] 
Background
Financial institutions, central banks and other participants in the financial market in their daily operations apply a variety of mechanisms designed to reduce their exposure to the insolvency of a counterparty. First, they use various types of security interest, or collateral, e.g. in the form of guarantee, pledge, hypothec, charge or transfer of title. Second, since the early 1990s, they have been using close-out netting.
Regulatory authorities (most recently, the Financial Stability Board (FSB) and the Cross-border Bank Resolution Group of the Basel Committee on Banking Supervision) strongly encourage the use of close-out netting arrangements (alongside collateral) because of their beneficial effects on the stability of the financial system. As these techniques are capable of reducing counterparty risk, both collateral and close-out netting are also taken into account to determine a financial institution’s capital ratio under the Basel II and III Accords.
The notion of close-out netting is a relatively new addition to the legal terminology. Broadly speaking, close-out netting is often understood as resembling the classical concept of set-off applied upon default or insolvency of one of the parties. However, close-out netting encompasses many additional elements and is functionally and conceptually different from traditional set-off. A close-out netting mechanism comes into operation either by a declaration (‘close-out’) of one party when a pre-defined event happens, in particular default or insolvency of its counterparty (‘termination event’), or it is triggered automatically when such an event occurs (‘automatic termination’). The mechanism extends to a number, often hundreds, of financial contracts between the parties that are contractually included in a netting agreement.
Upon close-out or automatic termination, all covered contracts are terminated and the market value of each is determined under a pre-defined valuation mechanism. The sum value of all contracts is then aggregated, resulting in one single payment obligation (‘net amount’). The net amount remains the only obligation to be settled and is generally due immediately after being determined.
Close-out netting, as a new concept, initially faced obstacles in a number of jurisdictions. In particular, it used to conflict with ‘cherry picking’ powers of insolvency administrators, i.e. the right to chose amongst the executory contacts those that are favourable for the insolvency estate and therefore have to be performed. Since the 1990s, some 40 jurisdictions, amongst them nearly all important financial markets, have recognised the positive effect of netting on the stability of the market and changed their legal framework so as to accommodate this new legal concept.
However, in recent years, financial markets have become much more international. Consequently, the two parties to a netting agreement are often located in different jurisdictions. In the event of insolvency of one of the parties it might be unclear whether the close-out netting agreement remains enforceable, in particular if it is governed by the law of the other party or the law of a third country. This doubt as to the enforceability of close-out netting agreements in a cross-jurisdictional context has negative repercussions on the risk assessment of financial institutions. If a close-out netting agreement were to be held to be unenforceable by a court, the other party might face severe financial losses and fall insolvent itself. If the same type of close-out netting agreement is used in a wider market, such effects can even become systemic.
Project status
At its 67th session (Rome, 1 December 2010) the General Assembly of UNIDROIT approved the work programme for the triennium 2011-2013 and endorsed the recommendation of the Governing Council concerning the development of an international instrument on netting and assigned the highest level of priority to this subject.
UNIDROIT
has commissioned a study assessing the extent of legal risk arising out
of situations involving cross-jurisdictional netting and identifying
the causes of legal obstacles to the proper operation of netting
agreements. Additionally, the study explores possible solutions and
appropriate steps to take, if any. [Preliminary
draft Report on the need for an international instrument on the
enforceability of close-out netting in general and in the context of
bank resolution ]
The Secretary General of UNIDROIT set up a Study Group of renowned experts in the law of international financial markets which met in April 2011, in September 2011 and in February 2012. The Study Group established a set of draft Principles regarding the enforceability of close-out netting provisions.
At its 91st session (Rome, 7-9 May 2012), the UNIDROIT Governing Council endorsed the proposal of the Secretariat to convene a Committee of governmental experts for further consideration and finalisation of these draft Principles for adoption by the Governing Council. The Committee of governmental experts met for two sessions, in October 2012 and March 2013 respectively. At its second meeting (4-8 March 2013), the Committee of governmental experts approved a revised set of the Draft Principles as Draft Principles on the Operation of Close-out Netting Provisions.
The UNIDROIT Governing Council, at its 92nd session held from 8 to 10 May 2013, adopted the Principles on the Operation of Close-out Netting Provisions retaining the text of the provisions as prepared by the Committee.
Documents of the Governing Council, 92nd session, 8 – 10 May 2013
UNIDROIT 2013 – C.D.(92) 6 (a)
Adoption of the Principles on the Operation of Close-out Netting Provisions.
Documents of the Committee of governmental experts, second session, March 2013
C.G.E./Netting/2/W.P. 1
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. Second session, Rome, 4-8 March 2013. Annotated draft agenda - December 2012.
C.G.E./Netting/2/W.P. 2
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. Second session, Rome, 4-8 March 2013. Draft Principles regarding the enforceability of close-out netting provisions - December 2012.
C.G.E./Netting/2/W.P. 3
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. Second session, Rome, 4-8 March 2013. Revision Notes - December 2012.
C.G.E./Netting/2/W.P. 4
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. Second session, Rome, 4-8 March 2013. Joint proposal by the Governments of France, the United Kingdom and the United States of America - January 2013.
C.G.E./Netting/2/W.P. 5
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. Second session, Rome, 4-8 March 2013. Draft Principles regarding the enforceability of close-out netting provisions. Comments submitted by the Governments of Poland, the People’s Republic of China and Sweden.
C.G.E./Netting/2/W.P. 6
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. Second session, Rome, 4-8 March 2013. Draft Principles regarding the enforceability of close-out netting provisions. Comments submitted by the Governments of France and Japan - February 2013.
C.G.E./Netting/2/W.P. 7
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. Second session, Rome, 4-8 March 2013. Draft Principles regarding the enforceability of close-out netting provisions. Comments submitted by the Government of Canada - February 2013.
C.G.E./Netting/2/W.P. 8
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. Second session, Rome, 4-8 March 2013. Draft Principles regarding the enforceability of close-out netting provisions. Comments submitted by the World Bank - February 2013.
C.G.E./Netting/2/W.P. 9
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. Second session, Rome, 4-8 March 2013. Joint proposal by the Governments of Canada and France - February 2013.
C.G.E./Netting/2/W.P. 10
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. Second session, Rome, 4-8 March 2013. Draft Principles regarding the enforceability of close-out netting provisions. Comments submitted by the Government of the United Kingdom - March 2013.
C.G.E./Netting/2/INF. 1
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. Second session, Rome, 4-8 March 2013. Mark-Up Version of the Draft Principles - December 2012.
C.G.E./Netting/2/Report
Report (prepared by the UNIDROIT Secretariat).
Documents of the Committee of governmental experts, first session, October 2012
C.G.E./Netting/1/W.P. 1
UNIDROIT Committee of governmental experts on
the enforceability of close-out netting provisions. First session,
Rome, 01-05 October 2012. Annotated draft agenda - May 2012.
C.G.E./Netting/1/W.P. 2
UNIDROIT Committee of governmental experts on
the enforceability of close-out netting provisions. First session,
Rome, 01-05 October 2012. Draft Principles regarding the enforceability
of close-out netting provisions - May 2012
C.G.E./Netting/1/W.P. 2
Add
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. First session, Rome, 01-05 October 2012. Draft Principles regarding the enforceability of close-out netting provisions – addendum July 2012
C.G.E./Netting/1/W.P. 3
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. First session, Rome, 01-05 October 2012. Comments received by UNIDROIT from the Governments of Poland, Sweden and the United States of America and from the United Nations Commission on International Trade Law (UNCITRAL).
C.G.E./Netting/1/W.P. 4
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. First session, Rome, 01-05 October 2012. Comments received by UNIDROIT from the Government of France.
C.G.E./Netting/1/W.P. 5
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. First session, Rome, 01-05 October 2012. Comments received by UNIDROIT from the Government of Canada.
C.G.E./Netting/1/W.P. 6
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. First session, Rome, 01-05 October 2012. Comments received by UNIDROIT from the World Bank.
C.G.E./Netting/1/W.P. 7
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. First session, Rome, 01-05 October 2012. Comments received by UNIDROIT the Government of Brazil.
C.G.E./Netting/1/Report
UNIDROIT Committee of governmental experts on the enforceability of close-out netting provisions. First session, Rome, 01-05 October 2012. Report.
Documents of the Governing Council, 91st session, 7–9 May 2012
UNIDROIT 2012 – C.D.(91) 15
UNIDROIT Governing Council, Report on the 91st session, Rome 7 – 9 May 2012.
UNIDROIT 2011 – S78C -Doc. 1
UNIDROIT Study Group on
principles and rules on the netting of financial instruments. First
meeting, Rome, 18 - 21 April 2011. Preliminary draft agenda - March
2011
UNIDROIT 2011 – S78C -Doc. 2
UNIDROIT Study Group on
principles and rules on the netting of financial instruments. First
meeting, Rome, 18 - 21 April 2011. Preliminary draft Report on the need
for an international instrument on the enforceability of close-out
netting in general and in the context of bank resolution, prepared by
Philipp Paech, London School of Economics and Political Science - March
2011
UNIDROIT 2011 – Study
LXXVIII C - Doc. 3
UNIDROIT Study Group on
principles and rules on the netting of financial instruments. First
meeting, Rome, 18 - 21 April 2011. A first tentative structure for
Principles regarding the enforceability of netting agreements (prepared
by Philipp Paech, London School of Economics) - April 2011
UNIDROIT 2011 – Study
LXXVIII C - Doc. 4
UNIDROIT Study Group on
principles and rules on the netting of financial instruments. First
meeting, Rome, 18 - 21 April 2011. Report (prepared by the UNIDROIT Secretariat) - July 2011
UNIDROIT 2011 – Study
LXXVIII C - Doc. 5
UNIDROIT Study Group on
principles and rules on the netting of financial instruments. Second
meeting, Rome, 13-15 September 2011. Annotated draft agenda - July 2011
UNIDROIT 2011 – Study
LXXVIII C - Doc. 6
UNIDROIT Study Group on
principles and rules on the netting of financial instruments. Second
meeting, Rome, 13-15 September 2011. Revised Preliminary Draft of
Principles regarding the enforceability of Close-out Netting Agreements
- August 2011
UNIDROIT 2011 – Study
LXXVIII C - Doc. 7
UNIDROIT Study Group on
principles and rules on the netting of financial instruments. Second
meeting, Rome, 13 - 15 September 2011. Overview payment, clearing and
settlement systems (prepared by the UNIDROIT
Secretariat) - September 2011
UNIDROIT 2011 – Study
LXXVIII C - Doc. 9
UNIDROIT Study Group on Draft
Principles and rules on the netting of financial instruments. Second
Meeting, Rome, 13 - 15 September 2011. Report (prepared by the UNIDROIT Secretariat) - December 2011
UNIDROIT 2012 –
Study
LXXVIII C - Doc. 10
UNIDROIT
Study Group
on principles and rules on the netting of financial instruments. Third
meeting,
Rome, 7-9 February 2012. Annotated draft agenda - January 2012
UNIDROIT 2012 –
Study
LXXVIII C - Doc. 11
UNIDROIT
Study Group
on principles and rules on the netting of financial instruments. Third meeting,
Rome, 7-9 February 2012. Preliminary Draft of Principles regarding the
enforceability of Close-out Netting Agreements - January 2012
UNIDROIT 2012 –
Study LXXVIII C - Doc. 12
Report on the third meeting
UNIDROIT 2012 –
Study LXXVIII C - Doc. 13
Draft Principles regarding the enforceability of close-out netting provisions