Government of India Volume I: Analysis and Recommendations

FOUNDATIONS OF CONTRACTS AND PROPERTY
Table of Recommendations 13.1 Insurance contracts
With respect to insurance law, the Commission recommends:
1. Consumers must have a duty of good faith obligation towards the insurer;
2. The regulator should be able to make an insurable interest mandatory for only specified types of insurance
contracts;
3. The law should allow free assignment of insurance contracts subject to anti-fraud restrictions placed by the
regulator;
4. Adequate consumer protection regulations should be placed in the law requiring notice of impending default
of insurance contracts due to non-payment of premium; and
5. The duties of the insured and the insurer in the various events arising out of subrogation must be clearly
stated in law, in accordance with relevant Supreme Court rulings.
Table of Recommendations 13.2 Defining securities
To define securities, the Commission recommends:
13.2.2. Securities
1. Securities must be defined in two parts;
2. The first part is the test of a freely transferable financial interest.
3. The second part is an illustrative list of securities;
4. The government should be allowed to add more securities to the illustrative list and financial markets develop
and the innovation creates new securities.
Defining what constitutes securities has been a challenge in many jurisdictions. The Commission
found that the test depends on the free transferability of the instrument which
leads to the creation of markets. Table 13.2 provides the recommendations of the Commission
on defining securities.
Financial derivatives contracts are transactions, where parties agree that one party
will pay the other a sum determined by the outcome of an underlying financial event such
as an asset price, interest rate, currency exchange ratio or credit rating. Such contracts
help in raising and allocating capital as well as in shifting and managing risks. Derivative
contracts may be exchange traded or non-exchange traded, the latter being referred to
as OTC. They may be standardised or non-standardised.
At the moment, there are certain complexities in enforcing derivative contracts. Section
30 of the Indian Contract Act, 1872 renders all wagering contracts void. Financial
derivatives may be rendered unenforceable because of this provision. Exceptions to this
rule have therefore been carved out through special legal provisions. Section 18A of the
Securities Contracts (Regulations) Act, 1956 and Chapter III-D of the Reserve Bank of India
Act, 1934 (introduced by the RBI Amendment Act, 2006) are examples of such special
provisions. The Commission is of the view that for legal certainty in the enforceability of
financial derivatives, an exception to the general application of section 30 of the Indian
Contract Act, 1872 must be clearly specified in the law in a more general way.
The Commission has reviewed the question of requiring central clearing of OTC derivatives.
Internationally, after the financial crisis in 2008, there has been a marked shift in
favour of centrally cleared OTC derivative trading. In light of the positions taken by the G-
20, both the European Union and the United States (US) have moved towards a regulatory
framework for OTC derivatives trading that encourages central clearance. The Commission
recommends that the regulator should have sufficient discretion to authorise such
a position as and when required.
The Commission also reviewed the issue of inheritance of securities and other financial
products. It found that the issues of inheritance should not create undue burdens
on intermediaries who hold securities on behalf of the deceased. For example, property
FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION 121