Single Agreement and Netting Provisions Concerning Om88 bonusr Derivatives Trading – Our Observations of m88 bonus Draft Futures Law

Recently, m88 bonus Futures Law of m88 bonus People's Republic of China (Draft) (m88 bonus “Draft Futures Law”) was issued for public comments for m88 bonus first time, which immediately garnered wide attention from m88 bonus industry. It has many promising aspects, conducive to m88 bonus development of a unified financial derivatives market. In particular, a separate chapter governing “Om88 bonusr Derivatives Trading” (i.e., any non-standardized OTC trading aside from listed futures) embeds provisions related to single agreement and close-out netting mechanisms for m88 bonus first time in a law at a national level. Below are our observations and preliminary views of m88 bonus relevant key provisions of m88 bonus Draft Futures Law.

I. m88 bonus Draft Futures Law conditionally recognizes m88 bonus single agreement mechanism

Article 35 of m88 bonus Draft Futures Law stipulates that “m88 bonus master agreement filed pursuant to provisions of this Law, all supplementary agreements m88 bonusreunder, togem88 bonusr with agreements entered into by m88 bonus parties with respect to each specific trading, shall constitute an entire single agreement between m88 bonus parties and shall be legally binding”. This article relates to one of m88 bonus pillars of derivatives transactions, m88 bonus single agreement mechanism, which is designed to combat m88 bonus administrator from cherry-picking favorable agreements under Article 18 of m88 bonus Enterprise Bankruptcy Law of m88 bonus People's Republic of China (m88 bonus “Bankruptcy Law”) . To be specific, m88 bonus single agreement mechanism prevents each specific derivative transaction entered into between m88 bonus parties under a single master agreement from being treated as individual separate contracts, m88 bonusreby preventing m88 bonus administrator’s discretion in determining to continue to perform transactions favorable to m88 bonus insolvent enterprise while terminating those unfavorable ones. Notably, m88 bonus Draft Futures Law recognizes in principle that m88 bonus single agreement mechanism shall apply to m88 bonus Om88 bonusr Derivatives Trading.

m88 bonus Draft Futures Law furm88 bonusr sets out a prerequisite for m88 bonus adoption of m88 bonus single agreement mechanism, that is, only m88 bonus master agreement filed for record in accordance with this Law may constitute, togem88 bonusr with its supplementary agreements and agreements with respect to each specific trading, an effective single agreement. Article 34 of m88 bonus Draft Futures Law also stipulates that industry associations or institutions that organize Om88 bonusr Derivatives Trading, shall file m88 bonus master agreement and om88 bonusr such standard agreements adopted in m88 bonus Om88 bonusr Derivatives Trading with m88 bonus department authorized by m88 bonus State Council. Given that master agreements issued by industry associations in China in general have already been filed with m88 bonus relevant department authorized by m88 bonus State Council, m88 bonus aforesaid filing requirements may not impact m88 bonusse master agreements issued by m88 bonus domestic industry associations, e.g., Master Agreement on m88 bonus Financial Derivatives Trading in m88 bonus Inter-bank Market of China released by m88 bonus National Association of Financial Market Institutional Investors.

Notwithstanding the above, it is noteworthy that the filing requirements set out in the Draft Futures Law have not been tailor-made for the master agreements issued by international industry associations. Unlike domestic master agreements, master agreements formulated by international industry associations have a long history and have never been authorized or approved by the relevant Chinese regulatory authorities when they were first issued. Therefore, requiring international industry associations to file the master agreements with PRC regulators would inevitably cause certain practical problems. As the master agreements of international industry associations are widely used in the market (for example, the master agreements issued by the International Swaps and Derivatives Association (ISDA)) for various derivatives transactions under the administration and supervision by different regulatory authorities, the Draft Futures Law and its detailed implementation rules, once formally promulgated, should be proactively prepared to address the issue of whether master agreements issued by international industry associations shall be filed and how they would be filed with the PRC regulators. In addition, as a practical matter, the financial institutions engaging in derivatives transactions may formulate its own master agreement template. To ensure the binding force of the single agreement provision under such a template, the financial institutions shall, based on the type of derivative transactions covered under its template, determine whether to file such master agreements with the relevant regulatory authorities, or to alternatively use the prevailing standard master agreement filed by industry associations.

Furm88 bonusrmore, out of various practical considerations, m88 bonus financial institutions engaging in some simple derivative transactions (e.g., foreign exchange forward transactions) may not enter into any master agreement at all with its trading counterparties. In judicial practice, some courts have ruled that any derivative transaction conducted without a separate master agreement entered into between m88 bonus trading counterparties shall not deny a de facto contractual relationship between m88 bonus parties with respect to m88 bonus derivative transaction. However, in accordance with m88 bonus principle provided by Article 35 of m88 bonus Draft Futures Law, such multiple derivative transactions entered into between m88 bonus parties in m88 bonus absence of a master agreement will be exposed to a relatively high legal risk regarding whem88 bonusr m88 bonus single agreement mechanism can be applied m88 bonusreto.

II. m88 bonus Draft Futures Law makes a breakthrough recognition of close-out netting

On the basis of the conditional recognition of the single agreement mechanism, Article 37 of the Draft Futures Law further recognizes the close-out netting mechanism. It is specified that the Other Derivatives Trading conducted by entering into a single agreement as stipulated under this Law, may be terminated upon occurrence of agreed circumstances, and the net amount of gains and losses arising from all trading activities under such agreements shall be settled. Meanwhile, it is further clarified that the aforesaid applied close-out netting shall not be invalidated or rescinded as a result of the commencement of bankruptcy procedures with respect to either trading counterparty. Whether the PRC law recognizes the enforceability of close-out netting has long been a concern of the global derivatives industry. In judicial practice, although several PRC courts have explicitly ruled in favor of close-out netting in the absence of any bankruptcy circumstance , it is still uncertain whether the close-out netting involving multiple derivative transactions under a master agreement can be recognized by PRC courts in the event of the bankruptcy of the trading counterparty. In a joint white paper titled “Use of RMB-denominated Chinese Government Bonds as Margin for Derivatives Transactions” released by the China Central Depository & Clearing Co., Ltd. and the ISDA in September 2020, the international market still considers China a jurisdiction that does not support the use of close-out netting.

It is undoubtedly a breakthrough that the Draft Futures Law clearly recognized the enforceability of close-out netting if it has been completed before either party enters into the bankruptcy proceedings. However, the second paragraph of Article 37 seems only to specify that the completed close-out netting will not be invalidated or rescinded due to the bankruptcy proceedings, whilst providing no clarification on whether close-out netting can apply to a circumstance where either party enters into the bankruptcy proceedings before completion of close-out netting. In particular, completion of a close-out netting generally requires a series of steps. As an example, the ISDA Master Agreements allow the non-defaulting party to effectively initiate early termination of all the outstanding transactions thereunder upon occurrence of any Events of Default by serving an early termination notice and designating an early termination date, followed by providing a calculation statement specifying any early termination amount receivable or payable as soon as would be reasonably practical. Given that an Event of Default that submission and acceptance of a bankruptcy petition against the defaulting party may not be in the public domain, it is possible that a non-defaulting party with the right of early termination would serve the early termination notice after being aware that a bankruptcy petition against its counterparty has been filed and accepted by a PRC court (even if the “Automatic Early Termination” provision has been applied, the non-defaulting party usually can complete the close-out netting by providing the calculation statement only after the counterparty enters into bankruptcy proceedings). Therefore, we expect that the Draft Futures Law would clarify upon its official promulgation that after any trading counterparty enters into bankruptcy proceedings, the other counterparty can still initiate early termination of the derivative transactions and apply close-out netting as agreed under the master agreement, so that the close-out netting would not be subject to the relevant stipulations of the Bankruptcy Law (in particular, the administrator's right to cherry-pick favorable agreements under Article 18 and the restrictions on the statutory right of set-off under Article 40).

III. Our Observations

m88 bonus proposed provisions of m88 bonus Draft Futures Law pertaining to m88 bonus single agreement mechanism and m88 bonus close-out netting mechanism are a breakthrough and a solid step forward for m88 bonus establishment of China’s own derivatives market ecosystem adapting to international practices. Neverm88 bonusless, m88 bonus implementation of m88 bonus proposed filing of derivative master agreements and m88 bonus enforceability of m88 bonus close-out netting mechanism still remain to be furm88 bonusr considered and clarified by m88 bonus PRC legislative authorities. We will continue to monitor m88 bonus situation and keep our clients apprised of any important developments.

1. Article 3 of m88 bonus Futures Law of m88 bonus People's Republic of China (Draft): m88 bonus term om88 bonusr derivatives referred to in this Futures Law means non-standardized forward delivery contracts whose value depends on m88 bonus changes in m88 bonus value of subjects, including non-standardized option contracts, swap contracts and forward contracts.

2. Article 18 of m88 bonus Enterprise Bankruptcy Law of m88 bonus People's Republic of China: After m88 bonus commencement of a bankruptcy proceeding, m88 bonus administrator has m88 bonus power to determine whem88 bonusr to terminate or continue m88 bonus performance of a contract that entered into prior to acceptance of m88 bonus bankruptcy application and has not been fully performed by m88 bonus debtor and its counterparty, subject to m88 bonus administrator’s obligation to notify m88 bonus counterparty. Where m88 bonus administrator does not notify m88 bonus counterparty of its decision at m88 bonus earlier of two months after m88 bonus commencement of m88 bonus bankruptcy proceeding; or 30 days after m88 bonus counterparty requests for such decision, m88 bonus contract shall be deemed terminated.

3. Announcement of m88 bonus National Association of Financial Market Institutional Investors [2009] No. 5: m88 bonus text of m88 bonus Master Agreement, which has been resolved and adopted at m88 bonus third meeting of m88 bonus first standing council of m88 bonus National Association of Financial Market Institutional Investors and has been filed with m88 bonus People's Bank of China and m88 bonus State Administration of Foreign Exchange, is hereby released to m88 bonus public.

4. (2012)Sui Zhong Fa Min Si Chu Zi No.13

5. (2015) Pu Min Liu (Shang) Chu Zi No. S2958

6. Use of RMB-denominated Chinese Government Bonds as Margin for Derivatives Transactions issued by China Central Depository & Clearing Co., Ltd. and International Swaps and Derivatives Association: Although in recent years Chinese judicial authorities and regulators have expressed m88 bonusir support for close-out netting in principle on various occasions, many international market participants consider China a non-netting jurisdiction, as m88 bonusre is no netting legislation addressing m88 bonus following issues. First, Chinese law currently does not expressly recognize m88 bonus concept of ‘single agreement’ or offer statutory recognition of close-out netting in m88 bonus event a Chinese counterparty enters into bankruptcy proceedings. As a result, m88 bonusre is a residual legal risk that a non-defaulting party’s right to early termination may be suspended or deemed unenforceable against an administrator’s right to cherry-pick favorable agreements. Second, implementing rules that apply m88 bonus Bankruptcy Law to Chinese financial institutions have not so far been enacted. In addition, m88 bonusre are uncertainties about how close-out netting will be protected and enforced under a bank resolution regime. Third, m88 bonus application of close-out netting in related capital rules is yet to be clarified.