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Wednesday, 1 April 1998
Page: 2064


Mr MILES (10:03 AM) —I move:

That the bill be now read a second time.

Overview of the bill

The common law has long recognised the principle of set-off between an insolvent company and its creditors. Where a company is insolvent there would be an injustice if the law allowed the liquidator to insist upon receiving 100 cents in the dollar on the whole of a debt due to the company, while insisting that the creditor must be satisfied with less than 100 cents in the dollar in relation to a debt owed by the company to the creditor. To address this, the law has allowed liquidators and creditors to set-off the debts, so that only the net amount becomes payable or provable, as the case may be, in the liquidation. This important principle has been taken up into section 553C of the Corporations Law.

However, the common law in this area has not kept pace with technology. Improved communications technology and computers have made it possible for large institutions to enter into many transactions in the course of a day, and to be able to identify precisely the time each day each transaction was entered into.

Taking advantage of this technology, the major financial institutions have many dealings each day with each other and their customers, usually for very large sums of money. Further, instead of paying each other the gross amount owing on each of these transactions, the parties have agreed to set-off the debts owed to each other at the end of each day. As there are several participants in the system, the parties commonly agree to a form of multiparty set-off, known as multilateral netting.

Multilateral netting has three significant advantages for the parties. First, because only the net amounts are actually paid, it reduces their liquidity requirements. Second, an institution does not have to wait until it receives funds from one transaction before entering into another transaction. Third, there is a reduction in risk should one of the other parties become insolvent, because only the net amount is at risk, rather than the gross amount owed to the insolvent party.

However, because the common law has only recognised set-off between two parties, there is some doubt about the effectiveness of multilateral netting on the insolvency of one of the parties. The bill will overcome that uncertainty.

In particular, the bill will provide legal certainty for multilateral netting currently undertaken in the Australia payment system overseen by the Reserve Bank. This will enhance the stability of the Australian financial system. The bill will also provide certainty for netting undertaken in connection with the trading of derivatives, known as close-out netting, and for netting undertaken in accord ance with the rules of a stock or future exchange or an associated clearing house, known as market netting.

In addition, the bill will provide legal certainty for transactions undertaken through the real time gross settlement system to be implemented by the Reserve Bank at around mid-1998.

These measures will enhance the integrity of the Australian payment system and the international competitiveness of Australian financial institutions. They will make a significant contribution towards the government's commitment to establishing Australia as a major regional financial centre, and bring to Australia new business and employment opportunities in the financial sector.

Integrity of netting in the payment system

The Australian payment system currently comprises a number of separate systems for transferring funds in Australia between banks, other financial institutions and their customers. The multilateral netting system currently operating in the payment system produces a result reflecting a participant's overall debit or credit position vis-a-vis all the other participants. The system sums the exposures of each participant in the system and calculates a multilateral net position at the end of the day for each participant.

In the present framework of banking and insolvency law some uncertainties attach to the effectiveness of these multilateral netting arrangements. These uncertainties focus on the application of the law concerning unfair preferences in relation to multilateral netting arrangements. While insolvency law confers a statutory right of set-off in certain circumstances, there is some uncertainty about whether multilateral netting arrangements are enforceable in an insolvency. The bill will ensure that multilateral netting arrangements in the payment system that are approved by the Reserve Bank will survive the insolvency of a participant in the arrangement.

Integrity of the real time gross settlement system

The Wallis report recommended that the Reserve Bank give high priority to promoting cost-effective control of domestic and international settlement risks. The Reserve Bank, the Australian Payments Clearing Association Ltd (APCA) and the major national banks have participated actively in the establishment of a sound framework to support enhanced clearing and settlement systems in the payment system. As part of this process, high-value payments—which account for more than two-thirds of the value of cleared payments in Australia—are to be settled on a real time gross settlement basis.

Under real time gross settlement, the processing of payments will only occur if the paying institution has funds available in its settlement account with the Reserve Bank. At the same time as the funds are debited to the paying customer's account and credited to the payee's account, the corresponding entries are passed to their institutions' accounts with the central bank. In this way the transaction is completed in all its elements—including settlement—immediately and irrevocably. The Reserve Bank and Australian Payments Clearing Association Ltd are working towards implementing real time gross settlement at around mid-1998.

However, because of the zero hour rule, some uncertainties attach to the effectiveness of real time gross settlement arrangements. When a court-ordered liquidation commences, any payments or transfers of property made by the company thereafter are void, subject to certain exceptions such as payments made by the liquidator. It has been suggested that a court-ordered liquidation may be taken to have commenced at the beginning of the day on which the order was made—this possibility is known as the zero hour rule. Accordingly, payments made through the real time gross settlement system could be void if the paying party enters into liquidation. This would undermine the irrevocability of those payments and create severe liquidity problems in the payment system. To prevent this possibility from arising, the bill will exempt real time gross settlement payments from the possible application of the zero hour rule.

Integrity of netting for close-out and market contracts

In June 1997, the Netting Subcommittee of the Companies and Securities Advisory Committee recommended the enactment of legislation to clarify a number of issues arising in netting in financial market transactions. The subcommittee was particularly concerned to ensure that the appointment of a liquidator to a party to a netting contract does not affect the validity of the contract.

In its discussion paper `Electronic Commerce', released as part of the corporate law economic reform program in December 1997, the government indicated that it would be legislating along the lines recommended by the subcommittee to provide a more certain and robust legal framework for close-out and market netting. These reforms have received strong support from the financial sector.

To allow the existing legal uncertainties to remain would leave Australia well behind international best practice in financial market reform. These uncertainties have already been addressed or are presently being addressed in a number of other jurisdictions, including the United Kingdom, France, Canada and New Zealand, and at the international level by the Basel Committee on Banking Supervision, to promote the legal enforceability of netting arrangements.

The bill will therefore take up the subcommittee's recommendations and provide legal certainty for close-out netting in the financial markets and for netting undertaken in accordance with the rules governing stock and futures exchanges and the associated clearing houses. It will put the Australian legal system supporting financial market netting on par with that in a number of OECD countries.

Enhancing the integrity of close-out and market netting will make it easier for financial institutions and their customers to obtain all the benefits of transactions which are generally regarded as an essential part of sound financial management, such as interest rate and currency swaps and other arrangements which hedge exposures. It will also assist Australian financial institutions to join Exchange Clearing House Ltd, an international clearing house for foreign exchange transactions.

Ministerial Council for Corporations

The bill will alter the effect, scope or operation of the Corporations Law. Accordingly, as required by clause 510 of the Corporations Agreement between the Commonwealth, the states and the Northern Territory, the Commonwealth has notified the states and the Northern Territory of the bill. I present the explanatory memorandum to the bill and I commend the bill to the House.

Debate (on motion by Mr McMullan) adjourned.