Close-out netting is the single most important legal mechanism that allows financial markets to function safely during periods of volatility and counterparty default. It ensures that when a party to a financial contract defaults—whether in a derivatives transaction, repurchase agreement, or securities loan—the non-defaulting party may terminate all outstanding transactions, calculate a single net obligation, and proceed to enforce payment of that net amount.
But in the Philippines, the legal enforceability of close-out netting in insolvency scenarios remains uncertain, and that uncertainty imposes real costs on banks, corporates, and investors.
The Financial Rehabilitation and Insolvency Act of 2010 (FRIA) makes a clear distinction between liquidation and rehabilitation. In liquidation, Section 124 explicitly allows mutual set-off of debts: if two parties are creditors and debtors of each other, only the net balance will be included in the liquidation proceedings. This aligns with the principles underlying close-out netting.
However, the complication arises in rehabilitation. Section 17(c) of FRIA provides that the Commencement Order renders null and void any set-off made after the commencement date, which retroacts to the date of filing the petition. This means that if a counterparty attempts to terminate and net financial contracts after the filing of a rehabilitation petition but before the Commencement Order is issued, that netting may be deemed void. While the stay is not indefinite (it lasts only until a rehabilitation plan is confirmed or the proceeding is terminated), this window of legal uncertainty creates significant credit and operational risk for counterparties holding exposure to the distressed entity.
Even if the contract is governed by foreign law—say, an ISDA Master Agreement governed by New York or English law—a Philippine rehabilitation court can block enforcement within the country. In a system where timing is everything, where seconds matter in terminating and valuing exposures, this lack of clarity undermines the confidence of participants in our financial markets. Foreign banks, understandably, factor this risk into pricing or avoid transacting with Philippine entities altogether.
Other jurisdictions have already addressed this. India passed its Bilateral Netting of Qualified Financial Contracts Act in 2020. Malaysia enacted its Netting of Financial Agreements Act in 2015. These laws override stay provisions for defined financial contracts and ensure that netting clauses are enforceable even during insolvency proceedings. The ISDA Model Netting Act and the UNIDROIT Principles on Netting both provide international benchmarks for legal certainty.
The Philippines, by contrast, has no standalone netting law. FRIA, the Civil Code, and BSP regulations contain relevant provisions, but none provide an integrated, comprehensive netting framework. The result is a patchwork of legal doctrines—set-off, compensation, insolvency stays—being applied to contracts that demand precision and certainty.
What we need is a Philippine Netting Law. Such a law should do three things. First, it should define close-out netting and recognize its enforceability in both contractual and insolvency settings. Second, it should provide that the automatic stay under FRIA rehabilitation proceedings does not apply to qualified financial contracts, particularly those governed by master netting agreements. Third, it should empower regulators—BSP, SEC, and the Insurance Commission—to specify which contracts and counterparties qualify, and to recognize netting for purposes of risk-based capital treatment.
This is not a radical reform. It is a basic regulatory upgrade for our financial system. It will reduce risk-weighted assets, lower the cost of hedging, improve our credit profile among international counterparties, and deepen our capital markets.
It’s time we passed a Netting Law.
Russell Stanley Q. Geronimo is a finance lawyer advising foreign clients on derivatives and cross-border financial transactions, and founder of a corporate law firm in Makati.
