ISDA Chief Executive Officer Scott O'Malia offers informal comments on important OTC derivatives issues in derivatiViews, reflecting ISDA's long-held commitment to making the market safer and more efficient.

If asked to name one single thing a country could do to bolster the safety and efficiency of its derivatives market, our answer at ISDA would be the same every time: implement legislation to ensure the enforceability of close-out netting. The good news is that India has joined the ranks of countries that have taken that step, at a stroke creating more certainty for financial institutions and encouraging greater participation in the local market by both foreign and domestic firms.

This has been some time in the making, and ISDA has worked closely with authorities in India over the course of several years to provide input and technical advice on the drafting of the legislation. In fact, the bill passed by parliament earlier this week was based closely on the ISDA Model Netting Act, a template containing model provisions and guidance intended to help jurisdictions implement their own netting legislation.

The benefits for India’s financial markets are huge. By allowing each pair of counterparties to compress their various obligations into a single payment due by one to the other, netting mitigates the credit risk associated with derivatives and means a default is less likely to be disruptive to the financial system. Without close-out netting, firms would need to manage their credit risk on a gross basis, dramatically reducing liquidity and credit capacity.

A legally enforceable netting regime will also enable more efficient use of capital by financial institutions active in India. Regulators the world over recognize close-out netting as risk reducing when it comes to setting regulatory capital requirements, so long as there is a high degree of legal certainty over the enforceability of close-out netting under applicable laws including the law of the jurisdiction in which the counterparty is incorporated. The existence of a clean netting opinion is therefore a critical criterion for global banks when deciding their level of involvement in a particular country. India’s Ministry of Finance (MOF) and the Reserve Bank of India have also acknowledged the considerable impact this will have for major banks operating in India’s derivatives market.

There are similar advantages under the global margin framework for non-cleared derivatives, with firms able to exchange collateral on a net basis. This significantly reduces the cost of transacting and encourages more participation in markets where close-out netting is enforceable. It also means more credit is available to firms looking to raise financing or hedge their exposures, improving liquidity and contributing to economic growth.

In a letter sent to the MOF earlier this month, ISDA and two other trade associations stressed how important it is that banks have the capacity to provide liquidity and extend credit to the real economy – a fact made more urgent by the coronavirus pandemic and related economic slowdown. We consequently urged the MOF to bring the netting bill before parliament during the current parliamentary session.

The passing of that bill is a huge achievement. With only a few procedural steps remaining until it become law, the stage is now set for India’s derivatives market to thrive. For our part, we will now seek an update to the netting opinion for India to confirm the enforceability and consistency of application of close-out netting in order to support trading in this market.

As we’ve done for more than 30 years, ISDA will continue to work with authorities across the globe to help them draft legislation on the enforceability of close-out netting. So far, we have published netting opinions on more than 70 countries, and that number continues to climb. We strongly believe that certainty on close-out netting creates the foundations for strong, safe and efficient derivatives markets, in turn leading to a robust and vibrant ecosystem for capital markets funding and hedging.

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