Opinion of the European Central Bank of 7 January 2021 on the enforcement of close-out netting agreements (CON/2021/1)
Date: 2021-01-07
Institutions: European Central Bank
Subjects: banking supervision, financial stability, monetary policy

EN 

ECB-PUBLIC 

OPINION OF THE EUROPEAN CENTRAL BANK 

of 7 January 2021 

on the enforcement of close-out netting agreements 

(CON/2021/1) 

Introduction and legal basis 

On 17 November 2020 the European Central Bank (ECB) received a request from the Ministry of Finance 

of the Republic of Latvia for an opinion on a draft law on the enforcement of close-out netting in qualified 

financial transactions and on draft laws containing related amendments to the Law on credit institutions and 

to the Law on insolvency (the ‘draft laws’). 

The ECB’s competence to deliver an opinion is based on Articles 127(4) and 282(5) of the Treaty on the 

Functioning  of  the  European  Union  and  the  third  and  sixth  indents  of  Article 2(1)  of  Council  Decision 

98/415/EC1, as the draft laws concern Latvijas Banka, rules applicable to financial institutions insofar as 

they materially influence the stability of financial institutions and markets and the specific tasks conferred 

on  the  ECB  concerning  the  prudential  supervision  of  credit  institutions  pursuant  to  Article  127(6)  of  the 

Treaty.  In  accordance with  the  first  sentence  of  Article 17.5  of  the  Rules  of  Procedure  of  the  European 

Central Bank, the Governing Council has adopted this opinion. 

1. 

Purpose of the draft laws 

1.1  The purpose of the draft laws is threefold: first, to ensure financial market stability by limiting systemic 

risk  that  might  be  caused  by  legal  protection,  insolvency  or  winding-up  proceedings  against  a 

financial market participant; second, to protect the parties to a close-out netting agreement in the 

event that legal protection, insolvency or winding-up proceedings are carried out in relation to any of 

the parties; and third, to contribute to the development of the financial instruments market in Latvia, 

consolidating Latvia’s position as a regional hub for financial services.  

1.2  As set out in the explanatory memorandum to the draft laws, at present close-out netting in Latvia is 

applicable only to transactions where both counterparties are regulated credit institutions or other 

financial market participants or public entities, pursuant to the transposition of the relevant provisions 

of Directive 98/26/EC of the European Parliament and of the Council2, Directive 2002/47/EC of the 

European Parliament and of the Council3 and of Directive 2001/24/EC of the European Parliament 

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Council Decision 98/415/EC of 29 June 1998 on the consultation of the European Central Bank by national authorities 
regarding draft legislative provisions (OJ L 189, 3.7.1998, p. 42). 

Directive 98/26/EC of the European Parliament and of the Council of 19 May 1998 on settlement finality in payment 
and securities settlement systems (OJ L 166, 11.6.1998, p. 45). 

Directive  2002/47/EC  of  the  European  Parliament  and  of  the  Council  of  6  June  2002  on  financial  collateral 
arrangements (OJ L 168, 27.6.2002, p. 43). 

 
 
 
 
 
 
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and of the Council4. The draft laws establish a legal framework governing close-out netting applicable 

to derivative and spot transactions with regard to currency, securities and commodities where one of 

the  contractual  parties,  although  not  a  regulated  financial  market  participant,  falls  within  a  list  of 

eligible entities, as described in paragraph 1.4. Latvia is one of the last Union jurisdictions in which 

the  enforcement  of  close-out  netting  transactions  with  unregulated  entities  has  not  yet  been 

implemented.  The  lack  of  relevant  legislation  subjects  the  financial  sector  in  Latvia  to  a  greater 

domino  effect  when  a  financial  crisis  arises.  This  lack  of  legislation  also  hinders  Latvian  financial 

market participants and large enterprises in attracting cheaper financing in situations where the other 

counterparty  is  from  a  jurisdiction  in  which  such  legislation  exists,  because  the  lack  of  close-out 

netting is a risk that is included in the price of any financial instrument. Introducing such legislation 

will reduce the costs of complying with capital adequacy requirements for Latvian credit institutions 

and financial market participants, as it will allow them to hold less capital relative to their risk-weighted 

assets.  

1.3  The draft laws aim to ensure the enforceability of close-out netting in qualified financial transactions5. 

Finanšu un kapitāla tirgus komisija (FKTK, the Latvian Financial and Capital Market Commission) 

may issue regulations to designate any other type of transaction, in addition to those specified by the 

draft  laws,  as  qualified  financial  transactions.  For  the  purpose  of  the  draft  laws,  an  agreement  is 

deemed  to  be  a  close-out  netting  agreement  notwithstanding  the  fact  that  such  agreement  may 

contain  provisions  relating  to  transactions  that  are  not  qualified  financial  transactions,  provided, 

however, that such agreement is deemed to be a close-out netting agreement only with respect to 

the qualified financial transactions.  

1.4  The draft laws regulate the enforcement of close-out netting where the parties to the close-out netting 

agreement fall into one of the following three categories: first, where both parties to the close-out 

netting agreement are Latvian or foreign State authorities, Latvijas Banka, the ECB, central banks of 

other States, the Bank for International Settlements (BIS), the International Monetary Fund (IMF), 

specified  multilateral  development  banks,  or  credit  institutions,  a  wide  range  of  financial  market 

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Directive 2001/24/EC of the European Parliament and of the Council of 4 April 2001 on the reorganisation and winding 
up of credit institutions (OJ L 125, 5.5.2001, p. 15). 
For this purpose qualified financial transactions are defined to include transactions in respect of financial instruments 
specified under Section 3, Paragraph two, Clauses 4, 5, 6, 7, 8, 9 and 10 of the Law on financial instruments markets: 
(1)  Options,  futures,  swaps,  forward  rate  agreements  and  any  other  derivative  contracts  relating  to  securities, 
currencies, interest rates or yields, emission allowances or other derivatives instruments, financial indices or financial 
measures which may be settled physically or in cash; 
(2) Options, futures, swaps, forwards and any other derivative contracts relating to commodities that must be settled 
in cash or may be settled in cash at the option of one of the parties other than by reason of default or other termination 
event; 
(3) Options, futures, swaps, and any other derivative contract in accordance with Regulation (EU) 2017/565 relating to 
commodities that can be physically settled provided that they are traded on a regulated market, a multilateral trading 
facility (MTF), or an organised trading facility (OTF), except for wholesale energy products traded on an OTF that must 
be physically settled; 
(4) Options, futures, swaps, forwards and any other derivative contracts in accordance with Regulation (EU) 2017/565 
relating to commodities, that can be physically settled not otherwise mentioned in point 3 and not being for commercial 
purposes, which have the characteristics of other derivative financial instruments; 
(5) Derivative instruments for the transfer of credit risk; 
(6) Financial contracts for differences; 
(7) Options, futures, swaps, forward rate agreements and any other derivative contracts in accordance with Regulation 
(EU) 2017/565 relating to climatic variables, freight rates or inflation rates or other official economic statistics that must 
be settled in cash or may be settled in cash at the option of one of the parties other than by reason of default or other 
termination event, as well as any other derivative contracts relating to assets, rights, obligations, indices and measures 
not otherwise mentioned in this Section, which have the characteristics of other derivative financial instruments, having 
regard to whether, inter alia, they are traded on a regulated market, OTF, or an MTF. 

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participants and central counterparties regulated by Latvia or other Union, European Economic Area 

(EEA)  or  Organisation  for  Economic  Co-operation  and  Development  (OECD)  member  states; 

second, where one of the parties is one of the aforementioned entities and the other party is a legal 

entity or private individual who is not a consumer6; and third, where both parties are legal entities 

which, at the moment of entering into the close-out netting agreement, meet two of the following size 

requirements: (1) a total balance sheet of EUR 40 million, (2) a net turnover of EUR 50 million and 

(3) 250 employees.  

1.5  The scope of the draft laws is limited in a number of respects. First, the draft laws clarify that legal 

relationships concerning financial collateral are regulated by the Law on financial collateral. Second, 

the draft laws do not apply to systems operated by Latvijas Banka or which the FKTK has notified to 

the  European  Securities  and  Markets  Authority  (ESMA)  under  the  Law  on  settlement  finality  in 

payment  and  financial  instruments  settlement  systems,  or  to  participants  in  such  systems,  or  to 

collateral provided to participate in such systems. Third, the draft laws do not apply to collateral used 

by central banks in transactions related to the performance of their central bank functions. 

1.6  The draft laws clarify that close-out netting can be enforced and is not affected by legal protection, 

insolvency or the winding-up of any of the parties, which includes any related statutory provisions, 

such as those on relationships with creditors, the management or retention of funds or any other 

steps taken in insolvency. After enforcement of close-out netting, the only obligation or claim of either 

party will be equal to its net obligation to or claim on the other party as determined in accordance 

with the terms of the close-out netting agreement. To ensure the enforceability of close-out netting, 

the  draft  laws  eliminate  the  powers  of  the  administrator  in  insolvency  proceedings  to  unilaterally 

terminate a close-out netting contract concluded in the six months prior to the opening of proceedings 

under  the  Law  on  insolvency  with  regard  to  a  company  insolvency  and  under  the  Law  on  credit 

institutions with regard to the insolvency of a credit institution. The legal effect of the provisions of a 

close-out netting agreement are not affected by the limitations of set-off, discharge of claims and 

liabilities  or  equivalent  limitations  provided  under  the  Law  on  insolvency  or  the  Law  on  credit 

institutions. Close-out netting may not be declared invalid or cancelled merely because it has taken 

place before the commencement of the relevant winding-up or insolvency proceedings. Close-out 

netting is valid and binding vis-à-vis third parties.  

1.7  According to the explanatory memorandum, the issue of potentially fraudulent transactions prior to 

an  insolvency  has  been  carefully  analysed  and  the  outcome  is  to  presume  that  certain  specified 

eligible entities, such as Latvian or foreign State authorities, Latvijas Banka, the ECB, central banks 

of other States, the BIS, the IMF, specified multilateral development banks, or credit institutions, a 

wide range of financial market participants and central counterparties regulated by Latvia or other 

Union, EEA or OECD member states, are reasonably reliable counterparties which are highly unlikely 

to enter into fraudulent transactions.  

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Within the meaning of the Latvian Law on the protection of consumer rights. 

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1.8  Finally, the draft laws implement Article 7(6) of Directive (EU) 2019/1023 of the European Parliament 

and of the Council7, which states that Member States may provide that a suspension of individual 

enforcement measures in preventive restructuring does not apply to netting mechanisms, including 

close-out netting mechanisms, in financial markets, energy markets and commodity markets. 

2. 

Observations  

2.1  The ECB notes that the purpose of the draft laws is to provide a legal framework governing close-

out  netting  applicable  to  derivative  and  spot  transactions  with  regard  to  currency,  securities  and 

commodities where one of the contractual parties is not a regulated financial market participant. Such 

legal standardisation is an important element of facilitating organised platform trading and central 

clearing  in  line  with  the  2009  Pittsburgh  G20  commitments  to  reform  over-the-counter  (OTC) 

derivatives markets8. Further, legal certainty regarding close-out netting is an important element for 

reducing  counterparty  credit  risk  and  to  ensure  the  adequacy  of  the  amount  of  any  collateral 

exchanged9.  As  such,  the  enforceability  of  close-out  netting  is  an  important  element  for  the  risk 

management of firms and a prerequisite for the development of  safe and sound OTC derivatives 

markets as well as covered spot transaction markets. 

2.2  The adoption of the draft laws could have practical implications for Latvian credit institutions as well 

as for other credit institutions dealing with Latvian counterparties. In particular, close-out netting is 

an  important  risk  mitigation  tool  for  credit  institutions  which  allows  for  effective  reduction  of 

counterparty  credit  risk,  and  thus  contributes  to  sound  risk  management  practices  of  credit 

institutions. Due to the broader application of close-out netting provided for in the draft laws, meaning 

that it will also apply to transactions where one of the contractual parties is not a regulated financial 

market participant, provided that the party falls within the list of eligible entities, the draft laws may 

contribute  to  credit  institutions  dealing  with  Latvian  counterparties  meeting  the  conditions  for 

contractual netting arrangements to be recognised as an eligible form of credit risk mitigation and 

risk reduction under Regulation (EU) No 575/2013 of the European Parliament and the Council10. 

2.3  With regard to operations conducted by Latvijas Banka or the ECB with Latvian credit institutions, 

the draft laws should enhance the enforcement of close-out netting arrangements that central banks 

have with such counterparties arising out of financial transactions that are not based on collateral 

arrangements,  e.g.  foreign  exchange  swap  transactions.  In  this  respect,  the  precise  interaction 

between  the  enforcement  of  close-out  netting  provisions  contained  in  financial  collateral 

arrangements under the Law on financial collateral, the enforcement of collateral used by central 

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Directive (EU) 2019/1023 of the European Parliament and of the Council of 20 June 2019 on preventive restructuring 
frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of restructuring, 
insolvency and discharge of debt, and amending Directive (EU) 2017/1132 (Directive on restructuring and insolvency) 
(OJ L 172, 26.6.2019, p. 18). 
See  the  2010  FSB  working  group  report  ‘Implementing  OTC  Derivatives  Market  Reforms’,  available  on  the  FSB’s 
website at www.fsb.org. 

Bank for International Settlements (2013), Supervisory guidance for managing risks associated with the settlement of 
foreign exchange transactions, available on the BIS’s website at www.bis.org. 
Articles 295 to 298 of Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 
on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 
(OJ L 176, 27.6.2013, p. 1). The ECB has clarified the process regarding recognition of contractual netting agreements 
as risk-reducing in its letter to significant credit institutions of 10 October 2019 and which is available on the banking 
supervision website at www.bankingsupervision.europa.eu. 

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banks in transactions related to the performance of their central bank functions under the Law on 

settlement finality in payment and financial instruments settlement systems, and the enforcement of 

close-out  netting  provisions  contained  in  qualified  financial  transactions  subject  to  the  draft  laws 

could be more clearly articulated. The draft laws provide that legal relationships related to financial 

collateral are regulated by the Law on financial collateral, that the draft laws do not apply to collateral 

used by central banks in transactions related to the performance of their central bank functions, and 

that an agreement is deemed to be a close-out netting agreement notwithstanding the fact that such 

agreement  may  contain  provisions  relating  to  transactions  that  are  not  qualified  financial 

transactions, provided, however, that such agreement is deemed a close-out netting agreement only 

with respect to qualified financial transactions. The ECB understands that it is intended that close-

out netting provisions contained in a single agreement covering both collateral arrangements and 

qualified financial transactions not having a collateral element are intended to be enforceable. An 

explicit clarification of this understanding would be welcomed, for the sake of legal certainty.  

2.4  Finally, as regards the clarification that the draft laws do not apply to participants in systems operated 

by Latvijas Banka or which the FKTK has notified to ESMA under the Law on settlement finality in 

payment and financial instruments settlement systems, legal certainty could be further enhanced by 

explicitly clarifying, for the avoidance of doubt, that participants in such systems are exempt from the 

draft laws only regarding their actions, rights and obligations arising in connection with such systems. 

This opinion will be published on EUR-Lex.  

Done at Frankfurt am Main, 7 January 2021. 

[signed] 

The President of the ECB 

Christine LAGARDE 

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