Research On The Application Of ISDA Close-out Netting In The Event Of Bankruptcy

The application of Netting to over-the-counter (OTC) financial derivatives market has the function of transaction simplification and risk prevention. The Master Agreement issued by International Swaps and Derivatives Association (ISDA) is now the most widely used standard agreement in international OTC financial derivatives transaction, which provides two kinds of Netting, including Netting of Payments and Close-out Netting. As one of the three pillars of ISDA Master Agreement, Close-out Netting is constituted by three factors of applicable condition, early termination and netting after the termination. It can reduce the transaction cost and credit risk of the parties and control the systemic risk of the whole market. In general event, Close-out Netting in ISDA Master Agreement is enforceable for its application complies with the principle of autonomy of will. However, its application in the event of bankruptcy may face the challenge of domestic bankruptcy law, which leaves the problem to its legal validity.Bankruptcy is one of the Events of Default in ISDA Master Agreement, which means it is one of the applicable conditions of Close-out Netting. However, when this term is applied in the event of bankruptcy, it probably conflict with the principle of equality, the right of cherry-picking and setoff provision in domestic bankruptcy law, leading to many problem in legal validity of Close-out Netting. The provision of Single Agreement and Automatic Early Termination theoretically can solve this problem. ISDA and many countries have made efforts in legislation to remove the above conflicts as well.In Chinese legislation, there is no concept or related regime of Close-out Netting, while practical circle has strong demand on it. Now related associations have issued some financial derivatives transaction master agreements to confirm the validity of Close-out Netting, but these still can not form a binding legal regime. In view of Chinese legislation, especially the provisions in bankruptcy law such as invalidation of individual repayment, administrator’s right of cherry-picking, bankruptcy revocation and setoff provision, there are many problems in applying ISDA Close-out Netting in the event of bankruptcy. Specifically, Chinese law has not confirm the validity of Close-out Netting, and the enforceability of Single Agreement provision, right of early termination and netting arrangement remains uncertain as well. Besides, the setoff in bankruptcy law can hardly replace Close-out Netting either. So there is no good idea to completely avoid above legal risk of application. However, the parties should still pay attention to some essential detail when entering into ISDA Master Agreement and performing the right of Close-out Netting, to help the application of this provision in the event of bankruptcy.