Netting Passes Senate, Part of Controversial Bankruptcy Reform

December 11, 2000 ( U.S. Senate Thursday passed a bankruptcy reform bill that contains protections for contract netting in the event of the insolvency of a large financial institution, a matter of potential importance to the alternative investing community.

The House passed the same bill in October. The bill next goes to President Clinton, who has threatened to veto it.

It is generally accepted in Washington that financial-netting reform is needed. A financial institution can have several contracts pending with the same counter-party, requiring regularly scheduled cash settlements in both directions. In such instances, the parties frequently net out the impact of the entire set of contracts instead of treating each as a separate deal. As a result, net liability on each side is far less than the paper value.

The financial-netting provisions of the Senate bill would deny an automatic stay to set-offs under swap or netting agreements, and would restrict the authority of a bankruptcy trustee in regard to such transfers. There is some concern that, in the absence such provisions, the insolvency of a large financial institution and its effort to renege on swaps and netting agreements could cause a liquidity crisis in the world financial system.

When the House passed this bill, Dick Peterson, aide to John LaFalce, D-N.Y., suggested that Republicans were using the netting issue as leverage to avoid a veto of the rest of the bankruptcy package.

“Financial netting reform should definitely be done,” said Mr. Peterson. “We’ve been trying to get it through for two Congresses now.”

The most controversial features of the bill concern consumer bankruptcies. Critics point to what they see as rampant abuse and argue that this bill would require debtors to do more than simply dissolving their debts. Opponents, notably Sen. Paul Wellstone, D-Minn., argue that the bill is too harsh on debtors and gives an indirect subsidy to credit card companies.

The bill passed the Senate by a veto-proof majority, 70 to 28. But the House passed it on a voice vote, making the margin uncertain. However, the House last year passed a somewhat different version of the bill on a roll call vote of 313 to 108, which would be enough for an override.

The president has another option: a “pocket veto.” He could simply leave the bill unsigned, and if Congress adjourns within 10 days (excluding Sundays), the bill fails.

Even if the lame-duck Congress stays in session long enough to prevent a pocket veto, i.e. until Dec. 20, and forces Clinton to employ a more explicit veto, the large margin of passage may not hold upon reconsideration.

With such a consensus for financial-netting reform, could it be detached from the more controversial measures? The House of Representatives passed such a bill in three contexts this year – as a stand-alone bill, as part of the Commodity Futures Modernization Act, and as part of the bankruptcy package. Christi Harlan, an aide for the Senate Banking Committee, said Friday that she does not expect the Senate to enact the financial-netting provisions as a separate bill. But she does expect that the Senate will address commodity futures modernization, perhaps attaching it as a rider to a pending appropriations bill.

The best chance for passage of financial-netting reform this year seems to be as a rider on a rider.

By Christopher Faille, Reporter


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