Introduction

The Saudi Central Bank (SAMA) has recently introduced the “Close-out Netting and Related Collateral Arrangements Regulation” to enhance financial stability and provide legal certainty in financial transactions. The regulation ensures that netting agreements and collateral arrangements are enforceable, even in the event of insolvency or bankruptcy. It is considered a crucial step in aligning Saudi Arabia’s financial framework with international best practices, reducing systemic risk, and increasing investor confidence. The regulatory framework enhances the position of Saudi Arabia as a secure and reliable financial hub, protecting contractual rights in financial transactions.

Background and Legal Framework

The regulation stems from the need to address uncertainties in financial transactions involving derivatives, repurchase agreements, and other similar financial instruments. It is particularly significant in the context of bankruptcy proceedings and aims to ensure the stability and predictability of financial transactions. It further aligns with article 214 of the Bankruptcy Law, which governs the enforceability of financial contracts in insolvency proceedings, and article 79 of the Implementing Regulation of the Bankruptcy Law, which outlines the legal framework for close-out netting mechanisms. The regulation is definitely aligned with international best practices, ensuring compliance with the principles established by the International Swaps and Derivatives Association (ISDA) and the Financial Stability Board (FSB).

The regulation applies to netting agreements and related financial collateral arrangements connected with one or more qualified financial contracts. these contracts must involve at least one party under the supervision of SAMA, or a bankrupt party supervised by SAMA. The key terms defined in the regulation include “netting” as the process of offsetting obligations between two parties under a netting agreement, which can be triggered by a default or other termination events. A netting agreement is an agreement that provides for the netting of payment or delivery obligations arising from qualified financial contracts.

The regulation defines “Qualified Financial Contracts” as the financial agreements, contracts, or transactions, including those listed in Annex (1) of the regulation. A financial collateral arrangement is an arrangement for providing collateral or other credit support related to a netting agreement or qualified financial contracts. Annex (1) lists a number of 27 types of contracts which includes derivatives such as currency and interest rate swaps, commodity swaps, futures, options, index derivatives and contracts for differences. SAMA has the authority to amend or designate additional agreements, contracts, or transactions as qualified financial contracts, in coordination with the Capital Market Authority and the Ministry of Commerce.

Qualified financial contracts are enforceable and valid under the regulation according to their terms, regardless of any subsequent changes in circumstances.  this enforceability extends to multibranch netting agreements, which involve foreign entities with branches in Saudi Arabia. The regulation provides specific provisions for the enforceability of multibranch netting agreements against bankrupt local branches. it limits the liability of a bankrupt local branch to the lesser of the global net payment obligation or the local net payment obligation. similarly, the liability of the non-bankrupt party is limited and can be reduced by amounts paid or received by bankruptcy trustees.

Non-bankrupt parties can retain and apply collateral taken under financial collateral arrangements to satisfy obligations of the foreign multibranch party. any excess collateral must be returned to the foreign multibranch party. the regulation ensures that the provisions of a netting agreement are enforceable against a bankrupt party and any guarantors or collateral providers.  it also limits the powers of the bankruptcy trustee and the bankruptcy commission to interfere with the termination, liquidation, or acceleration of obligations under qualified financial contracts.

It further protects certain transactions from being nullified or suspended by the bankruptcy trustee or the bankruptcy commission, unless there is clear evidence of intent to defraud. the primary objective of the regulation is to ensure the enforceability of netting agreements and related financial collateral arrangements, both outside and within the scope of bankruptcy proceedings. This is in accordance with Article (214) of the Bankruptcy Law and Article (79) of its implementing regulation.

Conclusion

The “Close-out Netting and Related Collateral Arrangements Regulation” is a milestone in Saudi Arabia’s financial legal landscape. It provides a robust legal framework to support the enforceability of netting agreements and related financial collateral arrangements in Saudi Arabia. It aims to enhance financial stability and predictability, particularly in the context of bankruptcy proceedings.

By providing legal certainty and enforceability for netting agreements, the regulation enhances financial stability, reduces systemic risk, and aligns with global best practices. Financial institutions and market participants must proactively review their contracts, implement robust risk management strategies, and seek legal counsel to ensure compliance.

Authors: Ashraf Hendi, Partner and Head of Banking & Finance and Njoud Almarshad, Trainee Lawyer.