This content is from: Local Insights

Evolution of regulations on OTC derivatives

Carlos Fradique-MéndezAna María Rodríguez Maldonado

Colombian derivatives transactions have been growing and gaining sophistication over the past few years. Pursuant to statistics published by the Central Bank of Colombia, the most common type of over-the-counter transactions locally negotiated are COP/USD forwards. Nonetheless, the negotiation of other derivatives, such as swaps, has likewise consistently grown.

In 2009, the average of COP/USD monthly negotiated forwards (including future flows of COP/USD swaps) amounted to approximately $16.63 million, while the average increased to approximately $19.1 million per month in 2010. This represents an increase of 15% over a one-year period.

Pursuant to the statistics published by the Central Bank of Colombia, most of these transactions are short-term forwards with a maximum term of 15 to 35 days.

On the other hand, from the regulatory perspective, the Colombian derivatives market needs to confront important challenges and further development.

Recently, the Central Bank of Colombia, by means of Regulation 37 of December 28 2010 which amended Regulation DODM-144 of September 19 2008 on derivative transactions, issued rules providing for netting, close-out netting and collateral granted in connection with derivatives transactions.

Pursuant to recent foreign exchange regulations, netting provisions may now be enforced at any time for derivatives transactions entered into with the same counterparty, including the ability to set-off collateral granted in connection with such derivatives transactions, if so agreed on by the counterparties within the relevant master agreement. These advances represent a significant improvement considering that they end previous controversies regarding legality and enforceability of provisions such as netting and multiple-transaction payment netting under the Isda (International Swaps and Derivatives Association) Master Agreement.

Furthermore, provisions such as early termination, close-out netting and set-off under the Isda Master Agreement are now enforceable from a forex (foreign exchange) perspective in the case of termination events and events of default.

Moreover, secured parties under derivatives agreements are now permitted to liquidate cash and securities granted as collateral to ensure payment of pending amounts as part of the close-out netting provisions. This legislation implies significant progress, considering that pursuant to previous regulations it was not clear whether or not collateral granted and located abroad could be properly used to discharge the obligations of the Colombian resident from the forex perspective, given the obligation to complete payments under these transactions subject to strict mechanisms and procedures established by the Central Bank.

This situation represented a contradiction in the past, considering the enforceability of said posted collateral under foreign laws and regulations that generally control such agreements. (These collateral provisions complement Law 1328 of 2009 according to which the non-defaulting party of a derivative contract should be permitted to enforce guarantees received in connection with the transaction to the extent that guarantees in cash or securities would have to be liquidated at the prevailing market price and guarantees in assets other than cash or securities would have to be liquidated at a fair market value.)

Although recent forex regulations imply a considerable effort to modernise local laws and bring them in line with international standards, the next goal that the government needs to tackle is to assure the complete effectiveness of Law 1328 of 2009, which, among others, generally provides for early termination and close-out netting provisions in insolvency proceedings.

By means of Law 1328 issued on July 15 2009, the Colombian Congress indicated that early termination and close-out netting provisions would be enforceable in events of default under derivatives contracts, due to insolvency proceedings, if one of the parties to the transaction was an entity subject to the supervision of the Superintendence of Finance or a so-called authorised professional foreign agent according to Colombian forex regulations. Nonetheless, the effectiveness of Law 1328 is still subject to implementing legislation mostly relating to registration requirements that need to be set forth by the Colombian government.

New forex regulations were issued to complement and harmonise local financial regulations that previously referred to netting and close-out netting provisions. Notwithstanding the above, pending regulations need to be issued in the near future to guarantee and effectively contribute to the real advancement and sophistication of the Colombian derivatives markets.

Carlos Fradique-Méndez and Ana María Rodríguez Maldonado

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