The Honorable Michael G. Oxley
Chairman
US House of Representatives
Committee on Financial Services
Room 2125
Rayburn House Office Building
Washington, DC 20515

The Honorable F. James Sensenbrenner, Jr.
Chairman
US House of Representatives
Committee on the Judiciary
Rayburn House Office Building
Room 2138
Washington, DC 20515

Dear Chairmen Oxley and Sensenbrenner:

The Association for Financial Professionals (AFP) urges you to support immediate passage of the Financial Contracts Bankruptcy Reform Act of 2001 (H.R. 3211), sponsored by Rep. Toomey (R-PA), which would revise the banking and bankruptcy insolvency laws with respect to the termination and netting of financial contracts. This bill would reduce legal uncertainty and enhance the liquidity of global financial markets

AFP represents over 14,000 treasury and financial professionals, drawn from approximately 5,000 organizations, many of which are significant end-users of derivatives.

AFP has long supported legislative and regulatory efforts to bring greater legal certainty to over-the-counter (OTC) derivatives markets.  We recognize that, given the size of these markets and their importance to the U.S. and global financial systems, legal uncertainty implies systemic risks that could have profound consequences in the event of market turmoil or instability.  Furthermore, many of the firms represented by AFP's members depend on OTC derivatives in their risk management activities and consider legal certainty essential to the management of the counterparty risk arising from those transactions.

H.R. 3211, is the product of a long line of industry initiatives designed to bolster the fundamental enforceability in U.S. insolvency proceedings of key contract provisions in most bilateral OTC derivatives documentation.  Foremost among these are provisions permitting a non-defaulting party, upon its counterparty's bankruptcy or insolvency, first to trigger the early termination of all outstanding transactions between the parties and then to perform close-out netting and apply any collateral held by the non-defaulting party toward any net amount owed to it.

Set forth below are AFP's observations on some of the additional principal improvements that would result from the enactment of H.R. 3211 in the treatment of OTC derivatives in U.S. insolvency proceedings.

Improved Product Coverage

Uncertainty currently exists as to the product coverage of the threshold term "swap agreement" contained in the U.S. Bankruptcy Code (Code) and the Federal Deposit Insurance Act, as amended by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989.  Most interest rate, currency and commodity derivatives are expressly enumerated as falling within the swap agreement definition.  However, doubts exist about many other types of products that are not enumerated and either are now actively traded in OTC derivatives markets -- such as equity, credit, and weather derivatives -- or may in the future become actively traded.  These products will only be treated as swap agreements if they are found to be sufficiently "similar" to the enumerated products.  Unfortunately, little legislative or judicial guidance is available as to what might cause a product to be deemed sufficiently similar.

H.R. 3211 reduces much of the uncertainty in the "swap agreement" definition.  First, it specifically enumerates several new types of products that have become actively traded in recent years.  Second, it endeavors to clarify the types of derivatives that will be deemed sufficiently similar to the enumerated product types; in particular it provides that a transaction must be both "the subject of recurrent dealings in the swaps markets" and:

"a forward, swap, future, or option on one or more rates, currencies, equity securities, or other equity instruments, debt securities or other debt instruments, quantitative measures associated with an occurrence, extent of an occurrence, or contingency associated with a financial, commercial, or economic consequence, or economic or financial indices or measures of economic or financial risk or value".

The proposed bill also reduces uncertainty surrounding the status in bankruptcy of collateral arrangements and other credit support, including guarantees.  It does so by expressly including within the swap agreement definition any security agreement or other credit enhancement relating to a covered transaction.  Thus, a non-defaulting party may to pursue any rights it may have against collateral or other credit support notwithstanding its counterparty's bankruptcy or insolvency.

Cross-Product Netting

Under current law there is substantial doubt about the enforceability of so-called "cross-product" netting provisions.  These provisions—whether contained in a single master agreement or in a separate umbrella agreement that nets transactions under different master agreements—purport to net exposures created under different types of financial products. For example, such a provision might provide for the netting of the net exposure on a group of swaps against the net exposure on a group of securities contracts, repurchase agreements, or commodity contracts.

Many market participants desire to enter into agreements with their counterparties to net their exposures arising on all types of transactions, whether those transactions are documented under a single master agreement or under a number of product-specific master agreements.  However, existing legislation does not easily accommodate this "cross-product" netting in bankruptcy.  For example, the bankruptcy code groups different types of products into separate silos—e.g., securities contracts, commodity contracts, forward contracts, repurchase agreements, and swap agreements.  Although it may authorize the netting of exposures within a silo, the code fails to authorize expressly the netting of the net exposure arising under one silo against that arising under any other silo.

H.R. 3211 amends existing legislation generally to give effect to cross-product netting provisions.  Among other things, it permits parties to exercise, free of the bankruptcy code's automatic stay, any contractual rights to trigger an early terminating of a master netting agreement, to perform close-out netting, and to foreclose on and setoff against any collateral held securing the underlying swap agreements and other contracts.  AFP Believes that by permitting cross-product netting H.R. 3211 will enhance the ability of market participants to manage their financial and other risks.

Walkaway Clauses Unenforceable

H.R. 3211 clarifies that so-called "walkaway" clauses are unenforceable.  Upon a counterparty's bankruptcy or insolvency, a walkaway clause enables the non-defaulting party, due solely to its status as a non-defaulting party, to avoid any payment obligation it might otherwise have to the defaulting party.  Some market participants argue that these clauses impose a useful added incentive on counterparties to fulfill their contractual obligations.  AFP believes that the clauses are nothing more than inappropriate forfeiture provisions that give a non-defaulting party a windfall while depriving the defaulting party or its estate in bankruptcy of a valuable asset.

As end-users of derivatives, AFP's members favor a market environment in which as much legal certainty as possible is afforded to all OTC derivatives and market participants.  We believe that, if enacted, H.R. 3211 would substantially enhance legal certainty in the U.S., thereby strengthening our capital markets.   Accordingly, we urge passage of H.R. 3211.

Sincerely,
William P. Miller, II
Independent Risk Oversight Officer
Commonfund
Chairman
End-Users of Derivatives Council

cc: Members of the House Committee on Financial Services
     Members of the House Committee on the Judiciary