firm must maintain all required documentation in its files;

  5. (5)

    the effects of netting must be factored into the firm's measurement of each counterparty's aggregate credit risk exposure and the firm must manage its CCR on such a basis; and

  6. (6)

    the firm must aggregate credit risk to each counterparty to arrive at a single legal exposure across transactions; this aggregation must be factored into credit limit purposes and internal capital purposes.

    [Note: BCD Annex III Part 7 point (b) (part)]

BIPRU 13.7.7R

If any of the competent authorities concerned is not satisfied that the contractual netting is legally valid under the law of each of the relevant jurisdictions2, the firm must not treat the contractual netting agreement as risk-reducing.

[Note: BCD Annex III Part 7 point (b) (part)]

BIPRU 13.7.8R

A legal opinion required under BIPRU 13.7.6 R (2) may be in the form of a reasoned legal opinion drawn up by type of contractual netting.

[Note: BCD Annex III Part 7 point (b) (part)]

BIPRU 13.7.9R

A firm must not recognise as risk-reducing any contract containing a provision which permits a non-defaulting counterparty to make limited payments only, or no payments at all, to the estate of the defaulter, even if the defaulter is a net creditor (a "walkaway" clause).

[Note: BCD Annex III Part 7 point (b) (part)]

BIPRU 13.7.10R

In addition to the requirements in BIPRU 13.7.2 R to BIPRU 13.7.9 R, for contractual cross product netting agreements the following criteria must be met:

  1. (1)

    the net sum referred to in BIPRU 13.7.6 R (1) must be the net sum of the positive and negative close out values of any included individual bilateral master agreement and of the positive and negative mark-to-market value of the individual transactions (the Cross-Product Net Amount);

  2. (2)

    the written and reasoned legal opinions referred to in BIPRU 13.7.6 R (2) must address the validity and enforceability of the entire contractual cross product netting agreement under its terms and the impact of the netting arrangement on the material provisions of any included individual bilateral master agreement; a legal opinion must be generally recognised as such by the legal community in the United Kingdom or a memorandum of law that addresses all relevant issues in a reasoned manner;

  3. (3)

    the firm must have procedures in place under BIPRU 13.7.6 R (3) to verify that any transaction which is to be included in a netting set is covered by a legal opinion; and

  4. (4)

    taking into account the contractual cross product netting agreement, the firm must continue to comply with the requirements for the recognition of bilateral netting and the requirements of BIPRU 4.10 and BIPRU 5 for the recognition of credit risk mitigation, as applicable, with respect to each included individual bilateral master agreement and transaction.

    [Note: BCD Annex III Part 7 point (b) (part)]

Effects of recognition

BIPRU 13.7.11R

For the purposes of the CCR mark to market method, the CCR standardised method and the CCR internal model method a firm must recognise netting as set out in BIPRU 13.3 and BIPRU 13.6.

[Note: BCD Annex III Part 7 point (b) (part)]