'Shadow Banking – legal issues regarding collateral and
insolvency law' Briefing for the European Parliament’s ECON Committee (2013)
In its first part, the paper addresses issues relating to close-out netting and bank insolvency. In many financial markets repurchase agreements (repos) and securities lending agreements benefit from special insolvency treatment which - broadly speaking - consists of an exemption from a number of insolvency law mechanisms. There was some discussion triggered by the Financial Stability Board’s Recommendation 13 on repos and securities lending, aiming at changes of the special insolvency treatment of these transactions. However, this analysis submits that no changes should be made in this regard. Instead, the regulators should be given the power to temporarily stay close-out netting, as in bank resolution proceedings. At the same time, regulatory haircuts to collateral assets (FSB Recommendations 6 and 7) may buffer systemic consequences but are unable to act as a circuit breaker.
In its second part, the paper addresses legal uncertainty in relation to proprietary interests in collateral securities. Repo and securities lending collateral assets face increased enforcement difficulties in cross-border settings, stemming from different national rules regarding good-faith acquisition and close-out netting. Haircuts, as proposed by some commentators, are not an appropriate solution. Instead, only harmonisation of securities law and of the relevant insolvency rules can guarantee a consistent cross-border framework.
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‘Study on Directors’ Duties and Liability in Europe’ (2013), prepared for the
European Commission (with Philipp Paech and Edmund-Philipp Schuster)
This comparative study analyses directors' duties and liabilities in all EU
Member States, identifying regulatory strategies and trends across Europe and
discussing enforcement strategies. The report has been prepared for the European
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Enforceability of Close-out Netting: Draft UNIDROIT
Principles to Set New International Benchmark, by Philipp Paech. (2013) 1
JIBFL 13, Butterworths Journal of International Banking and Financial Law,
January 2013, pp 13-19.
UNIDROIT has recently launched an intergovernmental process intended to set an international non-binding standard for close-out netting legislation. This paper, first, provides insights into the question of why harmonisation is needed. The colossal exposures inherent in the derivatives, securities lending, repo, forex and similar markets are generally covered by close-out netting provisions, which are contained in the relevant master agreements. Close-out netting reduces mutual exposure by about 80–90%. The ‘net’ exposure is taken as a basis for the calculation of collateral and underlying capital, thus being vital for market participants' risk management, as well as for prudential supervision. Even though most developed markets have adopted netting-friendly legislation, the international nature of the modern financial market complicates enforceability of close-out netting in cross-jurisdictional situations, in particular in insolvency scenarios. Further, the Article explains the current difficulties in transposing the concept of close-out netting across jurisdictional borders and advocates a functional approach alongside the five criteria (immediate discharge of obligations? obligations due? obligations of the same kind?). Lastly, it sheds light on the concepts underlying the current UNIDROIT draft principles.
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'Market Needs as Paradigm: Breaking Up the Thinking on EU
Securities Law' by Philipp Paech. Law Society and Economy Working Paper
Series, WPS 11-2012 October 2012 (forthcoming in
Thévenoz, Conac and Segna, Intermediated Securities, Cambridge University
Press, early 2013).
Modern patterns for holding investment securities face three basic legal challenges: first, negotiability and the possibility of good faith acquisition must be ensured as they are the basis of today’s anonymous trading and settlement of securities. In the past, securities have been incorporated in paper certificates to achieve this result, allowing for the application of principles of property law to what in substance is a set of mutual rights and obligations. Second, account holders need to be protected against intermediary risk. Traditionally, concepts like safekeeping or trust were applied to achieve this result. Since there is a need to adjust to modern, basically electronic holding of securities, these concepts are now stretched to a considerable extent. Third, 40% of holdings entail cross-jurisdictional questions. Therefore, the issues of both negotiability/good faith acquisition and protection against intermediary risk need to be addressed from an international perspective. Modern conflict-of-laws concepts, in particular PRIMA, lead to the application of different laws to the 'same' securities, with potentially differing legal analyses in respect of these securities. The EU legislator was so far unable to address these problems. The Geneva Securities Convention and the Hague Securities Convention provide for answers but face criticism and are not yet implemented.
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'Draft Principles and Commentary regarding the
Enforceability of Close-out Netting Provisions', UNIDROIT 2012 Study 78C –
Doc. 13 (April 2012).
This paper sets out eight principles designed to ensure the cross-jurisdictional enforceability of close out-netting. Close-out netting is heavily used by the financial industry and used in many regulatory mechanisms like in particular bank’s capital requirements (Basel II). However, as soon as banks located in different jurisdictions agree to apply close-out netting between them, they risk that the relevant provisions are unenforceable in the event of insolvency of either of them. About 40 countries do allow close-out netting, however on differing terms. The Principles shall provide guidelines to legislators on how to amend national insolvency laws so as to be compatible with each other. Principle 1 defines close out netting. Principles 2 and 3 set a standard regarding the circle of netting-eligible parties and netting-eligible financial transactions. Principles 4-6 deal with formal requirements, promoting in particular the idea that unenforceability as a consequence of non-compliance with formal requirements is not the right means to achieve regulatory goals. Principle 7 is the core rule and defines the relationship between close-out netting and insolvency avoidance rules. Principle 8 clarifies the role of Principle 7 in respect of bank resolution procedures as recently promoted by the Financial Stability Board. Each Principle is accompanied by a detailed commentary explaining its background and reasoning. The paper is the final one in a sequence of four that the Author has produced for
UNIDROIT. It has greatly benefited from the input of other Members of the
UNIDROIT Study Group and will serve as a basis for intergovernmental negotiations.
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Kanda/Thévenoz/Beraud, Official Commentary on the Geneva Securities
Convention on Substantive Rules for Intermediated Securities, Oxford
University Press (2012); Initial author of Article 1(b), Article 1(c), Article
1(d), Article 1(n) with K. Löber, Article 1(o) with K. Löber, Article 5, Article
6, Article 22, Article 27 with K. Löber.
The Geneva Securities Convention was adopted in October 2009 with a view to
creating an international framework for the alignment of the laws governing
securities holding and disposition. Its 48 Articles follow an extremely
complex architecture designed to accommodate the need for rights over
securities which are robust in case of insolvency of intermediaries while at
the same time being neutral in respect of different legal concepts in place
around the globe. Dr Paech was one of the main contributors to the
Convention and is the initial author of the commentary accompanying the
definitions of intermediated securities, securities account,
intermediary, securities clearing system, securities settlement system
,and the relevant commentary on articles relating to central banks and
regulated intermediaries, transparent systems (excluded functions),
prohibition of upper-tier attachment, insolvency of system operator or
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Cross-border issues of securities law:
European efforts to support securities markets with a coherent legal
framework (Briefing for the ECON Committee of the European Parliament)
This study was
commissioned by the European Parliament as a briefing paper for its
Committee on Economic and Monetary Affairs (ECON), in view of the
Commission’s preparatory work on securities law. The study attempts to break
down this highly complex area to the origins of the legal uncertainties
surrounding intermediated securities. It explains the tensions of legal
concepts stemming from the fact that securities in their substance are
obligations but as a legal concept are treated as chattel in most
jurisdictions. Further complication results from the internationalisation of
the financial market, where securities are transferred, pledged and lent
across jurisdictional borders. The fact that they are legally treated like
movables leads to confusing results of the conflict-of-laws analysis,
following which more than one law might influence the securities’ legal
status. The paper compares the various legal models that are applied to
securities holding and explains which aims would need to be achieved by the
law in order to make cross-jurisdictional holdings legally sound.
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'The need for an international instrument on the
enforceability of close-out netting in general and in the context of bank
resolution' UNIDROIT 2011 Study 78C – Doc. 2.
Close-out netting is typically applied to transactions such as derivatives, repurchase and securities lending agreements, and other kinds of transaction that tend to carry a high counterparty and/or market risk. Regulatory authorities strongly encourage the use of such close-out netting provisions (alongside collateral) because of their beneficial effects on the stability of the financial system. The reason is that referring market participants’ claims in the event of default of the counterparty to regular insolvency proceedings on a gross basis instead of on a net basis might expose the non-defaulting party to levels of credit risk and market risk that are difficult to calculate and manage for the relevant types of contract due to rapid changes in market values and uncertainty regarding the risk of repudiation of contracts during the proceeding. However, these beneficial effects can be particularly felt in the event of the insolvency of a party. In that case, the use of close-out netting assumes that the legal effects stipulated to that end by the parties (the close-out netting provision) will be recognised by and be enforceable under the applicable insolvency law. However, the current situation is that, even if about 40 jurisdictions recognise netting in insolvency, the extent to which they do so and the scope and legal effects of close-out netting provisions differ significantly. Furthermore, some jurisdictions do not clearly recognise netting, and the legal practice in such jurisdictions often resorts to the principles governing set-off, failing to recognise the fundamental differences between the two mechanisms. This patchwork is unsatisfactory in cross-jurisdictional situations, since it exposes the financial market participants’ risk management to unnecessary legal uncertainty and may even jeopardise it. An additional aspect of the enforceability of netting provisions has come to the fore since the beginning of the recent financial crisis: regulatory authorities, while underlining the usefulness of netting, have contemplated the need for a brief stay on the netting mechanism in pre-insolvency or insolvency situations affecting a financial institution, so as to allow the regulator the time needed to decide if and how to resolve an ailing financial institution in an orderly fashion so as to mitigate risks to financial stability. The paper analysis the commercial and insolvency law issues arising in relation to close out netting as well as the interplay with regulatory rules. This paper is the first in a series of four paper which the author produced for
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'A first tentative structure for Principles regarding the enforceability
of netting agreements' UNIDROIT 2011 – Study 78C – Doc. 3
A set of 19 Principles designed to capable of enhancing the cross-jurisdictional
enforceability of close-out netting provisions. The principles address different
issues of commercial and insolvency law as well as conflict of laws. The paper
is an Annex to and is build on the findings of the study (above) and serves as
basis for the work of the UNIDROIT Study Group.
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'Netting, Finanzmarktstabilität und Bankenrestrukturierung', WM Zeitschrift
für Wirtschafts- und Bankrecht 64(2010) 1965-1971
The UK and Germany have introduced, in 2009 and 2010 respectively, special resolution regimes for banks. Amongst the various tools like ‚bail in‘ and ‚bad bank‘ allowing regulators to wind up failing banks also figures the power to stay contractual termination rights that the non-defaulting party might otherwise exercise against the defaulting party. However, the non-defaulting party might be located abroad. As a consequence, the regulatory effect of such regulatory stay is questionable and the consequences in terms of commercial and insolvency law remain widely unclear. The paper therefore concludes that effective implementation of the relevant regulatory powers requires simultaneous changes to the insolvency and commercial law
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'Systemic risk, regulatory powers and insolvency law – the need for an
international private law framework for netting', Institute for Law and
Finance Working Paper, Series No. 116, Frankfurt, March 2010
The financial crisis has shown that regulatory tools to either save or wind
up failing financial institutions are inadequate. As a consequence, the
Cross-Border Bank Resolution Group of the Basel Committee developed a
blueprint of the design of a future framework for bank resolution. Both
collateral and netting play a vital part in this framework as they are
directly connected to issues of solvency (under Basel II) and liquidity of
financial institutions. The CBRG proposes to change the framework for
close-out netting. The working paper analyses this proposal in the context
of insolvency law and securities law and concludes that certain of the
proposed measure risk being less effective than predicted as long as the
legal concept of close-out netting and its treatment in insolvency are
approached piece-meal on a global scale. It is the initial paper of a series
of works that ultimately leads to a proposal for global close-out netting
principles (cf. above).
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'Post trading of securities: the European response to legal barriers',
Journal of International Banking and Financial law, 4/2009, 211-214 (with K.
Solutions to legal barriers related to post-trading within the EU (Second
Advice of the EU Clearing and Settlement Legal Certainty Group - LCG),
Brussels, August 2008 (co-authored as part of professional assignments)
'Interconnecting Law of Securities Holding and Transfer', Journal of
International Banking and Financial Law, 1/2007, p. 9-15, with K. Löber.
To increase the efficiency of both local and cross-border
transfers and collateral transactions, today the vast quantity of securities
are being held, transferred and pledged by entries to securities accounts
with intermediaries (eg banks, brokers, clearing and settlement systems,
etc), rather than in physical form by the investors or directly with the
issuers. Unfortunately, more often than not choice-of-law and substantive
law rules continue to reflect assumptions that securities were held,
transferred and pledged by physical delivery and were supposedly mainly
purely domestic transactions.
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'EU Post Trading, the 'Barriers' and Harmonisation of Law', Euredia,
Brussels 2006, p. 279-307
'Enhancing Legal Certainty over Investment Securities' (special editor of the
volume, as part of professional assignments), Uniform Law Review special
issue No. 1/2 2005, 295 p., Rome 2005
'Global Capital Markets and the law of intermediated investment securities', in
Kodificácia, Europpeizácia a harmonizácia súkromného Práva, Iura Edition,
'Grenzüberschreitende Wertpapierverfügungen', Wertpapiermitteilungen (WM)
2005, pp. 1101-1108