In its "netting ruling", the Ninth Civil Panel of the BGH, which is responsible for insolvency law, decided that settlement arrangements which were concluded by parties to equity option transactions for the event of insolvency of one of the parties and were incompatible with section 104 of the InsO were invalid. Instead, section 104 of the InsO was directly applicable, according to the ruling.

The new version of section 104 of the InsO now guarantees legal certainty with regard to the protection in the event of insolvency of contractual close-out netting clauses and their compatibility with the requirements of European supervisory law, thus averting danger to the international competitiveness of German institutions and market participants as well as to the functioning of the capital markets.

Immediate reactions from BaFin and federal ministries

The same day the BGH released its ruling, BaFin reacted by issuing a temporary general administrative act based on section 4a of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG), pursuant to which netting agreements within the meaning of Article 295 of the European Capital Requirements Regulation (CRR) were still to be settled as agreed by the counterparties (see BaFinJournal of June 2016). This was intended to counter the uncertainties which arose as a result of the ruling regarding the supervisory recognition of netting clauses in master agreements on financial futures transactions and other possible negative consequences for the financial markets.

The Federal Ministry of Finance and the Federal Ministry of Justice and Consumer Protection also published an announcement along similar lines on 9 June 2016. It stated that if necessary, the German government would initiate a legislative clarification in order to ensure that in Germany, as in all EU Member States, financial futures transactions could be validly incorporated into the standard master agreements.

Subsequently, the government presented a draft bill to amend section 104 of the InsO to the effect that netting clauses could be agreed that were protected against insolvency and also met the requirements for supervisory recognition – for example, pursuant to Article 296(2)(a) and Article 178 of the CRR – in full. This provision was accepted without changes into the law which was promulgated on 28 December 2016 in the German Federal Law Gazette and entered into force, partly retroactively.

Possible arrangements for netting agreements

A core element of the amendment to the law is that the new section 104 (4) of the InsO explicitly allows the possibility for contracts to diverge from the usual legal situation for the settlement of netting agreements as long as this is compatible with the basic principles of the legal provision. Specifically, the law provides for a permissible deviation under which the settlement takes place at the time the request to open insolvency proceedings is made at the market or exchange prices valid at the time, i.e. generally before insolvency proceedings are opened.

This solves a key problem of the netting ruling, since in the grounds for its decision the BGH initially left open the possibility of settling financial futures transactions prematurely, for example, when making the request to open insolvency proceedings, but at another point the grounds for the decision assumed, at least incidentally, that the market or exchange price after the opening of insolvency proceedings had to be decisive.¹ But in that case, the settlement could have been exposed to significant price fluctuations in the meantime.

This is questionable, not least under European law, because Article 7 of the European Directive on financial collateral arrangements obliges Member States to ensure that a close-out netting provision can "take effect in accordance with its terms".

The objection is sometimes raised in the legal literature that this is merely intended to ensure the essential validity of netting clauses and not any sort of deviation from binding insolvency law whatsoever.² However, the grounds for the decision caused a situation for the financial industry in which it found itself no longer able to conclude netting agreements which were both valid under insolvency law and met the supervisory requirements of the CRR.³ For example, Article 178(3) of the CRR evidently assumes that the ending and settlement of contracts before opening insolvency proceedings – in particular when making the request for insolvency – must also be a valid possibility. Against this backdrop, the majority of the legal literature also established a need for legislative clarification⁴, upon which the justification for the government draft is also based.

List of financial services (Finanzleistungen)

In addition, in the course of the revising of the InsO, the list of examples of financial services (Finanzleistungen) was updated (section 104 (1) sentence 3) in order to adapt it to the current state of financial market practice and regulation.

Footnotes