Saudi Arabia Introduces Netting Regulation to Enhance Financial Stability
On February 17, 2025, the Saudi Central Bank (SAMA) introduced the “Close-out Netting and Related Financial Collateral Regulation,” a significant step aimed at bolstering the country’s financial stability. This regulation ensures that netting agreements and related financial collateral arrangements with entities supervised by SAMA are enforceable, even in cases of default or bankruptcy. The primary goal is to reduce credit risk exposure and enhance financial stability by confirming that the contractual provisions of netting agreements are upheld both inside and outside bankruptcy proceedings.
Understanding Close-out Netting
Close-out netting is a legal process that allows parties involved in financial contracts to offset mutual obligations in the event of a default. Instead of settling each obligation individually, the parties calculate the net amount owed, resulting in a single payment from one party to the other. This mechanism is crucial in minimizing credit risk and providing certainty in financial markets.
Implications for Cross-Border Transactions
The introduction of this regulation has significant implications for cross-border transactions and businesses operating in Saudi Arabia. By streamlining the settlement process between defaulting and non-defaulting parties, the regulation reduces the risk and uncertainty associated with financial transactions. Firms can now engage in such transactions with greater confidence, knowing that their netting agreements will be upheld even in the event of a default.
Alignment with International Standards
This move aligns Saudi Arabia’s financial practices with international standards, notably those set by the International Swaps and Derivatives Association (ISDA). ISDA has long advocated for clear legislative support for close-out netting to mitigate systemic risk in financial markets. The regulation’s alignment with ISDA’s Model Netting Act serves as a reference for jurisdictions aiming to establish or refine their netting legislation.
Collaborative Efforts and Industry Response
The announcement of the regulation was met with enthusiasm during a joint conference in Riyadh on February 19, 2025. The event, organized by ISDA, the International Securities Lending Association (ISLA), and the International Capital Market Association (ICMA), highlighted the collaborative efforts to enhance financial stability in the region. Such joint initiatives are uncommon, underscoring the significance of this regulatory development.
Next Steps: Legal Opinions and Market Adoption
Following the regulation’s introduction, industry associations are expected to publish legal opinions supporting the enforceability of close-out netting provisions in their agreements on a cross-border basis. These annual opinions are crucial for parties relying on them to reduce credit risk exposure and, where applicable, regulatory capital requirements. The publication of these opinions will provide the ‘green light’ for financial institutions to engage in such transactions on a larger scale.
Public Consultation by the Capital Market Authority
In a related development, the Saudi Capital Market Authority (CMA) has initiated a 30-day public consultation on a proposed regulatory framework for close-out netting applicable to capital market institutions. This consultation, concluding on March 26, 2025, aims to enhance financial system stability and investor protection by ensuring the enforceability of qualified financial contracts involving capital market institutions in default scenarios. Stakeholders are encouraged to review the draft framework and submit feedback through the Unified Electronic Platform for Consulting the Public and Government Entities.
A Milestone in Saudi Arabia’s Vision 2030
The implementation of the Close-out Netting and Related Financial Collateral Regulation is a significant milestone in Saudi Arabia’s Vision 2030, which aspires to transform the nation into a global investment powerhouse. By adopting international best practices and enhancing the legal framework governing financial transactions, Saudi Arabia is positioning itself as an attractive destination for global investors. This development is expected to foster increased confidence among international counterparties and stimulate growth in the country’s financial markets.
Conclusion
Saudi Arabia’s introduction of the Close-out Netting and Related Financial Collateral Regulation marks a pivotal advancement in the nation’s financial sector. By ensuring the enforceability of netting agreements, the regulation reduces credit risk and aligns the country’s financial practices with global standards. This proactive approach not only enhances financial stability but also reinforces Saudi Arabia’s commitment to becoming a leading global investment hub.
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