Cross-Border Close-Out Netting and the Choice of Applicable Law

Abstract

The subject of this article is the choice of governing law in respect of cross-border close-out netting. This instrument is used to reduce the risks associated with derivative financial instruments, repurchase agreements, securities lending and foreign exchange transactions on international financial markets. Cross-border close-out netting is carried out on the basis of standard master agreements that form a part of standard documentation developed by international associations of financial markets participants. Also, the conduct of close-out netting following the events of default is prescribed by exchange rules. Some definitions of close-out netting contained in legislative and doctrine lead to the conclusion a conflict-of-laws rule on set-off may be applied to close-out netting. Since mutual offsetting of transaction claims is merely the final stage of the entire netting procedure, the qualification of the mechanism in question as a contractual method of termination of obligations is more justified. This approach makes it possible to determine the applicable law in respect of close-out netting carried out in respect of international standard documentation, as well as of on-exchange close-out netting. However, the issue of governing law in respect of close-out netting in non-standard agreements in case of absence of the choice of law by the parties remains unresolved. The rule on the choice of law applicable to close-out netting is currently absent in the domestic legislation on private international law. The conflict-of-laws issue related to the application of close-out netting in cross-border transactions was raised during the preparation of an international instrument in the field of netting by UNIDROIT. However, the recommendations regarding the applicable law were not included in its last version. Presumably, the lack of progress in the development of a special conflict-of-laws rule on netting is to be caused by practical reasons rather than by theoretical ones. Traditionally, over-the-counter close-out netting is carried out using standard documentation containing provisions on the choice of applicable law, which are recognized by all leading jurisdictions.