Portability is fundamental in the new FMI (financial market infrastructure) world of global derivatives. It is the ability to move transactions and collateral away from a defaulting participant in a clearing system in order to preserve the system and the market. In many countries, legal certainty is still an issue for this process. However, in Australia, legislative certainty is now on its way.
The Corporations and Financial Sector Legislation Amendment Bill 2013 (Cth) (a link is here) was introduced into the House of Representatives today. Amongst other things, the Bill proposes to amend the Payment Systems and Netting Act (PSN Act) to protect portability and security in clearing systems under Australian law. It is an important improvement in robustness of the legal framework supporting the operations and stability of financial markets clearing in Australia.
What is porting?
Porting is what happens when a participant in a clearing system defaults, and the participant’s transactions and collateral are moved to a participant who is not in default. It means that the transactions do not need to be closed-out and the collateral does not need to be enforced – which is the other alternative in dealing with participant default. Porting is most relevant to transactions entered into on behalf of clients, so that the transactions do not have to be affected by the participant’s default. For this reason, it has been identified by global regulators as vital when a participant defaults or is subject to insolvency proceedings. Also, legal certainty is critical for its operation. For example, the CPSS – IOSCO has said that a clearing house:
“should structure its segregation and portability arrangements in a manner that protects the interest of a participant’s customers and achieves a high degree of legal certainty under applicable law.”
Why is law change needed?
Despite the systemic policy objectives served by effective porting, it can give rise to issues under local insolvency laws if the defaulting participant is insolvent. This is because the rights of the defaulting participant could be regarded as (in part) its property, and dealing with that property, once insolvency proceedings have commenced could run against the provisions and policy of insolvency laws. It is this mismatch which can result in legal uncertainty in the operation of porting. This protection of porting from insolvency laws already exists in other “clearing” jurisdictions, such as in the United States and the United Kingdom. Currently, Australia does not have equivalent laws enabling porting to occur despite its insolvency laws (although such protection is already provided to close-out netting). As noted in the Explanatory Memorandum to the Bill:
“It is therefore necessary to amend the PSN Act to clarify that the porting of positions, including associated collateral, in the case of a default or insolvency of a participant is allowed, regardless of provisions in other legislation, including the Corporations Act.”
How would the Bill change the law?
The Bill amends the last part of the Payment Systems and Netting Act, which is the part which deals with “market netting contracts”. These are contracts of a “netting market”, being a financial marketplace which has been approved (and the rules of which have been approved) by the Australian regulators. The current provisions protect the close-out netting provisions of the rules of a netting market from Australian insolvency laws. The amendments proposed in the Bill extend the existing strong protection given to the close-out netting provisions to the dealing with rights, obligations and property in accordance with the netting market rules (which is what happens in ‘porting’), and also the enforcement of security contained in those rules. The intention is that these arrangements work in accordance with the rules despite other laws, including insolvency laws. The strength of this protection against insolvency law demonstrates the systemic importance of these approved markets and is consistent with the level of protection offered under equivalent foreign regimes. The Explanatory Memorandum to the Bill summarises this:
“The reason for providing this type of powerful authority to the provisions of the PSN Act is that the systems, activities and arrangements it covers are at the heart of the financial system. Ensuring that they have validity, including in situations where one of the parties enters insolvency, is considered fundamental to protecting the stability of the financial system.”
What happens next?
The timing for the passing of the Bill is not clear. Hopefully, the importance which it has to the maintenance of financial market infrastructure in Australia, and the use of overseas infrastructure by Australian entities, will mean that it will be enacted promptly. If so, Australian institutions will be well placed to establish, and participate in, the financial market infrastructure which is intended to assist in ensuring that the global financial crisis remains a thing of history.