Risk management is the process of identifying and mitigating the threats to an organisation’s capital and earnings. In the complex world of financial markets, 2 key risks with the potential to wipe out the capital of market participants and destabilise the entire market are counterparty risk and market risk. A contractual netting arrangement (especially close-out netting, which is a netting arrangement triggered by the default of one party to a financial contract) is an important tool which helps parties to financial contracts to mitigate such risks. However, the enforceability of close-out netting arrangements is itself subject to a significant risk – the lack of a supportive legislative framework. In this update, we take a deep dive into netting, examine recent legislative and regulatory interventions aimed at enhancing the legal framework for enforcing close-out netting arrangements in Ghana, and highlight the key issues to be addressed and next steps for ensuring that all netting arrangements are fully enforceable in Ghana.
Netting is a mechanism for the consolidation and settlement of competing rights or interests between 2 or more parties. It allows the gross value of multiple exposures or debt positions held by parties to a financial transaction to be aggregated and offset into a single net payable or receivable arrived at by deducting the aggregate amount one party owes a contractual counterparty from the aggregate amount the counterparty owes that party. In other words, the gross exposures from the various transactions between the parties are consolidated, offset against each other and settled by the payment of a single amount (representing the difference after the competing debts are netted off) to the party with the higher debt claim. The scenario we have just described is typically referred to as payment netting. Close-out netting is another type of netting arrangement, except that while payment netting generally occurs between solvent entities in the ordinary course of their transactions, close-out netting usually refers to netting arrangements between entities after a pre-defined termination event (such as a default) occurs. As such, close-out netting occurs between a defaulting party and a non-defaulting party and the event of default or termination event usually relates to insolvency.
Netting is essentially a risk mitigation tool, especially for financial transactions with high counterparty or market risk such as derivatives, repurchase agreements and securities lending transactions and it is no surprise that the contracts which underpin those transactions (such as the International Swaps and Derivative Association (ISDA) Master Agreement and Global Master Repurchase Agreement (GMRA)) have netting provisions. The enforceability of netting provisions is considered an important legal requirement for safe and effective financial markets and many developed markets have passed legislation to ensure the enforceability of close-out netting arrangements. Policymakers and legislators in Ghana have introduced a number of measures to ensure the enforceability of close-out netting, enhance the development of our financial markets and boost investor confidence in Ghana. We will examine the key legislative and regulatory interventions below.
The Corporate Insolvency and Restructuring Act, 2020 (Act 1015) (as amended) (CIRA)
The CIRA was enacted to repeal and replace the Bodies Corporate (Official Liquidations) Act, 1963 (Act 180) (the Official Liquidations Act), which applied to all companies incorporated in Ghana except the companies to which the insolvency rules under special legislation applied (such as banks and insurance companies). The passing of CIRA is a major step in Ghana’s journey towards ensuring close-out netting enforceability because there was generally no specific legislative framework or judicial precedent to recognise the enforceability of close-out netting arrangements prior to its enactment. Under the Official Liquidations Act, netting and close-out netting arrangements with defaulting parties were subject to the following risks:
- suspect periods: after the commencement of winding up proceedings, the liquidator may reverse any payment of money or transfer of property by the insolvent company which was made within the 21 days prior to the filing of the winding up petition. This posed the risk that payments which were made (through netting or close-out netting) by a defaulting company to a non-defaulting counterparty prior to the winding up of the defaulting party could be reversed by the liquidator for no reason at all after the commencement of insolvency proceedings;
- non-preferential treatment of creditors: any payment or transfer of property made by the insolvent company within the 6 months prior to the start of the winding up proceedings and at a time when the paying company was insolvent could be reversed by the liquidator if the liquidator determined that the payment or transfer of property was made with the dominant intent that the entity receiving the payment should benefit at the expense of the other creditors of the paying company. This posed the risk that payments made by a defaulting party to a non-defaulting counterparty through close-out netting could be reversed on the basis that the payments were made with the intention to benefit the non-defaulting party (as a creditor of the defaulting company) at the expense of the other creditors of the defaulting company; and
- temporary stays: from the time of the filing of the petition for the winding up of a company, any disposition of property (including the right to property or receivables) by that company was void unless the High Court directed otherwise and any civil proceedings against that company had to be stayed. There was the risk that this provision could be read to invalidate payments made by a defaulting company to a non-defaulting counterparty through the application of close-out netting after the insolvency of the defaulting company.
From the above, the pre-CIRA framework led to potentially unfair benefits for insolvent counterparties because a liquidator could (under its duty to secure the payment or discharge of all debts due to and manage the business of the insolvent company) enforce contracts which were in the money (for instance by insisting on receiving the gross amount due it from the non-defaulting party) while preventing counterparties from benefiting from contracts which were out of the money through temporary stays, the ability to reverse transactions made during the suspect period and general clawback powers.
Further, when the obligations of a defaulting party were repudiated (or payments were reversed) under the above circumstances, the claims of the non-defaulting party were regarded as unsecured claims, with the same entitlement to payment as other unsecured indebtedness of the defaulting insolvent party.
Due to these risks, there was significant uncertainty regarding the enforceability of close-out netting arrangements in the event of the insolvency of a Ghanaian counterparty and this uncertainty impacted the development of our financial markets. Counterparties were typically advised to elect automatic early termination (in which case all outstanding transactions automatically terminate before the insolvency event becomes effective) in order to navigate the hurdles regarding netting arrangements. The use of automatic early termination may not be commercially beneficial for the non-defaulting counterparty’s outstanding transactions because automatic close-out netting deprives a non-defaulting party of the ability to exercise its own discretion prior to the termination of all its ongoing transactions with the defaulting counterparty.
Post – CIRA (after 2020)
The CIRA has made significant inroads in insolvency law, including providing statutory recognition for netting arrangements in specified cases. The CIRA provides that a netting agreement under a qualified financial contract is enforceable against an insolvent party and a guarantor of (or other person who provided security for) the insolvent party in accordance with the terms of the contract. Pursuant to the CIRA, enforcement of the netting arrangements under qualified financial contracts cannot be stayed, avoided or limited by the action of a liquidator, other laws relating to insolvency or other enactment applicable to an insolvent party. Further, a netting agreement shall not be regarded as a creditor claim and must not affect the ranking of claims or distributions of dividends to creditors during insolvency.
A qualified financial contract is defined to include a financial agreement or contract which provides for a term or condition incorporated into the agreement by reference to another contract or transaction pursuant to which payment or delivery obligations are due to be performed at a certain time or within a certain period of time such as derivatives, securities contracts including margin loan and an agreement to buy, sell, borrow or lend securities or any other agreements and contracts or transactions designated as a qualified financial contract by the Securities and Exchange Commission of Ghana, the Bank of Ghana or other relevant authority.
Just like the Official Liquidations Act, CIRA does not apply to banks, insurance companies and other businesses subject to special legislation except where the special legislation does not provide for an insolvency regime. Even though CIRA excludes insurance companies from its ambit, the Insurance Act, 2021 (Act 1061) provides that the provisions of the CIRA relating to official liquidation shall apply to insurance companies and insurance intermediaries with the necessary modifications. Thus, pursuant to the CIRA, netting agreements entered into by companies (including insurance companies and intermediaries but excluding banks, specialised deposit-taking institutions and other regulated entities) are enforceable in accordance with the terms of the netting agreement.
Framework for netting arrangements for banks and specialised deposit-taking institutions
The Banks and Specialised Deposit-Taking Institutions Act, 2016 (Act 930) (BSDTI Act) regulates banks and other specialised deposit-taking institutions (SDIs) in Ghana and sets out the framework for the administration (which occurs pre-insolvency) and insolvency (or receivership, as it is termed under the BSDTI Act) of its regulated entities.
Under the BSDTI Act, the Bank of Ghana may appoint an official administrator for a regulated entity where (among other reasons) the capital adequacy ratio of the entity falls below the prescribed minimum or the regulated entity has seriously jeopardised the interests of its depositors, dissipated its assets, or is in an unsafe or unsound condition to transact business. Where an official administrator is appointed in respect of a bank or SDI, a right or obligation of a third party under any contract to which a bank or SDI is a party must not be terminated, accelerated or modified solely because of the appointment of the official administrator or any action taken by him.
Thus, the netting provisions under financial contracts such as the ISDA Master Agreement and GMRA are unenforceable on the occurrence of an event of default related to Bankruptcy or Act of Insolvency (as defined under the ISDA Master Agreement and GMRA, respectively) due to the appointment of an official administrator, unless automatic early termination is elected. Where automatic early termination has been elected, the event of default will be deemed to have occurred immediately before the appointment of the administrator and the netting provisions under the financial contract would be enforceable in accordance with the terms of the financial contract.
Further, set offs are not allowed in respect of claims acquired towards banks or SDIs within the 3 months before the appointment of a receiver (i.e. which may be during the period of official administration) or after the appointment of a receiver unless the Bank of Ghana determines that the payment or the transfer was made pursuant to an ‘eligible financial contract’ and the claims against the bank are validated.
Under the BSDTI, the Bank of Ghana has the power to revoke the licence of a bank or SDI and appoint a receiver in respect of that bank or SDI where it determines that it is insolvent or is likely to become insolvent within the next 60 days.
After receivership has commenced, effect will be given to the termination provisions of eligible financial contracts between the regulated entity and its contractual counterparts in determining the respective rights and obligations between the regulated entity and its contractual counterparts.
However, the Bank of Ghana is permitted to impose a temporary stay on the exercise of termination rights and prescribe safeguards to facilitate the orderly liquidation of the regulated entity to minimise any disruptions to the financial markets. The BSDTI Act permits the enforcement of netting provisions under eligible financial contracts where the Bank of Ghana has not imposed a temporary stay. In such circumstances, the net termination amounts would be determined on the basis of the contractual netting provisions and admitted by the receiver upon their validation.
The BSDTI Act does not specify what constitutes an eligible financial contract. However, the Bank of Ghana is authorised to prescribe the types of contracts that qualify as eligible financial contracts and these may include a master agreement covering more than one type of contract. Pursuant to notices dated 14 July 2020 (which initially designated only the GMRA as an eligible financial contract) and 15 January 2021, the Bank of Ghana has now designated all global standard documentation for all transactions in derivatives, securities repurchase and lending transactions as well as commodities transacted in Ghana, as eligible financial contracts to which the netting arrangements under the BSDTI Act apply. Thus, the netting obligations between a counterparty and a regulated entity under an eligible financial contract such as the ISDA Master Agreement and GMRA are recognised and enforceable under the BSDTI Act, except during a period of temporary stay imposed by the Bank of Ghana. Under the Bank of Ghana Capital Requirements Directive for banks dated June 2018, netting by banks is only recognised and acceptable by the Bank of Ghana if the contracts conform to international standards reflected in the GMRA or ISDA.
The BSDTI Act does not prescribe the length of time of a temporary stay that may be imposed by the Bank of Ghana or any specific basis that will trigger the imposition of the stay, apart from the general objectives of facilitating the orderly liquidation of a regulated entity and the protection of the financial markets against disruption. In the absence of a temporary stay imposed by the Bank of Ghana, a counterparty may proceed to net its obligations against the bank’s obligations in accordance with the eligible financial contract between the parties and the claims of the counterparty against the regulated entity will be admitted after the net termination value is validated.
The imposition of a temporary stay will not affect termination where automatic early termination is elected because in such circumstances, termination will be deemed to occur at the time immediately preceding the occurrence of the insolvency event. However, the imposition of a temporary stay may delay the payment of any outstanding balances payable by the regulated entity to the counterparty.
Key issues to be addressed
The scope of netting provisions under the CIRA in relation to entities regulated by the BSDTI Act
Under section 1 of the CIRA, banks and other entities subject to special legislation are expressly excluded from the application of the CIRA. However, section 165(1) of the CIRA provides that parties to a qualified financial contract shall treat the qualified financial contract in accordance with CIRA, the Securities Industry Act, 2016 (Act 929), the BSDTI Act or any other applicable enactment in the event of the insolvency of a party. Section 165(2) of CIRA seems to exclude a qualified financial contract containing a netting agreement from the application of specialised legislation applicable to the insolvent counterparty. This suggests that there may be a legislative intention to apply the netting enforceability regime under section 166 of CIRA to all counterparties.
We note further that the definition of qualified financial contracts for the purpose of netting enforceability under section 166 of CIRA includes contracts designated by the Bank of Ghana as qualified financial contracts. We are concerned that CIRA’s provisions on netting enforceability in relation to counterparties subject to specialised legislation creates significant uncertainty by appearing to subject the resolution of insolvent banks and SDIs which have entered into netting agreements to the CIRA instead of the relevant specialised legislation. Though it would seem that there may be some legislative intention to apply the netting provisions under the CIRA to banks and SDIs, this is inconsistent with section 1 of the CIRA and section 138 of the BSDTI Act, which prohibits the application of corporate insolvency legislations to banks and SDIs.
Outstanding issues under the BSDTI Act
There remain a number of issues pending resolution under the BSDTI Act to ensure that the laws in relation to banks and SDIs fully recognise and permit netting.
As indicated, termination provisions under eligible financial contracts are unenforceable in case of an event of default based on the appointment of an official administrator, unless automatic early termination has been elected. Where automatic early termination is elected, the termination provisions would be enforceable in accordance with the terms of the eligible financial contract because the event of default will be deemed to have occurred immediately before the appointment of the administrator.
Further, the imposition of a temporary stay by the Bank of Ghana or the absence of a cap on the length of such temporary stay after the commencement of receivership may significantly impact termination provisions under netting agreements entered into between an insolvent bank or SDI and a counterparty, especially where automatic early termination is not elected. Where automatic early termination is elected, the event of default will be deemed to have occurred immediately before the imposition of the temporary stay and the netting provisions may be enforced in accordance with the terms of the eligible financial contract.
Framework for netting arrangements involving the Bank of Ghana
The Bank of Ghana is one of the key players in the financial markets, and customarily enters into transactions documented under GMRA and ISDA Master Agreements. However, there is no legal regime for the insolvency or liquidation of the Bank of Ghana. The Bank of Ghana Act, 2002 (Act 612) as amended, provides that the Bank of Ghana may only be wound up in accordance with legislation passed for that purpose. Currently, no legislation has been passed to regulate the winding up of the Bank of Ghana.
This poses as a challenge because the definition of insolvency events which may trigger an event of default is a key issue for consideration under financial contracts to which the Bank of Ghana is a counterparty. In the absence of a statutory framework for the insolvency of the Bank of Ghana, it cannot be determined whether the termination provisions (including netting arrangements) under the financial contracts entered into by the Bank of Ghana will be enforceable on the winding up of the Bank of Ghana. This risk may be remote after all, and it is unlikely that such legislation will be passed, considering the impracticality of the liquidation of a state-owned central bank such as the Bank of Ghana.
We propose the following recommendations to give full effect to impressive steps already taken to promote the enforceability of netting arrangements under Ghanaian law:
- if the intention of the lawmakers is to have one composite legislation regarding the enforceability of netting agreements in Ghana, the CIRA must be amended to clarify that its provisions related to netting arrangements apply to banks, SDIs and other entities regulated under special legislation irrespective of the carve out for such entities under section 1 of the CIRA. In the alternative, the CIRA must be amended to clarify that its netting provisions do not apply to banks and SDIs. Such an amendment would settle the current confusion in the minds of market players due to the drafting of the netting provisions under sections 165 and 166 of the CIRA;
- pending the proposed amendment to the CIRA, the Bank of Ghana may consider issuing a notice or directive to clarify the applicability of sections 165 and 166 of the CIRA to banks and SDIs;
- regarding banks and SDIs, the BSDTI Act must be amended to exclude eligible financial contracts from the scope of restrictions which apply to termination rights related to the appointment of an official administrator;
- the Bank of Ghana must consider the issuance of a notice clarifying that the restriction on set offs under the BSDTI Act does not include set offs under the termination provisions of eligible financial contracts; and
- the Bank of Ghana must consider issuing a notice to clarify that the imposition of a temporary stay under the BSDTI Act shall not impact the termination provisions under eligible financial contracts or adopt the conditions for temporary stay under the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions (including the cap of 2 business days for temporary stays).
There is no doubt that the legal landscape for the enforceability of netting arrangements in Ghana has seen a significant improvement due to the enactment of CIRA and the provisions of the BSDTI Act on netting. There is no longer a need to advise counterparties to adopt automatic early termination as a means of navigating local laws on netting enforceability, except in the case of banks and SDIs. However, banks and SDIs constitute significant counterparties in our financial markets and a few things remain to be done to conclusively provide full netting enforceability under the BSDTI. The implementation of the above recommendations will boost investor confidence in the Ghanaian financial market and promote Ghana as a preferred financial hub.