|The Jolly Contrarian’s Glossary |
The snippy guide to financial services lingo.™
The Good Lord bless the netting opinion, for no-one else, who yet has spring left in its mortal coil, will.
It is, but is not just, a legal opinion — at the best of times a dreary, charmless and pointless affair — but one addressing one of the most soul-obliterating questions a grown adult could pose: whether an insolvency administrator of an insolvent counterparty of a certain type, in a certain jurisdiction, would be obliged to respect the close-out netting provisions under your master trading agreement should that counterparty go bust.
Because God — manifesting Herself this time in the guise of the Basel Committee on Banking Regulations and Supervisory Practices — has played a cruel cosmic joke on all inhouse lawyers. By diktat of the latest Basel Accord they must diligently read and draw reasoned conclusions from these God-forsaken tomes for each counterparty type, in each jurisdiction in which they do business, for each master trading agreement they trade under, so that their firm’s financial controllers can recognise balance sheet reductions as a result.
Netting opinions tend to be long, academic, laden with hypotheticals, appealing to Latinate principles of civil law and demanding of unusually skilled powers of comprehension and patience — they are required by regulation to be, in fact — but when it comes down to it, they all say the same thing: that close-out netting is, ultimately, enforceable: because a netting opinion would have no reason to exist if it said anything else.
And so, the netting opinion will say what you know to be true, at gruesome length, clothed in ambiguity and decorated with its own peculiar vocabulary. The following confection, uttered in any other context, would invite a bunch of fives, but it will go unchallenged in a netting opinion:
- “According to legal literature, forward contracts (marchés a terme) are synallagmatic (that is, the parties enter into mutual commitments, each binding itself to the other) and onerous contracts (that is, one party gives or promises something as a consideration for the commitment of the other party) and contain an aleatory element (contrat aléatoire).”
Continental lawyers will immediately recognise this terminology. They will tell you it stems from the Roman tradition, or some codex developed by a monk while Hannibal’s elephants trekked through the Dolomites, or something like that. Now we all have our legal folklore, and this is theirs: they learned it during their decades-long internment at the Faculté de droit de Paris. It is their snail in a gingerbeer; their negligent navigation of a flooded roadway by punt; their liability for a naturally ferocious domestic beast which escapes down your mineshaft.
And, make no mistake, across the ditch there is a strain of lawyer who quietly resents the tidal-wave of Anglo Saxon jurisprudence that has deluged the continent for its cross-border business. That the commercial affairs between a Belgian and an Italian should be adjudicated before the courts of England and Wales is a festering point. And he is just the sort to make his living — and thereby extract his revenge on the common law tradition — writing netting opinions.
And be assured that this ressentiment runs deep. For, when even a righteously incensed juriste must surely have had enough — as you leaf past page 93, hoping for sight of the first annex — you will find only a new section detailing specific rules protecting claims under the Insurance Sector Act. You will see this and you will beat your fists on the ground, your voice will crack and you will cry, “WHY ARE YOU EXPOSTULATING ON THE TOPIC OF FIRE AND GENERAL INSURANCE I SIMPLY DO NOT UNDERSTAND IT”. But box on you must, and you know that this avocat à la cour, in his pork-pie hat, will be enjoying a sweet pastry and schnapps with his friend the Belgian dentist , and as they clink glasses they will be thinking of your toil and torment, and they will be enjoying every goddamn minute of it.
Also, it is a fact, that no insolvency administrator, anywhere in the world, in the history of the world, has ever actually successfully challenged the netting down of offsetting transactions under a derivative trading agreement — or so far as this commentator knows, even tried to — because that would be a patently stupid thing to do, even by accident.
Netting opinions are mandated by CRE53 of Basel III —“internal models method for counterparty credit risk”. As of Early 2020 these provided, at CRE53.64:
- 53.64 The bank has written and reasoned legal opinions that conclude with a high degree of certainty that, in the event of a legal challenge, relevant courts or administrative authorities would find the bank’s exposure under the Cross-Product Netting Arrangement to be the Cross-Product Net Amount under the laws of all relevant jurisdictions. In reaching this conclusion, legal opinions must address the validity and enforceability of the entire Cross-Product Netting Arrangement under its terms and the impact of the Cross-Product Netting Arrangement on the material provisions of any included bilateral master agreement.
- (1) The laws of “all relevant jurisdictions” are: (i) the law of the jurisdiction in which the counterparty is chartered and, if the foreign branch of a counterparty is involved, then also under the law of the jurisdiction in which the branch is located, (ii) the law that governs the individual transactions, and (iii) the law that governs any contract or agreement necessary to effect the netting.
- (2) A legal opinion must be generally recognised as such by the legal community in the bank’s home country or a memorandum of law that addresses all relevant issues in a reasoned manner.
Note: The bank “has” written and reasoned legal opinions. Earlier iterations contemplated the bank being able to produce, if asked, such opinions.
Industry associations and law firms must do better
Given how hateful the process of reviewing and applying netting determinations is, it is a mystery of modern finance and an outright failure of free-market capitalism that the process of obtaining these opinions is as much of a bugger's muddle as it is, but it is. Two constituencies, only, gain from the netting opinion process: those law firms who write them, and the industry bodies which have fashioned an entire cottage industry out of commissioning them. Here, in a piece of contrarian advocacy, are some simple steps one could take to make the process better. This might dent the annual revenues of our learned friends, but it is hard to muster any tears about that.
If you are must write a 120-page opinion — and our learned friends would say, “we must: that is what a “written and reasoned” opinion means”, then at the very least, provide a curt summary at the front including a table with yes/no recommendations.
Now it goes against the grain for lawyers to get to the point, of course — bright line tests are for the birds — but ultimately their clients must make yes/no decisions, they must do that based on these opinions, and a verbose screed that labours over aleatory contracts, and spends pages defining what company is not, is of very little use to that endeavour.
How is it any more reassuring for the ongoing stability of the financial system that firms spend their time interpreting not the content of their legal agreements, but the content of legal opinions about their legal agreements?
Make it machine-readable
Providing a 120 opinion — especially one without a summary — as a locked, scanned, tiff image that cannot even be searched for words like “aleatory” speaks to a humour of the blackest and most wicked kind. We are two decades into the twenty-first century, friends.
Bizarrely, giant financial institutions who are past masters at, well, “relentlessly jamming their blood funnels into anything that smells like money”, give the industry associations they fund a free pass. This is so out of character as to make us wonder whether compromising photographs are involved.
You would like to think the FIA, ISDA, ICMA and ISLA would fall over themselves to prove their respective worths serving their largely common memberships by co-ordinating such a profoundly tedious exercise, gathering, summarising and articulating opinions — especially since the bulk of each opinion (the general review of each jurisdiction’s insolvency regime and general application of set off and netting) is common to all of them. (the question “is a single agreement enforceable as a matter of basic contract law?” is not, for most lawyers, an especially difficult one to answer).
But no: not only do these associations jealously prosecute their own netting opinion programmes, asking the same questions about the same jurisdictions and same legal entities, only in subtly different ways, they don’t even go to the same firms. In Luxembourg, ICMA uses Clifford Chance, the German Banking Association Allen & Overy and ISDA uses Allen & Overy for some and Linklaters for the others. Why would anyone be so wasteful? (The stock answer given: competition laws!)
So here’s the thing, friends: netting opinions are — to put it bluntly — a paranoid anachronism dating back to the prehistoric time of The First Men, when swaps were new, apparently comprised of fearful magic, and there was terror as to what they could do. Swaps are now part of the fabric of the space-tedium continuum. No insolvency administrator has so much as tried to pull one apart in 40 years, in any jurisdiction, however ropey its grasp of the principles of sound financial governance. Yet we contrive to let third-party bureaucrats we have appointed waste our time, resources, risk monitoring capacity and most importantly money, without a second glance?
If we have to have these fantabulous regulations, at least be efficient in how we handle them.
- What this seems to be saying is these derivative contracts involve binding mutual obligations — in other words, they are contracts — and consideration — in other words, they are contracts — and those mutual obligations are referable to unpredictable (“aleatory”) events beyond the control of the parties — in other words they are derivative contracts.
- Being the dim light in a tunnel containing 17 of the blessed things.
- I know what you are thinking: that shows what a prudent process netting compliance is. May I direct you to my favourite elephant joke?