24.06. 2011 Ministarstvo financija Republike Hrvatske mr.sc ... - ISDA

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use those tools for such purposes, but also many governments around the world via their statetreasuries manage their public debt by using interest rate swaps, currency swaps and variousrelated instruments. It is also quite common for state owned entities like large energyproviders (electricity utilities companies, oil producers etc.) and various state agencies andmunicipalities to use such instruments in order to manage the risks they are exposed to(particularly the risk related to the change of the market interest rates and the foreignexchange risk).For several years ISDA has been closely observing the development of OTC derivativesregulation in the Republic of Croatia. Cross-border transactions with Croatian counterpartieshave been growing steadily recently. We are delighted to see that the Croatian Ministry ofFinance and the Croatian National Bank have made significant progress and valuableimprovements in the Croatian legal system in respect of OTC derivatives, netting, financialcollateral and capital adequacy regulation. However, ISDA has noticed that it has been quitecommon to the majority of former and current EU accession countries come across certainissues when implementing specialized regulation regarding financial markets. This is due tothe fact that myriad EU directives have to be implemented in a very short period of time. Thisoften causes inconsistencies in the respective country’s legal system. In this context ISDA hasmade several observations on possible inconsistencies in the Croatian legal system in terms ofnetting in bankruptcy and around the regulation of financial collateral. These inconsistencieshave a serious effect on the financial markets as well as legal certainty. We would thereforerespectfully suggest that these issues be looked at by the Croatian authorities as soon aspossible.We understand that the Croatian Ministry of Finance intends to amend the FinancialCollateral Law, Official Gazette No. 76/07 (Croat.: “Zakon o financijskom osiguranju”,Narodne novine br.76/07) in the near future. ISDA is keen on entering into a dialogue withthe Croatian authorities in view of the forthcoming implementation of the amending Directive2009/44/EC of the European Parliament and Council of 6 May 2009. This occasion provides agreat opportunity to address some legal issues which are currently standing in the way of fulland unfettered recognition of close-out netting and financial collateral arrangements with alltypes of Croatian counterparties for regulatory purposes. This would result in a significantimprovement of the Croatian legal regime and would allow international market participantsas well as the Republic of Croatia and Croatian counterparties that participate in theinternational financial market to benefit from a higher degree of legal certainty.Having worked with regulators in jurisdictions around the world to promote legalenforceability of the close-out netting mechanism in the ISDA Master Agreement, (theleading standard form documentation for international OTC derivatives transactionsworldwide 2 ), we hope ISDA’s assistance could prove useful to you.Please allow us to briefly outline the main legal issues we have identified with regard toCroatia and provide a few suggestions for legal reform. We hope that you find theseappropriate in the interest of achieving a safer and more certain legal environment whichbenefits local and international market participants and the Croatian economy as a whole.What is close-out netting?Most contractual documents that are widely used in international financial derivative marketsare drafted as a type of master or framework agreement (such as the ISDA MasterAgreement). Each of these master agreements is designed as a master netting agreement2 ISDA has published five forms of the ISDA Master Agreement: (i) the 1987 ISDA Interest Rate Swap Agreement; (ii) the1987 ISDA Interest Rate and Currency Exchange Agreement; (iii) the 1992 ISDA Master Agreement (Local Currency – SingleJurisdiction); (iv) the 1992 ISDA Master Agreement (Multicurrency – Cross Border); and (v) the 2002 ISDA MasterAgreement.
under which the parties can enter into a number of different trades and, on close-out, calculatethe net exposure between the parties under all of these trades. Close-out netting in relation toOTC derivative transactions refers to the ability of a party under a master agreement for suchOTC derivative transactions (such as an ISDA Master Agreement) to net the mark-to-marketvalues of all existing transactions under the master agreement upon their early terminationfollowing the default of its counterparty or other specified events.Closely related to the issue of close-out netting are financial collateral arrangements under theFinancial Collateral Directive. Under a financial collateral arrangement, the obligation to paya net close-out amount is further secured by provision of financial collateral (cash, securitiesor credit claims). This is an additional means by which market participants minimize theircredit risks on derivative transactions, and thus systemic risk.The benefits of close-out netting and financial collateral arrangementsThe benefits of close-out netting and financial collateral arrangements are risk reduction andcost reduction. The risk reduction is twofold: reduction of credit risk and the consequentreduction of systemic risk. By reducing credit risk at each node in the network ofrelationships between market participants, close-out netting also has an important positiveeffect on systemic risk. Recognizing the value of close-out netting, the G10 central banks andcentral banks of other jurisdictions (including Croatia) may permit, subject to prudentialconditions, the recognition of netting for capital adequacy and large exposure purposes(leading to cost reduction).Close-out netting and financial collateral arrangements have proved to be extremely helpful inmitigating the impact of the current global economic crisis on all market participants (thecredit risk upon insolvency of a derivative counterparty being reduced to a net amount duebetween the parties, or even to zero where collateral has been transferred to cover the netexposure). The March 2010 report of the Basel Committee/FSB Cross-Border BankingResolution Group makes reference to this fact 3 .The particular benefits of an efficient legal framework for close-out netting and financialcollateral arrangements in the Republic of Croatia would include:(i) A cost cutting effect on derivatives pricing, benefiting Croatian clients using derivatives tohedge their business risks;(ii) Competitive advantage of lower capital adequacy requirements for Croatian financialinstitutions;(iii) Increased predictability of legal treatment and a safer legal environment in general(which is a valuable asset for attracting foreign investments);(iv) The incentive for a wider use of derivative instruments allowing Croatian businesses(also including the state treasury) to hedge their risks in the most efficient and secure way, inthe interest of the economy as a whole; and also(v) Close-out netting effectiveness is likely to encourage a wider use of master agreements inthe Republic of Croatia which would, close-out netting aside, allow the establishment of amore stable and foreseeable contractual basis for long term business relationships and set up asafe legal environment fostering product innovation (which then leads to the reduction oflegal risk by using standardized documentation templates for all kinds of financial products,including developing products such as trading in emissions allowances).3 http://www.bis.org/publ/bcbs169.htm
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Page 38 and 39: APPENDIX DArticle 353 of the Credit

24.06. 2011 Ministarstvo financija Republike Hrvatske mr.sc ... - ISDA

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