Briefing - The Net Effect

Author:Zul Rafique & Partners
Profession:Zul Rafique & Partners
 
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THE NET EFFECT The Netting of Financial Agreements Act 20151 came into force on 30 March 2015. It seeks to provide a legal framework governing close-out netting for financial transactions in Malaysia.

In this article, we discuss the relevant provisions, benefits and legal impediments faced under the Netting of Financial Agreements Act 2015.

INTRODUCTION Netting arrangements refer to the settlement of obligations between two parties that processes the combined value of transactions. It is designed to lower the number of transactions required. In simple terms, this means if A owes B MYR100,000 and B owes A MYR40,000, the value after netting would be MYR60,000.

Netting arrangements were previously prohibited in Malaysia. However, the Netting of Financial Agreements Act 2015 ("the Act") currently provides legal certainty to the enforceability of a close-out netting mechanism under the Malaysian law.

Close-out netting is an important risk management tool used by financial institutions and financial market participants to reduce risk exposure should there be a counterparty default for bilateral financial transactions entered into.

THE NETTING PROVISION The close-out netting mechanism is now embedded in financial contracts, known as a 'netting provision'.

A netting provision, as defined by the Act, is a provision in a qualified financial agreement2 which provides that, upon the occurrence of events specified by the parties in the agreement (eg, by default or insolvency of a counterparty), all obligations owed by one party to another party under a qualified transaction are reduced to, or replaced with, a single net amount in accordance with the qualified financial agreement.

The close-out netting mechanism essentially allows all transactions, upon the occurrence of events specified by the parties in the agreement, to terminate the transactions, determine the value for each transaction and the sum value to be aggregated to come to a single net amount payable by one party to another, instead of the gross amount for each individual transaction under the financial contract.

PERIOD OF STAY Although close-out netting is a good risk management mechanism, exercising the close-out netting against a troubled financial institution may result in challenges, thus a brief deferral on the close-out netting mechanism is needed in order to afford time to the relevant authorities to decide whether and how to resolve such institution. In such cases, the Act gives...

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