Country report: The Anguilla Netting Act 2006

By Arlene N L Ross, associate, Webster Dyrud Mitchell

The Anguilla Netting Act was enacted on October 19 2006 as part of the government’s ongoing efforts to strengthen its financial services legislation and ensure the competitiveness of its financial institutions in the global market. The Act is based on the International Swaps and Derivatives Association’s Model Act.

Prior to passage of the Act, the prevailing view was that close-out netting was enforceable in Anguilla. The Netting Act essentially codifies this view and now provides statutory support for the enforceability of close-out netting. Legal certainty is now assured – and derivatives market participants can take comfort from a clear and unequivocal statutory recognition of derivatives trading under contracts such as those based on ISDA’s Master Agreements.

Through close-out netting, this legislation will allow financial institutions to calculate their exposure with Anguilla counter-parties on a net rather than a gross basis. If a party is able to net its liabilities against its assets, its overall credit risk is considerably reduced. The reduction of credit risk in Anguilla should encourage leading international financial institutions to increase their credit lines to Anguilla counter-parties.

The Netting Act is very relevant for hedge funds, thereby contributing further to Anguilla’s position as an attractive financial-services jurisdiction. Anguilla is now ideal for the domiciliation of hedge funds engaged in derivative investments and other high-risk investment portfolio strategies.

What is netting?

Netting is used by counter-parties to reduce their exposure to risk. It is a process that enables institutions to settle only the net position with one another at the end of the day, in a single transaction, not trade by trade. It involves the offsetting with a counter-party of financial obligations one owes against those one is entitled to receive, thus reducing the costs arising out of payments settlements and maintaining a net rather than a gross asset or liability on the balance sheet.

The Anguilla Netting Act defines netting as the occurrence of any of the following:

The termination or acceleration of any payment or delivery obligations or entitlements under one or more qualified financial contracts entered into under a netting agreement;
The calculation or estimation of a close-out value, market value, liquidation value or replacement value in respect of each obligation or entitlement terminated or accelerated under above (1);
The conversion of any values calculated or estimated under above (2) into a single currency;
The offset of any values calculated under above (2), as converted under above (3).

While netting takes several forms, the two forms widely employed in the derivatives markets are payment netting and close-out netting. Payment netting reduces settlement risk and streamlines processing. If counter-parties are to exchange multiple cash flows during a given day they can agree to net those cash flows to one payment per currency.

Close-out netting reduces pre-settlement risk. Close-out netting is a contractual arrangement to settle all ‘contracted but not yet due liabilities’ to (and claims on) a counter-party by one single payment, immediately upon the occurrence of one of a list of defined events, such as insolvency. If counter-parties have multiple offsetting obligations to one another they can agree to net those obligations. If a counter-party defaults, or some other cause for termination occurs, the outstanding contracts are all terminated. Close-out netting is therefore a contractual device to reduce the risk of an insolvency of a counter-party.

The Act

The Anguilla Netting Act 2006 comprises six sections. The first contains the definition of terms used in the Act. These terms include ‘netting agreement’, ‘qualified financial contract’, ‘global net payment obligation’ and ‘global net payment entitlement’. The term ‘netting agreement’ is given a very broad definition. The term ‘qualified financial contract’ is also given a broad definition.

Sections two and three deal with the enforcement of bilateral netting agreements. The sections provide, among other things, that the only obligation or entitlement due to or from a party to a netting agreement is its net obligation or entitlement as determined in accordance with the terms of the agreement. These sections also contain provisions that protect collateral arrangements in the
event of insolvency and seek to
limit the power of a liquidator to assume or to repudiate qualified financial contracts at his option,
in disregard of the netting arrangement. These sections also
seek to prevent laws generally prohibiting set off from being interpreted in such a way as to interfere with the operation of netting. Similarly, payments under qualified contracts are protected from being treated as preferences in the absence of evidence that such payments were made with the intent to hinder, delay or defraud other creditors. Such statutory protection is intended to ensure that collateral takers realise collateral quickly.

Section four deals with the specific issues arising under netting agreements that include multi-branch close-out netting. It provides for the calculation of a single net termination amount on both a global and a local basis following the termination of a multi-branch master agreement. A liquidator will only be liable to pay to a non-defaulting counter-party the lesser of the global net payment obligation and the branch or agency net payment obligation.

Sections five and six provide for the making of regulations pursuant to the Act and for citation as ‘The Netting Act 2006’.

Under the Netting Act it is now certain that close-out netting would be enforceable in the event of voluntary or involuntary winding up proceedings in Anguilla. If close-out occurs – or is deemed to occur after the date of commencement of a winding up – the close-out netting will still be enforceable.

The Anguilla Netting Act assures the enforceability of close-out netting transactions in Anguilla. There is now definite legal certainty and current market participants are protected from risks associated with international insolvencies. The Netting Act should serve to attract foreign participants and counter-parties to the Anguilla financial marketplace.