The Netting Amendments were officially published on 13 July 2022 and took effect on 12 September 2022. Although the Netting Amendments technically came into force on 12 September 2022, their practical operation depends on the adoption of certain regulations which are yet to be adopted by the regulator - the Agency of the Republic of Kazakhstan for Regulation and Development of the Financial Market ("Agency").
The Netting Amendments apply across the territory of Kazakhstan, except the country's financial free zone - the Astana International Financial Center (AIFC). The AIFC has its own netting law under its separate jurisdiction on civil and commercial matters following English common law.
For the first time in Kazakhstani legislation, the Netting Amendments expressly recognize the concept of "close-out netting." This is a critical development given the historical uncertainty on the enforceability of close-out netting in an insolvency scenario under Kazakhstani law.
Prior to the Netting Amendments, there was no concept of "netting" in Kazakhstani legislation. As a result, netting was treated as a form of set-off allowing payments between two parties on a given day in a given currency to be set-off.
Even though outside of insolvency Kazakhstani courts should recognize and enforce netting arrangements, the application of the Bankruptcy Law with respect to the netting arrangements gave rise to some uncertainty. The core challenge arose because the Bankruptcy Law included certain provisions operating to preclude close-out netting from taking place. Such provisions included: (i) prohibition of contract termination, (ii) powers of the insolvency administrator to "cherry pick" profitable transactions, and (iii) restrictions on setting off following the opening of insolvency proceedings in Kazakhstan.
The Netting Amendments are intended to address these concerns by specifically providing that close-out netting should not be adversely affected by the opening of insolvency proceedings in respect of a Kazakhstani counterparty.
The Netting Amendments
Scope of qualified contracts
Under the Netting Amendments, close-out netting would be recognized and enforced in respect of derivatives contracts, repo transactions and other financial contracts documented under qualified master agreements.
The Netting Amendments provide that close-out netting would be enforceable, provided that the relevant individual transaction under the master agreement was executed at least one month before the insolvency court commenced bankruptcy proceedings (for non-banks), or at least one month before the Agency revoked a banking license (for banks).
In order for close-out netting to be recognized and enforced in Kazakhstan, derivatives, repo and securities transactions must be documented pursuant to master agreements developed by international industry bodies included into the list approved by the Agency.2 While such list is yet to be adopted, from our independent searches in public sources we understand that the intention is to include the ISDA, ICMA, The Securities Industry and Financial Markets Association and The International Securities Lending Association so that the documentation such as ISDA Master Agreement and Global Master Repurchase Agreement (GMRA) are master agreements qualified for netting.3
Counterparties covered under the Netting Amendments include:
- commercial companies organized under the laws of Kazakhstan (outside the AIFC);
- Kazakhstani banks which are licensed by the Agency under the Banking Law;
- Kazakhstani securities market participants (brokers, dealers, etc.);
- Kazakhstani companies which are licensed by the Agency to offer insurance and reinsurance services;
- National Bank of the Republic of Kazakhstan acting as the central bank under the NBK Law;
- JSC Development Bank of Kazakhstan;
- JSC Unified Accumulative Pension Fund;
- all other Kazakhstani pension funds that are not JSC Unified Accumulative Pension Fund; and
- state owned legal entities which are organized under the laws of Kazakhstan as either state enterprises or state institutions.
The Netting Amendments do not require the master agreement or any individual transactions concluded thereunder to be registered with any authority in Kazakhstan in order for close-out netting to be recognized.
However, there is a general requirement under the Banking Law (and regulations promulgated thereunder4) that Kazakhstani banks must report concluded transactions to the Central Securities Depository (CSD) that will, in turn, include the transaction into the register of OTC derivatives transactions. While not expressly stated in the Netting Amendments, concluded transactions will need to be included into the register maintained by the CSD.
The Netting Amendments include certain provisions required to provide legal certainty for netting arrangements within the context of the Bankruptcy Law.
First, the Netting Amendments specifically provide that the prohibition of contract termination does not apply in respect of qualified contracts so that the initial step in the close-out process can be enabled.
Second, according to the Netting Amendments, powers of the insolvency administrator to "cherry pick" qualified contracts which are profitable to the defaulting party are limited and may only apply to a net amount determined following the close-out process.
Third, the Netting Amendments specifically state that transfers of cash or collateral5 by the defaulting party during the suspect period cannot be challenged, subject to certain limited exceptions enumerated in the Netting Amendments (e.g., transfers aimed at defrauding creditors).
In addition, according to the Netting Amendments, collateral transferred by the defaulting party prior to insolvency should not be included into the bankruptcy estate and should not be subject to creditors' claims of such party. Under the Netting Amendments, if an individual transaction documented under the master agreement is invalidated after close-out process has already occurred, this does not invalidate the process as a whole and instead will result in the net termination amount being adjusted by way of excluding the value of the transaction that has been invalidated.
Potential issues and conclusion
There are certain issues that do not appear to be addressed as part of the Netting Amendments, including the question of whether close-out netting under more than one master agreement between the same parties is permissible. We are also waiting for the regulations to be adopted by the Agency in order for ISDAs and GMRAs to be qualified for netting. Further, the Netting Amendments do not appear to specifically mention whether fines, penalties and lost profit are eligible for netting in insolvency.
Nevertheless, the enactment of the Netting Amendments after the 30th anniversary of the Republic of Kazakhstan is an important step forward for the development of the OTC derivatives market in Kazakhstan. The Netting Amendments are a very welcome development as they make close-out netting available as a tool for mitigation of credit risks.
1 Law of the Republic of Kazakhstan On Making Changes and Amendments to Certain Legal Acts of the Republic of Kazakhstan on Matters of Regulation and Development of the Insurance Market and Securities Market, Banking Activity dated 12 July 2022.
2 Provided that at least one party to the master agreement is a non-Kazakhstani entity (Article 33.8 of the Securities Law).
3 See https://kaztag.kz/ru/news/planiruemyy-k-utverzhdeniyu-perechen-inostrannykh-proforganizatsiy-predstavilo-arrfr-rk (in Russian).
4 Resolution of the Management Board of the Agency of the Republic of Kazakhstan On Regulation and Supervision of the Financial Market and Financial Organizations dated 16 July 2007, No. 210.
5 In Russian, обеспечительная плата (Articles 338-5, 338-6 of the Civil Code).