Financial Contracts

Financial contract in America has undergone a revolutionary change with the introduction of amendments in Bankruptcy code and some other statutes. The aim was that the financial risk of the parties concerned is minimized so that bankruptcy of one of the parties does not adversely affect the other. The amendments vest certain powers to the bankruptcy trustee or the debtor.

Transfers and payments that were made by the bankrupt party immediately before such bankruptcy is now recoverable. The trustee may also reject ongoing contracts. Simultaneously, exercise of contractual liquidation and termination rights against the debtor is now prohibited.

Financial contract in United States can be of various types. One is the repurchase contract that now covers mortgage related securities and loans. Another is securities contract that now conforms to the definition provided by FDIA. Similarly, there are commodity contract, forward contract, and swap agreements.

A financial contract in America has various aspects. One may look at the origins of such contract, legally of course. There are the creditor’s rights, property rights, legalities, law and financial aspects. A few issues like legal protection of parties, especially the creditors and maturity of the contract are of prime importance.

A new aspect of the current legislations relating to financial contract is that the inclusion of a non-qualifying agreement will not be a bar for loss of benefits. Similarly and transaction under a master agreement is not a bar to the loss of benefits on other parts of the agreement. Thus the concern of transacting parties relating to multiple derivative transactions under one master agreement is now over.

The powers of the trustee is however limited in certain respect. This has been done to avoid total injustice to debtor. Therefore, the code also protects the financial rights of certain financial participants in terms of agreements, forward contracts and commodity contracts and the rights to net payment obligations are now protected under the code.

With the coming into force of the code there have been some marked changes in the field of swap agreements. Its effect is marked in those fields relating to return, debt, credit, commodity index, equity index etc. There is the flexibility now to cover new products under the umbrella.

Current legislations have added a new concept of financial participants too. The definition now embraces all clearing organizations having agreements and now the agreements will include the gross value in terms of the principal value outstanding. They will be declared as protected parties and this gives them rights of enforcing their financial contracts reducing their market risks.

The new legislations on financial contracts, on the one hand puts a limitation on automatic stay and right to setoff. On the other hand it permits set off against cash or securities etc held or under the control of a market participant who is protected by the contract. This right to set off can now be enforced against the transfer of property too.

Current laws also permit execution of right to terminate, and met across contracts in respect of each individual contract, that is covered under the master contract. The definitions of the term contractual rights have been expanded to give protection to a national clearing organisation. Therefore, now they are protected under section 561 of the new Act.

A country’s legal organisations and systems are always prominent in shaping private financial contracts. A creditor’s ability to take collateral is the vital factor in a financial contract since they ensure better bank support, longer maturity period, and lesser interest rates. Ultimately the capability of a creditor to take collaterals also minimises the risks involved in the financial contracts.

Another type of financial contract, at times known as Annuity in United States, is virtually an insurance contract. Such a financial contract comes into being when an individual takes out a policy from that insurance company. The company may invest the fund and distribute back a percentage to the owner in several ways, either as a lump sum or on a periodical payment basis.

Characteristics of any annuity contract are that there is an option for the client for a guaranteed distribution of income until the death of the annuity beneficiary. Since annuity provides a source of income that will never run out, retirees find the contract extremely useful. The annuity contract or financial contract is therefore like a pension plan.

Annuity contract in United States are regulated under the Internal Revenue Code implemented by individual states. Such annuities combine the features of life insurance on one hand and investment products on the other. However, annuity contracts can be sold only by the insurance companies under the federal laws.

A question arises on the remedies available to the creditor to ensure repayment when their rights are weak. A creditor can impose higher interest rate simultaneously reducing the maturity period in such case. Loan ownership is more diffuse in countries where the rights of the creditor are weak and legal formalism is greater.

A financial contract often involves Coasian bargaining that is related to interest rates. Where the risk of government expropriation is high the financial agencies can think of suitable private contracts. Use of collateral and maturity terms may be two of the important tools for the financial institution in such case.

The Coasian theory states that financial organisations will always find out clever ways to offset the weakness of the system and may also seek for extra protective measures beyond what is laid down in the ordinary financial contracts. However such extra protective measures shall always be subject to the costs and enforcement difficulties involved, which may restrict its use and operations. Whatever may be the case, difference in contractual environment is most likely to affect the formation, features, and outcome of a financial contract.

Loans with greater formalism are of course more secure but will have longer periods of maturity. Another affect of greater formalism is that the terms laid down for rated firms are better than those laid down for unrated firms. Major part of unrated loan is provided by domestic banks since foreign banks do not relish it and they also look forward to the courts to assist them in case of defaulted loans.

Micro level aspects relating to a financial contract involves the grass root level components like the borrower and lender basically. The second level belongs to the State that includes the creditor’s rights, borrower’s rights and other correlated legal stipulations. State level conditions also include the economic system of the country and the legal forum functionaries like the courts who are the last resort in case of putting on right track a defaulter.

Financial contract often involves venture capital, a term associated with banks only in older days but that has now acquired a much broader perspective. In this type of financial contract, both participants invest till the firm is firmly entrenched in the business world. The techniques that are involved here include restrictive covenants, redemption rights, and staged investments and the most significant characteristics of such a financial contract is the limited time period allowed.

Financial contract has many aspects that require attention of the parties involved in such a contract. There are much more than what has been described above. However, these are some of the basic aspects of a financial contract in United States that we have discussed in previous paragraphs.