STRENGTHENING CREDIT RISK: SAMA’S CLOSE-OUT NETTING & COLLATERAL FRAMEWORK

17 February 2025

Shuchi Goel

New Close-Out Netting & Financial Collateral Arrangements Regulation (SAMA - Effective 17 February 2025)

Riyadh: On 17 February 2025, the Saudi Central Bank (SAMA) brought into force its “Close-out Netting and Related Financial Collateral Arrangements Regulation” (the “Netting Regulation”), leveraging its authority under Article 214 of the Bankruptcy Law.

This landmark regime enshrines the legal certainty of netting agreements and collateral arrangements—critical tools for managing counterparty credit risk—by exempting them from the automatic stay and other restrictions that arise when a counterparty enters bankruptcy.

1.       Scope of Application

The Netting Regulation applies whenever:

• One or more Qualified Financial Contracts (“QFCs”) exist between parties, and

• At least one party is a SAMA-regulated entity (e.g., banks, finance companies, licensed brokers).

2. Key Definitions

• Qualified Financial Contract (QFC): Includes derivatives, repos, securities and commodities borrowing/lending, Shari’ah-compliant economically equivalent contracts, and any other instrument SAMA designates as a QFC (see Annex 1).

• Netting: The process of aggregating and combining payment or delivery obligations and entitlements under QFCs to calculate a single net amount owed by one party to another.

• Netting Agreement: A contractual arrangement that specifies how multiple obligations under QFCs will be netted and closed out upon default or insolvency.

• Financial Collateral Arrangements: Security interests over cash, securities, commodities, letters of credit, or other movable assets created under the Movable Assets Security Law to secure QFC obligations.

• Multi-Branch Netting: Netting across branches of the same financial institution, including where a foreign-based entity has a KSA branch that enters into QFCs.

3. Regulatory Objectives

SAMA’s primary goals are to:

• Preserve Financial Stability: Enable swift close-out of exposures to distressed counterparties without court delays.

• Protect Market Participants: Safeguard the rights of institutions that rely on netting and collateral for risk mitigation.

• Align with International Standards: Mirror best practices in major jurisdictions (e.g., UK, EU, U.S.) to bolster Saudi Arabia’s attractiveness as a financial center.

4. Enforceability Provisions

4.1 Netting Agreements – Remain valid and enforceable in full even after the counterparty commences bankruptcy procedures (protective settlement, restructuring, liquidation). – No automatic stay or voiding of set-off rights: parties may terminate and close out QFCs and calculate the net amount owing.

4.2 Financial Collateral Arrangements – Security interests over cash, securities, commodities, and other movables survive the commencement of insolvency proceedings. – Collateral can be realised and applied to outstanding obligations without seeking court approval.

4.3 Multi-Branch Netting – Close-out provisions in a netting agreement extend to a bankrupt local branch of a foreign-based institution. – Liability exposure is confined to the branch’s obligations; the foreign head office’s assets remain protected from local insolvency claims.

5. General Safeguards & Limitations

• Bankruptcy-Law Cross-Check: The regulation does not override SAMA’s reserve powers under the Law of Systemically Important Financial Institutions, which may permit temporary stays on close-out rights for designated banks.

• Post-Insolvency Payment: After insolvency is triggered, only the single net amount—as determined under the netting agreement—may be claimed or paid, preventing claims for individual gross amounts.

6. Practical Implications for Market Participants

• Agreement Review: Financial institutions should audit all existing QFCs and netting/collateral clauses to confirm alignment with the new regulation.

• Documentation Updates: Standard templates (ISDA, GMRA, etc.) may require tailored amendments or side-letters that reference SAMA’s Netting Regulation.

• Collateral Management: Re-evaluate collateral schedules, margin thresholds, and enforceability processes to ensure swift collateral calls and realisations.

• Cross-Border Coordination: International banks must verify that multi-branch netting provisions are properly documented to isolate KSA-branch exposures.

7. Next Steps

·       Gap Analysis: Convene legal, risk, and operations teams to map current practices against the Netting Regulation’s requirements.

·       Policy & Procedure Updates: Revise internal credit-risk policies and recovery-resolution playbooks to incorporate regulated close-out and collateral enforcement workflows.

·       Staff Training: Educate traders, treasury, and legal teams on the regulation’s mechanics, focusing on accelerated close-out and collateral realisation timelines.

·       Regulatory Filings: Where required, notify SAMA of material changes to your netting or collateral arrangements and submit any prescribed documentation.

In Conclusion

SAMA’s Netting Regulation significantly enhances legal certainty around netting and collateral enforcement in bankruptcy, reinforcing Saudi Arabia’s financial-market infrastructure. Firms under SAMA supervision should move swiftly to review and adapt their QFCs, netting agreements, and collateral frameworks, ensuring they can rely on robust close-out mechanics when counterparty distress arises. Continuous engagement with SAMA and your legal advisors will be key to seamless compliance and operational resilience.

ALKETBI TOUCH

As a specialized law firm we can help Saudi companies adapt to SAMA’s new netting regime by auditing existing financial contracts, redrafting netting and collateral clauses to ensure enforceability in insolvency, coordinating with SAMA on compliance filings, and training in-house teams on accelerated close-out processes. Feel Free to reach out if you need any assistance in Saudi Arabia!