The new Futures and Derivatives Law (中华人民共和国期货和衍生品法) (FDL) in China took effect on 1 August, 2022, for the first time recognising enforceability of close-out netting in the PRC’s futures and derivatives markets. On the same day, the International Swaps and derivatives Association (ISDA) published a netting opinion for the derivatives market in China.

The FDL is a much welcomed legislation by international market participants, as it provides the legal certainty they need on netting enforceability to trade with onshore Chinese counterparties. The new law also establishes a robust regulatory framework for the trading, settlement and clearing of futures and derivatives in China – and institutes an internationally accepted fundamental system for the continued growth and regulation of the futures and derivatives markets in China.

Having been passed earlier this year, the FDL explicitly aims to strengthen investor protection and regulations of the futures and derivatives market in China. According to the China Securities Regulatory Commission (CSRC), the new law provides “a strong legal guarantee for building a standardised, transparent, open, dynamic and resilient capital market and has a very important and far-reaching significance”.

Implications to the Derivatives Market

A key impact of the FDL in respect of the derivatives market is the express recognition of the enforceability of close-out netting provisions for over-the-counter derivatives documented under a master agreement. Article 32 provides that a master agreement, together with all supplementary agreements and confirmations with respect to specific transactions where applicable, constitutes a single legally binding agreement. Article 35 further states that the close-out netting provisions of the master agreement shall not be stayed, invalidated or revoked due to commencement of bankruptcy proceedings with respect to a party to the transaction.

Essentially, allowing counterparties to reduce their obligations to a single net payment through close-out netting would provide an important risk...