# Netting is a privilege not a right Author: Pal Sinha, Barnali Author URL: https://financedigest.com/author/pal-sinha-barnali Published: 2020-12-10 Category: BUSINESS Category URL: https://financedigest.com/category/business Meta Title: Raising the Bar: Challenges in Netting Agreements Compliance Meta Description: Discover why firms are struggling to meet the ECB's netting requirements, and the importance of data governance to justify capital-critical decisions. URL: https://financedigest.com/netting-is-a-privilege-not-a-righthtml ![undefined](https://prod.superblogcdn.com/site_cuid_cm5qst7v3003gwirgwqtxn8i8/images/beh-1736838688574-compressed.jpg) _It is nearly a year since the European Central Bank (ECB) introduced its new process for the recognition of netting agreements for risk reducing purposes – and what has been achieved? Not enough. Firms are struggling to meet these day-to-day reporting requirements and failing to consider the need for future scalability. They are focused on the legal opinion rather than the [data](https://www.financedigest.com/sterling-falls-vs-dollar-as-focus-turns-to-uk-data.html "Sterling falls vs dollar as focus turns to UK data") (across client, product, opinion and agreement data domains) that supports that opinion, and allows the application of the legal opinion to a set of facts._ _This is a fundamental and concerning misunderstanding of not only regulatory [goals but an essential shift in the climate](https://www.financedigest.com/countries-emissions-pledges-still-fall-short-of-global-climate-goals-un-says.html "Countries’ emissions pledges still fall short of global climate goals, UN says"). The ECB – along with other prudential regulators – has no interest in reviewing a lawyer’s essay to prove netting decisions: the [regulation is demanding](https://www.financedigest.com/strict-regulations-regarding-hygiene-at-industrial-workplaces-to-create-high-demand-for-industrial-dispensers-persistence-market-research.html "Strict Regulations Regarding Hygiene at Industrial Workplaces to Create High Demand for Industrial Dispensers: Persistence Market Research") the use of structured, consistent process, supported by data to demonstrate exactly how and why a netting decision has been made._ _Netting is a privilege, not a right. As Akber Datoo, Michael Wood and Eric Mueller of [D2 Legal Technology](http://www.d2legaltech.com/) insist, justifying these capital-critical decisions requires institutions to recognise the role data plays and create a far more strategic approach to control frameworks in this area._ **Raising the Bar** The ECB’s new netting requirement has [revealed a concerning lack of robust data governance](https://www.financedigest.com/big-pharma-may-have-to-reveal-government-deals-in-whos-draft-pandemic-rules.html "Big Pharma may have to reveal government deals in WHO’s draft pandemic rules") within significant EU institutions – one that has perhaps taken the regulatory community by surprise. Since January 2020, these firms have had to notify the [ECB when they intend to extend the scope of their netting](https://www.financedigest.com/ecb-weighs-bigger-rate-hike-with-safety-net-for-indebted-countries.html "ECB weighs bigger rate hike with safety net for indebted countries") agreements used for risk-reducing purposes. This includes, for example, notification of a new agreement type, a new counterparty type or a new material [change to the core netting provisions of a netting agreement that would require a supplemental legal](https://www.financedigest.com/hungary-pledges-legal-changes-to-secure-eu-recovery-funding-govt.html "Hungary pledges legal changes to secure EU recovery funding – govt") opinion to be commissioned.  In initiating this new process, it would appear the ECB assumed that [institutions already have access to this information in a structured data](https://www.financedigest.com/three-layers-of-hybrid-workforce-data-for-financial-institutions.html "Three Layers of Hybrid Workforce Data for financial institutions") form. After decades of capital requirements regulation and a growing push [towards improved digital](https://www.financedigest.com/the-clear-aligner-market-to-tilt-towards-digitization.html "The Clear Aligner Market to tilt towards digitization") information flows, such an assumption may have seemed reasonable. However, the reality is somewhat different. Firms want to default to the legal response – the tried and tested reams of lawyerly words – to meet this requirement rather than a constructive, consistent response based on client, product, opinion and agreement data. When pressed for more detailed information, the only option is to undertake cumbersome ad hoc reporting, relying on spreadsheets and searching for original documentation. Why? Because firms are still [failing to capture and retain the level](https://www.financedigest.com/uk-new-car-sales-rise-in-november-fail-to-zoom-past-2019-levels-smmt.html "UK new car sales rise in November, fail to zoom past 2019 levels- SMMT") of granular detail required. In fact, netting determinations are often made through binary yes/no indicators, without capturing any working at all. The excuse is that the ECB has not defined a specific taxonomy for this compliance requirement – [leaving firms](https://www.financedigest.com/russias-offer-to-foreign-firms-stay-leave-or-hand-over-the-keys.html "Russia’s offer to foreign firms: stay, leave or hand over the keys") to come up with their own responses. The reality is that the ECB [expected firms](https://www.financedigest.com/german-engineering-firms-expect-hit-from-supply-chain-bottlenecks-next-year.html "German engineering firms expect hit from supply chain bottlenecks next year") to have robust data governance and classifications to support both compliance with capital requirements regulation and, more critically, netting decision-making. It is concerning that so many institutions’ do not maintain and structure the basic [data to support this seemingly simple regulatory](https://www.financedigest.com/how-to-navigate-multiple-data-privacy-regulatory-frameworks.html "How to navigate multiple data privacy regulatory frameworks") requirements. [**Mind the Data Gap**](https://www.financedigest.com/mind-the-gap-plugging-the-physical-disconnect-in-a-digital-first-retail-era.html "Mind the gap: plugging the physical disconnect in a digital-first retail era") For instance, under the new requirements institutions may continue to determine if a change is material or not according to their internal processes. This implies that a reporting institution [must also be able to document for each new trading agreement whether or not a core netting provision has been amended, and if amended, whether or not the change is so material as to require a supplemental opinion which must be notified to the ECB](https://www.financedigest.com/ecb-must-be-prudent-with-rates-hikes-as-recession-risk-rises-panetta.html "ECB must be prudent with rates hikes as recession risk rises: Panetta"). Fundamental to satisfying these new requirements is the [way in which firms view their data](https://www.financedigest.com/three-ways-data-unlocks-business-value-for-financial-organisations.html "Three Ways Data Unlocks Business Value for Financial Organisations ") – most notably, counterparty types, agreement types and agreement type data. Of course, [firms are collecting vast amounts of data](https://www.financedigest.com/sterling-holds-firm-after-uk-jobs-data-muddies-rate-outlook.html "Sterling holds firm after UK jobs data muddies rate outlook") – it underpins every business decision. But that is the issue – firms have not bothered with, for example, updating client onboarding data taxonomies for close-out netting determination purposes. As a result, essential aspects of the data capture process have been overlooked – hence the cumbersome, burdensome and manual [reporting required to meet the ECB demands](https://www.financedigest.com/cable-cars-and-ropeways-market-report-size-growth-demand-scope-opportunities-and-forecast-2016-2026-fmi.html "Cable Cars and Ropeways Market Report | Size, Growth, Demand, Scope, Opportunities and Forecast 2016-2026: FMI"). For example, simply recording a counterparty as an Investment Fund may meet [business and compliance data needs; but the close-out netting determination requires far more granularity](https://www.financedigest.com/the-four-pillars-of-data-integrity-what-finance-businesses-need-to-know.html "The four pillars of data integrity: what finance businesses need to know"). Is it a Trust, an OEIC (Open Ended [Investment Company](https://www.financedigest.com/wait-and-see-u-s-companies-curb-investment-as-they-await-fed-moves.html "Wait and see: U.S. companies curb investment as they await Fed moves")) or an ACS (Authorised Contractual Scheme)? The legal opinion will be – must be – far more specific about the different [types of funds because each may result in different close-out netting analysis](https://www.financedigest.com/extruded-soy-products-market-overview-analysis-by-source-type-product-regional-outlook-industry-analysis-report-and-forecast-2022-2029.html "Extruded Soy Products Market Overview & Analysis by Source, Type, Product, Regional Outlook, Industry Analysis Report and Forecast, 2022 – 2029"). Or take the [case of a bespoke legal opinion which simply reflects only those types of funds](https://www.financedigest.com/norway-wealth-fund-ceo-denies-pay-discrimination-in-case-by-female-employee.html "Norway wealth fund CEO denies pay discrimination in case by female employee") which the law firm has been asked to include, to the exclusion of other types. And what about agreement vintage? A firm may have identified agreement types, but not noted agreement versions. Yet there are multiple versions of, for example, certain French, German and Spanish domestic netting agreements. There are versions of the ISDA Master Agreement, GMRA and GMSLA preprints that are no longer covered by [standard industry](https://www.financedigest.com/how-fortyhill-financial-solutions-recognised-mailock-as-an-industry-standard.html "How Fortyhill Financial Solutions Recognised Mailock as an Industry Standard") opinions. If all agreement vintages are under one heading, how is the institution going to make a valid distinction between them other than by a laborious manual process? **Financial Stability** An institution’s inability to immediately surface this information is a [red flag to the ECB](https://www.financedigest.com/no-messing-around-with-red-hot-inflation-five-questions-for-the-ecb.html "No messing around with red-hot inflation: Five questions for the ECB") – as it would be to any regulator. It should also be a [red flag](https://www.financedigest.com/finance-brokers-bank-on-red-flag-alert-to-help-beat-fraud.html "FINANCE BROKERS BANK ON RED FLAG ALERT TO HELP BEAT FRAUD") for the institution. Close-out netting is a vital process and correctly taking its benefit [underpins](https://www.financedigest.com/whose-role-is-it-anyway-why-finance-underpins-data-led-digital-transformation.html "Whose role is it anyway? Why finance underpins data-led digital transformation") financial stability and has implications for billions of pounds of regulatory capital. How can a [firm confidently take the decision to net without accurate and well-governed data](https://www.financedigest.com/how-financial-services-firms-can-mitigate-against-their-top-data-security-threats.html "How Financial Services Firms Can Mitigate Against Their Top Data Security Threats") and without the ability to confidently and rapidly show its working? It is extremely concerning that [institutions are not looking to the data to support](https://www.financedigest.com/how-payment-institutions-can-leverage-data-to-support-merchant-customers.html "How payment institutions can leverage data to support merchant customers") these decisions or to confirm that the regulatory requirements are being met before the netting benefit is taken. The ECB requirements have highlighted a very clear [shift in regulatory attitude and approach:](https://www.financedigest.com/why-businesses-need-to-shift-their-e-invoicing-approach-from-local-and-tactical-to-scalable-and-strategic.html "Why businesses need to shift their e-invoicing approach – from local and tactical to scalable and strategic") this is not just about recording data in far more detail but also putting in place the right control framework to support these fundamental netting decisions. A ‘netting-first’ approach is no longer (in fact, it never was!) accepted. Netting cannot be regarded as a right – it is a privilege and the decision to [net has to be supported](https://www.financedigest.com/supporting-the-net-zero-agenda-as-technology-leaders.html "Supporting the net zero agenda as technology leaders ") by proof; by trusted, accurate legal data and a robust approach to data governance. --- This blog is powered by Superblog. Visit https://superblog.ai to know more. ---