EU directives and their impact on netting Available to Purchase

Nobody disputes the risk‐reducing effect of netting agreements in over‐the‐counter (OTC) derivative contracts. There is an evident interest for banking supervisors to promote such agreements, in order to improve the soundness of banks. The European Union (EU) has started to recognise this in its Solvency Ratio Directive of December 1989, limiting it to certain contracts of netting by novation. But, the Basle Committee consider that all netting agreements by novation and close out netting should be recognised as risk reducing. The European Commission has followed this advice and proposed two directives, one of which was adopted in March 1996, in order to align European regulation with the Basle guidelines. However, the European Commission has gone still further and, in May 1996, proposed a directive which will also make most of the netting agreements enforceable in the case of failure of one of the parties. As the above texts address mostly bilateral netting, with the emergence of multilateral netting, both the European Commission and the Basle supervisors have decided to try to apply to such agreements the rules on bilateral netting with some adaptations, through interpretation notes. Only the experience of the coming years will show if legislation is needed for the prudential recognition of multilateral netting.