GOVERNMENT MOVES TO PROTECT DERIVATIVES INVESTORS AGAINST BANKRUPTCY OF INTERMEDIARIES

The Dutch government has published a consultation document on the legislative proposal for the Financial Markets Amendment Act 2016 (Amendment Act). 

The Amendment Act contains new rules regarding the protection of derivatives investors in the case of the bankruptcy of their intermediary (a bank, investment firm or clearing institution, hereinafter the Intermediary). The purpose of this Amendment Act is to segregate the Intermediary’s other funds from the derivatives positions entered into for the benefit of its clients with a third party. 

The proposed effective date of the Amendment Act is 1 January 2016. 

Background

In 2004, the Markets in Financial Instruments Directive (MiFID) became effective. Article 13 (7) of MiFID requires that an investment firm shall, when holding financial instruments belonging to clients, make “adequate arrangements so as to safeguard clients’ ownership rights, especially in the event of the investment firm’s insolvency”. 

In practice, implementation of this obligation in the Netherlands has been rather complex with regard to derivatives. This is due to the fact that derivatives positions an Intermediary enters into or manages on behalf of clients are not separated from the other assets and liabilities of the Intermediary (legal structures such as trusts do not exist in Dutch legislation).

In 2005 this problem arose during the bankruptcy of Van der Hoop Bankiers (a Dutch bank). Clients with derivatives positions were not protected against the bank’s bankruptcy: the claims brought against the bank with regard to their derivatives positions were considered as a part of the assets of the bank in liquidation. They could only present their claim to the receiver. 

To rectify this situation, a legislative proposal was introduced in 2009 to make it possible to transfer derivative positions to another Intermediary in the case of bankruptcy. The draft legislative proposal was met with criticism and was withdrawn by the Dutch government. In 2012 a new attempt was made to protect derivatives’ holders against the bankruptcy of their Intermediary, but this proposal was also withdrawn by the Dutch government. 

However, in the same year (2012), the European Market Infrastructure Regulation (EMIR) was introduced. EMIR requires, amongst other things, that central counterparties ensure that they are authorised to transfer the derivatives positions of defaulting clearing members affiliated to the same central counterparty to a non-defaulting clearing member. In cases where the remainder is in default as a result of the bankruptcy of the clearing member, such transfers are not automatically possible, at least not without the cooperation of the receiver, according to Dutch insolvency law as it stands. As a result, some central counterparties exercise restraint in entering into a relationship with Dutch clearing members, because they fear they are not able to comply with the demands of EMIR. 

In view of the above, the purpose of the proposed Amendment Act is, on the one hand, to keep the derivatives positions of clients outside the bankruptcy of their Intermediary and consequently to protect clients against bankruptcy, and, on the other hand, to arrange that the derivatives positions and the accompanying security held by clients can be transferred to a solvent Intermediary without complications. For that purpose, the separation of a part of an Intermediary’s funds is the most important instrument. 

Segregation of Derivatives Funds

Based on the present legislative proposal, a new regime will be incorporated in the Dutch Securities Book- Entry Administration and Transfer Act (Wet giraal effectenverkeer). All derivatives positions that an Intermediary enters into for the benefit of its clients with a third party are separated from the funds of the Intermediary. All rights and obligations arising from the derivatives positions that the Intermediary has entered into for the benefit of its clients fall within the separated derivatives funds, usually known as the ‘corresponding position’. This position concerns both the rights and obligations arising from the positions, as well as the  rights and obligations from exchanging securities.

The components of these separated funds are reserved to serve as settlement under the related derivatives positions of clients (in general named ‘client positions’).

Entering into a corresponding position can be based on various legal concepts. Irrespective of the various legal concepts, the corresponding positions of an institution are part of the separated derivatives funds, if and as long as the corresponding position is related to a client position. Which corresponding position belongs to which derivatives position entered into by a client must be evident from the Intermediary’s administration.