The Netting of Financial Contracts Bill seeks to provide for greater stability in an area of financial trading which is comparatively new. This legislation is needed urgently so that a forthcoming EU directive can be implemented which will, in effect, allow banks in member states to compete more effectively with their counterparts in non-EU countries. The fact that such a Bill is being introduced serves to reinforce the ongoing commitment of the Government to make the financial services sector grow as a means of producing high quality employment and wealth for this country.
The Bill is short, containing only five sections, and seeks simply to ensure that agreements between two parties to set off their mutual liabilities to arrive at a single net amount owing by one party to another are enforceable. The ability of both parties to reduce their mutual exposure to risk to the net amount owing between them at any time is clearly of benefit to both parties. The calculation of this net amount is called set off or netting.
I stress that it is only the netting of liabilities in respect of "financial contracts" that is provided for in the Bill. These are interest rate, foreign exchange and commodity based contracts, more commonly called derivative contracts. The liabilities of the same two parties in respect of other trading activities between them will not benefit from the provisions of this Bill.
Stability, through prudent risk management, is a substantial concern of financial services companies, particularly banks, in view of the large sums involved in their business and the volume of business they may transact with individual major clients. In the case of banks and other credit institutions, there are special requirements that they hold reserves in proportion to their risk exposure.
These requirements are embodied in the EU Solvency Ratio and Capital Adequacy Directives and their implementation is supervised by the Central Bank. The European Commission, however, is currently finalising an amending directive to the Solvency Ratio Directive which will allow supervisors, such as the Central Bank, to recognise the risk reducing effects of the type of set off or netting I described.
Netting agreements are already recognised in many countries, particularly non EU countries, and banks based in those countries benefit from increased stability since enforceable netting agreements reduces their exposure. Just as importantly, because they are permitted to carry lower reserves than their EU counterparts, they benefit from lower operating costs. The draft directive, which I expect to be finalised within the next two months, represents the Commission's response to concerns that credit institutions in member states are not disadvantaged vis-a-vis their non EU counterparts.
However, Irish law does not refer specifically to netting and so there are doubts about the enforceability of netting in cases of insolvency. The company law area contains, as far as the provisions relating to examinership are concerned, specific barriers to the operation of netting or set off. This Bill seeks to address the issue of doubt and specific barriers only to the extent that they interfere with the operation of netting agreements and even then, as I mentioned already, only to netting agreements that cover derivative contracts. The more general issues in relation to examinership legislation and the interpretation of that legislation by the courts are the subject of recommendations by the company law review group and are being considered in the first instance by my colleague, the Minister of State at the Department of Enterprise and Employment, Deputy Rabbitte. These issues have broader implications for business in general and will be dealt with by company law amendment, if appropriate.
The Government, however, is satisfied that the narrow case in relation to netting agreements should be dealt with separately because of the capital adequacy benefits on offer to banks and similar institutions, building societies and investment firms authorised under the investment services directive, for example, fund management companies, collective investment companies, unit trusts, etc., and recognised third country investment firms, when the forthcoming EU directive is finalised because of the need to maintain the most favourable environment for financial service, consistent, of course, with the highest regulatory and prudential requirements. In fact, the forthcoming directive will require those institutions seeking its benefits to furnish the Central Bank with written and reasoned opinion confirming that the netting agreements are legally enforceable. Many banks operating in the domestic market and from the International Financial Services Centre have made clear the importance they attach to the new directive. I understand that it was the undertaking to move ahead more quickly than many of our competitors in this regard that has secured one major international project for the IFSC already and that a number of major players in the North American market have signalled their interest in Dublin as a result of the enhanced overall package — combining advanced communications, quality labour, high specification accommodation and an accessible and responsible regulatory and fiscal environment — now on offer in the IFSC. I mentioned that the Bill is short and that its purpose is simple. However, some of its provisions are complex and highly technical, reflecting the nature of the transactions and the agreements which cover them.
I will now turn to the major elements of the Bill. Section 1 is the interpretation section. It contains standard definitions of the Central Bank of Ireland, the Minister for Finance and Companies Acts. "Party" to a netting agreement is defined as a person — relying on the meaning of person in the Interpretation Act, 1937, so that an individual, partner, company of any kind, etc. may be one of the two parties to a netting or master netting agreement. The term "money" is also defined, to include foreign currency.
The term "financial contracts" is defined to include those contracts, basically derivative contracts, which are contained in Annex III of the EU solvency ratio directive. Annex III is currently being revised and the definition anticipates the outcome of that revision, especially as regards the inclusion of commodity based contracts. It is the contracts in Annex III that the forthcoming directive on netting will recognise. Other contracts which are regularly used in the market but which are not recognisable by the Central Bank for capital adequacy purposes are included in the definition, in particular foreign exchange contracts of less than 14 days' duration and contracts traded on exchanges. Finally, provision is made within the definition of "financial contract" for the Central Bank to formally add to the definition any contract contained in Annex III or any contract contained in any revised annex or equivalent and for the Minister of Finance to include contracts within the definition, thereby allowing for the inclusion of new contracts which are rapidly evolving.
The term "netting" is defined to include the termination of individual financial derivative contracts, the calculation of the amount owing on each contract to either party and the addition of all amounts due and owing to each party to arrive at a single amount due by one party to the other. A netting agreement would contain provisions setting out the circumstances under which it would operate.
"Netting agreement" is defined so that any agreement providing for netting of financial contracts will be within the scope of the legislation. Such an agreement may also provide for security, guarantees and collateral to be supplied by either party — where one party to an agreement requires security to be supplied for use in the event that a net amount is owing to that party as a result of the operation of a netting agreement. It is sometimes the practice in the industry that two parties would have separate netting agreements in relation to interest rate, foreign exchange and commodity based contracts and, accordingly, master netting agreements are used to sum the outcomes of each netting agreement.
"Master netting agreement" is defined as any agreement where provision is made to offset the amounts due between two parties under a number of netting agreements. For operational reasons, two parties might have separate agreements in relation to their interest rate, currency and commodity based transactions but, in the event of the agreements being triggered, they would require that the net amount under each, in both directions, be aggregated. As with netting agreements, master netting agreements may contain provisions in relation to security, guarantees and collateral.
Section 2 deals with the powers of the Central Bank. The bank is given the power by this section to include in the definition of "financial contract" any contract included in Annex III of the solvency ratio directive or any contract added to same from time to time. The bank will give effect to any changes by the issuance of notice under this section. As I have already indicated, the definition of financial contract in the Bill is based on, but is more comprehensive than, Annex III of the relevant EU directive, so it is not anticipated that the bank will have to issue a notice under the section on enactment.
Section 3 deals with the powers of the Minister for Finance. The Minister for Finance is empowered to include, in consultation with the Central Bank, contracts or types of contracts within the definition of financial contracts. He is also empowered to exclude contracts within the scope of the definition — and therefore from within the scope of the legislation — whether or not they were included. The Minister exercises his powers under this section by issuance of regulations which must be laid before the Houses of the Oireachtas. As a safeguard, to ensure that contracts in Annex III are not inadvertently ruled out, any regulation by the Minister which excludes any contract from within the definition of financial contract cannot exclude any contract which has been included by the Central Bank under its powers at section 2.
Section 4 deals with the enforceability of netting, set off and collateral under netting and master netting agreements. This is the core section of the Bill. Subsection (1) (a) provides certainty, by disapplying any prohibitions which may exist in case law in bankruptcy, liquidation, examinership or receivership, or in the Companies Acts or the Bankruptcy Act, 1988, that netting is legally enforceable where a netting agreement exists. It also ensures that, where security guarantees and collateral are provided for in the agreement, a party will be entitled to use these against any net amount owing to it as a result of the netting provisions of the agreement. The provision is drafted so that its terms will apply to security in the form of money, securities, guarantees and secured guarantees, provided specifically to meet any net amount due under a netting agreement. Identical provisions are included in subsection (1) (b) in relation to enforceability of master netting agreements and security, guarantees and collateral given in relation to them.
Section 4 (2) ensures that the relevant rules of law and sections of the Companies Acts and the Bankruptcy Act, 1988, in particular, which deal with fraud, misrepresentation, etc., will not be set aside by subsection (1). It also seeks to ensure that neither a netting or master netting agreement can be enforced by virtue of section 4 where the terms of the agreement would render it void or unenforceable.
The final two subsections of section 4 provide for two other matters which are deemed necessary to remove doubt in relation to derivative trading in general. Section 4 (3) disapplies the provision in the Statute of Frauds, 1695, which obliges contracts with a duration of greater than one year to be committed to writing before being enforceable. This recognises the industry practice of screen to screen or telephone based trading, and that such trading is often in relation to two and three year contracts. Such contracts will now be immediately enforceable. Section 4 (4) clarifies, for the avoidance of doubt, that financial contracts are excluded from the scope of the Gaming and Lotteries Acts, 1956 to 1986, and that they always were excluded. Clearly, that legislation was never intended to apply to derivative contracts. Section 5 provides for the Short Title of the Bill.
I have tabled a number of amendments with which I will deal on Committee Stage. The majority of them arise from drafting changes only and, together with some others which seek to make explicit the intention of the legislation on guarantees, they serve to clarify the text as passed by the Dáil rather than add anything to the scope or powers provided for in the legislation.
The main purpose of the Bill is to ensure that banks and other parties trading in derivatives will have the certainty that netting agreements entered into by them for the purpose of reducing their risk exposure will be legally enforceable in the event of bankruptcy, insolvency or examinership, providing always that the agreements are properly drafted. The Bill will ensure, where security is provided by either party specifically to secure potential obligations in the event of a netting or master netting agreement being acted upon, that the security so provided can be set off against amounts owed to that party under an agreement.
My appointment as Minister of State with responsibility for the IFSC demonstrates the commitment of this Government to the continued development of Dublin as a financial services centre which can compete internationally. The decision by the European Commission to extend the deadline for new entrants to the centre by an additional six years coincided with the formation of this Government. This focused my attention on developing a strategy so that those extra years could be used to best advantage. Having said that, six years is a relatively short time. I am also intent on looking beyond that again, where appropriate, to seek to secure the long term expansion and development of the centre. To this end, I am currently engaged in a series of meetings with senior public sector and industry figures aimed at developing an agreed way forward to capitalise on the opportunities provided by the extension of the deadline.
There is still a very significant flow of new projects being brought forward by IDA Ireland. The desired expansion for the centre will come naturally as the number of IFSC companies builds, as the range of products and services on offer grows and as the experience and reputation of IFSC companies increases.
I have set the following objectives for the economic development of the centre. First, to substantially increase the level of direct employment from the current level, which is approaching 2,500, over the next five years to bring the total to between 4,000 and 6,000 — 6,000 is the figure I have in mind. Second, to create at least 1,000 jobs in related back office activity. The provision of 5,000 additional jobs over a five year period by these first two aims is a reasonable target. Third, to maximise consequential employment in associated legal, accounting and general services — such as software development and security, cleaning and catering — in the domestic economy.
In addition, I have set up a long term review group under my chairmanship, consisting of representatives at senior level from the Department of the Taoiseach, the Department of Finance, the National Treasury Management Agency and the IDA, to plan in a concerted way the long term development of the centre.
I am intent on taking a pro-active role in the development of the centre which has now achieved its critical mass stage and is accepted as a player on the international stage. With this in mind, I recently visited Boston and New York and met some of the most senior figures in the financial world, many of whom have interests in the IFSC or are interested in locating there, to hear at first hand their views on Dublin. It was clear to me that the chief executives of major companies are acutely aware of the centre and the benefits of locating there, and many of them visited Dublin to see for themselves.
I intend to appoint an international ministerial advisory committee to advise on realisable targets to ensure that the great progress made in establishing the IFSC continues to gain momentum and is maximised. As part of my overall strategy for the centre I intend to ensure that a continuous programme of legislative change, consistent with a well regulated environment, is maintained so that we can keep our competitive position. This Bill is one such step in that programme and I commend it to the House.