[Congressional Record Volume 145, Number 63 (Tuesday, May 4, 1999)]
[Senate]
[Pages S4679-S4680]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. BENNETT:
  S. 958. A bill to amend certain banking and securities laws with 
respect to financial contracts; to the Committee on Banking, Housing, 
and Urban Affairs.


       financial institutions insolvency improvement act of 1999

  Mr. BENNETT. Mr. President, I rise today to introduce the Financial 
Institutions Insolvency Improvement Act of 1999. Recognizing that the 
changes to our Nations' banking laws have not kept pace with changes in 
our capital markets, this bill would strengthen the laws that enforce 
and protect certain financial agreements and transactions in the event 
that one of the parties involved becomes insolvent. This legislation 
would also harmonize the treatment of financial instruments under the 
bankruptcy code and the banking insolvency laws.
  The legislation that I am introducing is based largely on the 
recommendations made in March of 1998 by the President's Working Group 
on Financial Markets. This same working group reiterated on April 29th 
of this year, in their report on hedge fund activity, that Congress 
should pass this legislation. However, in an effort to keep this 
legislation free and separate from the ongoing bankruptcy debate, I am 
only introducing those portions of the proposal which amend banking 
law. I will be chairing a hearing on this legislation on the Financial 
Institutions Subcommittee tomorrow morning.
  Since the adoption of the Bankruptcy Code in 1978, Congress has 
recognized that certain financial market transactions qualify for 
different treatment in the event that one of the parties becomes 
insolvent. Specifically, many financial instruments are exempted from 
the automatic stay that is imposed on general commercial contracts 
during a bankruptcy proceeding. This is largely due to the fact that 
the Federal Deposit Insurance Corporation (FDIC), by law, becomes a 
trustee during any bankruptcy proceeding.
  Mr. President, the ability to terminate, or close out and ``net'' 
financial products is an essential and vital part of our capital 
markets. Congress has recognized that participants in swap transactions 
should have the ability to terminate and ``net'' their swap agreements. 
Simply put, netting means that money payments or other obligations owed 
between parties with multiple contracts can be offset against each 
other, and one net amount can be paid by one party to the other in 
settlement. Cross-product netting means that parties can net out 
different kinds of financial contracts, such as swap agreements being 
offset with repurchase agreements. By eliminating the need for large 
fund transfers for each transaction in favor of a smaller net payment, 
netting allows parties to enter into multiple-transaction relationships 
with reduced credit and liquidity exposures to a counterparty's 
insolvency.
  Many parties involved in financial transactions have entered into 
them for hedging purposes. My legislation encourages this type of 
behavior by clarifying that cross-product close-out netting should be 
permitted for positions in securities contracts, commodity contracts, 
forward contracts, repurchase agreements and swaps.
  For example, in certain cases, the protections for financial 
contracts in the bank insolvency laws have not kept pace with market 
evolution. Assume, for example, that Party A and Party B have two 
outstanding equity swaps in which the payments are calculated on the 
basis of an equity securities index. If Party A enter insolvency, it is 
not entirely clear whether Party B's contractual rights to close-out 
and net

[[Page S4680]]

would be protected by the current ``swap agreement'' definition in the 
Federal Deposit Insurance Act. If both of the parties are ``financial 
institutions'' under the Federal Deposit Insurance Corporation 
Improvement Act or the Federal Reserve Board's Regulation EE and the 
swap agreements are ``netting contracts,'' then Party B might (although 
it is not entirely clear) be able to exercise its close-out, netting 
and foreclosure rights.
  However, if one of the parties is not a ``financial institution'' or 
the contract does not constitute a ``netting contract'' (for example, 
because it is governed by the laws of the United Kingdom), then Party B 
could be subject, among other things, to the risk of ``cherry-
picking''--the risk that Party A's receiver would assume responsibility 
only for the swap that currently favors Party A, leaving Party B with a 
potentially sizable claim against Party A (which would be undersecured 
because of the impairment of netting) and the risk that its foreclosure 
on any collateral would be blocked indefinitely. This could impair 
Party B's creditworthiness, which in turn could lead to its default to 
its counterparties. It is this sort of ``chain reaction'' that can 
exacerbate systemic risk in the financial markets.
  Finally, Mr. President, it is important to recognize that the 
framework for the bill I am introducing was contained in S. 1301, the 
bankruptcy bill introduced by Senator Grassley last year which passed 
the Senate by a vote of 97-1.

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