78 3 Reduction of External Funding Needs
mation day, after which the netting center performs preliminary netting and trans-
mits the results to the participating companies for review. On the confirmation
day, the participants receive information about their preliminary net positions. The
netting center then makes adjustments as advised by the participating companies.
On the business day, each participating company gives payment instructions to its
bank, and the netting centre performs the currency conversions and runs the final
netting. On the settlement date, each of the participating companies’ banks effects
transfers for the net amount owed to the netting center, which acts as a clearing-
house for the settlement on same day. The settlement day is therefore the value
date of all internal netting payments paid/received by participants on a same-day
value basis. The third party day is the value date for third party transactions.
Community law. Insolvency laws and Member States' traditional set-off rules
have created legal risks that influence the finality of payment netting and the va-
lidity of collateral security provided in connection with participation in payment
netting. The availability of a set-off under the applicable national insolvency law
is important if it turns out that the assets of the debtor are insufficient to satisfy all
claims. However, there are differences in the national insolvency laws regarding
set-off.^213 Because of national insolvency laws and traditional provisions on set-
off, the netting of payments has not always been legally enforceable and binding
on third parties. The commencement of insolvency proceedings may have a retro-
active effect on the rights and obligations of participants in a netting system.
Legal risks relating to the finality of payment netting may give rise to concern
as to how the level of exposure of a participant (a participating company or a
bank) to a particular counterparty should be calculated. Is the party entitled to
measure its exposure by reference to the net position, so that it may assume that,
in a liquidation of the counterparty, the rights and obligations under the various
contracts between them will be set against each other so as to produce a balance?
Or should the party look instead to the gross position, whereby it may have to per-
form the unprofitable contracts and only receive a dividend on the contracts that
otherwise would have been profitable from its point of view (the problem of
“cherry-picking” and the Herstatt risk)?^214
Problems relating to the finality of payment netting can give rise to a systemic
risk in capital markets. Community law has addressed this risk. The purpose of the
Settlement Finality Directive adopted in May 1998 was to reduce the systemic risk
(^213) In Germany, the Insolvency Code (Insolvenzordnung, InsO) provides that the insol-
vency creditors’ right to set-off is not affected by the filing or the petition or by the
court’s order of commencement (§ 94 InsO). However, set-off requires that the debts are
due (§ 95(1) InsO). In addition, set-off is not permissible (1) if the creditor becomes a
debtor of the estate only after proceedings have commenced, (2) if the creditor acquires
its claim from another creditor after proceedings have commenced, or (3) if it acquires
the right of setoff by means of a voidable transaction (§ 96(1) InsO). See also § 20(1) of
the Austrian Bankruptcy Code (Konkursordnung, KO). In England, Rule 4.90 of the In-
solvency Rules 1986 provides that set-off of mutual debts is mandatory in all liquida-
tions and cannot be excluded by agreement between the parties.
(^214) See Derham SR, Set Off and Netting of Foreign Exchange Contracts in the Liquidation
of a Counterparty: Part 1, JBL 1991 p 463.