New Saudi netting laws reduce capital requirements and boost trading opportunities for financial institutions

Key points

• On 16 February 2025, Saudi Arabia's new Close-out Netting and related Financial Collateral Arrangements Regulation took effect.
• The regulation establishes a framework for the enforcement of close-out netting and related margin arrangements entered into by a SAMA¹ -regulated counterparty, both before and after insolvency. It also protects these types of arrangement from certain provisions of the Saudi Bankruptcy Law (2018)².
• The regulation is based on ISDA's 2018 Model Netting Act, tailored to Saudi Arabia's regulatory framework and legal environment.
• Industry netting and collateral opinions will be published in due course, which will significantly reduce the capital costs of derivatives trading and securities financing activity in the region and increase trading volumes and associated liquidity.
• The regulation is also expected to strengthen Saudi Arabia's position as a regional financial centre competing with the UAE's extensive financial markets.

Background - close-out netting and financial collateral arrangements

Close-out netting is an integral part of the derivatives and securities financing³  markets. It typically involves a three-stage process:

1.  terminating transactions between two parties upon the default by one of them; or accelerating the parties' payment and delivery obligations in respect of those transactions;
2.  valuing those transactions or the parties' payment and delivery obligations; and
3. combining those values into a single net sum which is payable between the parties, instead of the payment or delivery obligations which would otherwise have been due in respect of the terminated transactions.

If enforceable, close-out netting reduces a non-defaulting party's credit exposure to its defaulting counterparty. This is because, rather than the non-defaulting party being required to account to the defaulting party for the value of transactions which are valuable to the defaulting party (and potentially rank as an unsecured creditor for the value of transactions which are valuable to the non-defaulting party), these values are collapsed into a single net sum. Large gross credit exposures are therefore converted into smaller net exposures.

Similarly, financial collateral arrangements are integral to the operation of the derivatives and securities financing markets. The exchange of financial collateral reduces the parties' credit exposure further, by giving a party with a (net) exposure access to liquid assets to apply against its (net) exposure upon a default of the other party. Financial collateral arrangements may take the form of title transfer arrangements or security interest arrangements (see box entitled Financial collateral arrangements).

Commonly-used master agreements that incorporate close-out netting and financial collateral arrangements include, amongst others, the ISDA Master Agreements and Credit Support Annexes, the Global Master Repurchase Agreements (GMRA) and the title transfer versions of the Global Master Securities Lending Agreement (GMSLA).

Efficient capital allocation

As a result of this reduced exposure, firms transacting with counterparties in jurisdictions that recognise close-out netting and financial collateral arrangements benefit from reduced capital costs, as they are required to hold less capital against potential losses. This makes capital allocation more efficient and increases trading activity and liquidity in those jurisdictions. However, for the benefits to apply, close-out netting and financial collateral arrangements must be enforceable in all relevant jurisdictions both before and after insolvency.

Enforceability

As noted above, the benefits of a reduced credit exposure resulting from close-out netting or financial collateral arrangements only arise if the close-out netting or financial collateral arrangement is enforceable. Similarly, firms will only benefit from associated reduced capital costs if they have legal opinions confirming the enforceability of those arrangements in all relevant jurisdictions.

Enforceability of close-out netting will primarily be a matter of two legal regimes:

• the governing law of the netting agreement - generally speaking, the enforceability of close-out netting as a matter of contract is not problematic, as the netting agreements are typically governed by laws (such as English and New York laws) under which close-out netting is enforceable as a matter of contract; and
• applicable insolvency law - even though close-out netting may be enforceable under the governing law of the netting agreement, if the defaulting party is insolvent or subject to bankruptcy, insolvency or recovery and resolution proceedings, it will be a matter of local insolvency law as to whether close-out netting is recognised and effective. In some jurisdictions, close-out netting is consistent with local insolvency laws, such that specific legislation is not required to give effect to it. However, in other jurisdictions, there is either doubt about whether close-out netting would be enforceable upon insolvency, or insolvency law precludes the application of close-out netting. In these cases, legislation permitting close-out netting would be needed.

Enforceability of financial collateral arrangements will primarily be a matter of three legal regimes:

• the governing law of the collateral arrangement – this is equivalent to the position in relation to close-out netting discussed above;
• applicable insolvency law – this is equivalent to the position in relation to close-out netting discussed above; and
• the law of the location of the collateral – this is because enforcement will likely require action to be taken in this jurisdiction.

Alignment with ISDA Model Netting Act

ISDA has long advocated for the introduction of specific legislation to protect post-insolvency close-out netting and related financial collateral provisions in all major jurisdictions. As part of its advocacy efforts, ISDA developed a "Model Netting Act" in 1996, which was most recently updated in 2018. The Model Netting Act sets out the basic principles needed to ensure the enforceability of bilateral close-out netting, multibranch netting, and related financial collateral arrangements. It also acts as a blueprint for jurisdictions that want to enact their own close-out netting or financial collateral legislation.

The new Saudi regulation is based on ISDA's 2018 Model Netting Act, tailored to recognise Saudi Arabia's regulatory framework and legal environment. It was enacted pursuant to Article 214 of the Saudi Bankruptcy Law (2018).

In summary, the regulation:

• confirms the validity and enforceability of close-out netting and related financial collateral arrangements both before and after insolvency of a SAMA-regulated entity; and
• exempts in-scope transactions from certain provisions of the Saudi Bankruptcy Law.

Protection for netting agreements and financial collateral arrangements

The regulation applies to netting agreements and related financial collateral arrangements that are entered into under a "qualified financial contract", where at least one of the counterparties is supervised by SAMA.

The key operative provision provides that:

(i) a qualified financial contract will be enforceable and valid in accordance with its terms against any party thereto; and

(ii) the enforceability and validity of any such contract will not be affected by a subsequent change in the circumstances under which it was entered into. This includes the onset of insolvency proceedings under the Saudi Bankruptcy Law or related regulation.

A qualified financial contract is defined broadly, encompassing financial agreements, contracts or transactions in relation to which any payment or delivery obligations are to be performed at a certain time or within a certain period of time. A non-exhaustive list of in-scope contracts is annexed to the regulation and includes, among other things, swaps, futures, options, murabahas, musawamas, wa'ads, repo transactions, securities lending transactions, and margin loans.

Further provisions provide that any netting agreement under a qualified financial contract (including related financial collateral arrangements) will also be enforceable in accordance with its terms, including against a counterparty which is subject to Saudi Bankruptcy Law proceedings, or a relevant credit support provider. There is also an explicit acknowledgement that any netting provisions will not be stayed or otherwise limited by any provision of the Saudi Bankruptcy Law. Any bankruptcy trustee or similar official will therefore only be able to exercise its powers in respect of any amount due after the application of close-out netting.

"Netting agreement" is defined broadly, tracking the Model Netting Act, and includes close-out netting and related collateral arrangements. "Collateral arrangements" explicitly includes security interests in collateral and title transfer collateral arrangements.

Various other provisions prevent the application of other provisions of the Saudi Bankruptcy Act to the protected arrangements described above.

Historically, netting provisions in financial contracts were merely contractual obligations, and it was unclear whether they would be upheld by an insolvency officeholder or relevant court upon insolvency. The new regulation addresses this legal ambiguity, establishing a clear regulatory framework and ensuring the enforceability of netting arrangements in insolvency scenarios.

Carve-out for Law of Systemically Important Financial Institutions

The regulation contains a carve-out that allows SAMA and/or the Capital Market Authority to stay the right to terminate, liquidate, or accelerate any present or future payment or delivery obligation in connection with certain qualified finance contracts to which a netting agreement applies, under the Law of Systemically Important Financial Institutions (Law of SIFIs).

The Law of SIFIs is a regulatory framework for identifying, supervising, and managing financial institutions whose failure could pose a significant risk to the broader financial system and economy. The Law of SIFIs and the new netting regulation are closely linked, as both are key regulatory tools designed to enhance financial stability and mitigate systemic risk in Saudi Arabia’s financial sector.

Banks, financial market infrastructures, and key financial institutions are among the most prolific users of netting arrangements. Accordingly, the new regulation supports the Law of SIFIs in multiple ways:

• it is particularly relevant for SIFIs, as they hold higher capital buffers due to their systemic importance;
• it ensures that, in an insolvency or resolution scenario, counterparties can enforce netting agreements without undergoing lengthy legal processes;
• it strengthens netting protections, making the Saudi market more attractive for derivatives trading, repo markets, and interbank transactions; and
• as SIFIs are major participants in these markets, it increases liquidity generally in the region and reduces counterparty risk, ensuring a more stable financial environment.

Multibranch netting

The regulation covers multibranch netting where one of the counterparties is established outside Saudi Arabia but has entered into a qualified financial contract through a Saudi branch, allowing financial obligations between branches to be consolidated and netted, with only the net balance being settled on default or insolvency.

Under the regulation, any such contract would be enforceable as a matter of Saudi law if the Saudi branch were to become subject to proceedings under the Bankruptcy Law, subject to certain limitations. Of course, the regulation only covers Saudi law, and so it would still be necessary to consider other applicable laws, such as the law of the head office of the defaulting counterparty.

SBL Regulations

The new regulation is different from and unrelated to the Securities Borrowing and Lending Regulations (the SBL Regulations) introduced by the Securities Depository Centre Company (Edaa) in 2017, which provide a legal and operational framework for borrowing and lending securities in Saudi Arabia. However, both this new regulation and the SBL Regulations demonstrate a deliberate opening up of the Saudi markets, removing obstacles and facilitating derivatives and securities financing transactions.

We have seen significant increased activity in the Saudi securities lending markets since the introduction of the SBL Regulations, acting for both domestic and international clients in their participation in this market, and the new regulation is likely to have a similar effect.

Next steps

Entities that are supervised by SAMA (and their counterparties) should review their existing contracts to check that they are in scope of the new regulation and can benefit from its protections.

Although we have historically seen a certain level of derivatives and securities lending activity in Saudi Arabia, the introduction of this new protection for netting and collateral arrangements will undoubtedly lead to increased trading levels and enhanced liquidity in the region.

When the industry netting and collateral opinions are available, this will free up large amounts of capital for deployment elsewhere, helping to strengthen Saudi Arabia's position as a regional financial centre competing with the UAE's extensive financial markets.