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BaFin reduces risks under BGH judgment on netting agreements

On 9 June 2016 the German Federal Court of Justice (Bundesgerichtshof, BGH) held a contractual close out netting provision ineffective for deviating from mandatory German law (File No. IX ZR 314/14). The claimants had a dispute with an English Lehmans entity on the close out amount in relation to two equity option transactions over SAP shares after the defendant's insolvency.

Under the contractual netting provision between the parties, based on the German Master Agreement for Financial Derivatives Transactions (the Master Agreement), the close out amount is based on the market price of the shares on the date of filing for insolvency proceedings. Section 104(3) of the German Insolvency Act, however, requires the parties to agree on a point in time no later than five working days after the opening of the insolvency proceedings. In the absence of such an agreement, the second working day after the opening of the insolvency proceedings is used as the relevant point in time. In addition, the netting provision limited the financial benefit to be compensated by the solvent party to the loss which the insolvent party suffered.

The BGH decided that German statutory law did not permit these deviations in the netting provision, and the statutory default rule prevailed over the netting provision. The BGH referred the case back to the Frankfurt Higher Regional Court for determining the market price of the shares on 17 September 2008, the second day after the insolvency proceedings were opened.

Immediately after the judgment was rendered, the German Federal Ministries of Finance and of Justice jointly announced their intention to initiate, promptly, legislation to clarify the relevant insolvency law provisions or to make them more precise. First, they will assess whether the judgment has a broader impact, beyond the individual case, on the Master Agreement being accepted in the market and by the supervisory authorities. The ministries wish to ensure that the common master agreements remain accepted.

Also, the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdiensleistungen, BaFin), issued a general administrative act (Allgemeinverfügung), establishing that contractual netting agreements under the Capital Requirements 

Regulation (Regulation (EU) No. 648/2012) must continue to be settled as contractually agreed. The BaFin stated that this was to ensure legal certainty as the new legislation will take some time. The BaFin may issue orders to eliminate or prevent undesirable developments that may be detrimental to the stability of financial markets or undermine confidence in their proper functioning.

Legal and Regulatory Risk Note