Malaysia: Briefing - The Net Effect

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 power to the Minister of Finance to impose a period of stay on the rights of the close-out netting under the Act for the purposes of the provisions specified in Part II of the Schedule, namely, subsections 115(3) and 180(1) of the Malaysia Deposit Insurance Corporation Act 2011; subsection 209(2) of the Financial Services Act 2013; subsection 220(2) of the Islamic Financial Services Act 2013; and section 41 of the Pengurusan Danaharta Nasional Berhad Act 1998.

This legislation is very important to give assurance to international and domestic financial market participants, whether fund management, insurance, banking institutions or public and private companies, to enforce the close-out netting mechanism when an 'event of default' occurs under a certain agreement. – Datuk Ahmad Maslan (Deputy Finance Minister).

IMPORTANCE AND BENEFITS Close-out netting allows parties in the financial market to perform financial transactions with reduced exposure to credit and market risks as well as confining counterparty credit risk to a single net amount payable, instead of on a gross basis upon termination of transactions.

With the Act coming into force, efficiency of the financial markets in Malaysia will be enhanced as Malaysian banks are able to deal more competitively with foreign counterparts globally and develop new hedging instruments and innovative financial products to corporations, businesses and consumers. – Statement issued by the Ministry of Finance.

It also reduces the cost of conducting business and effecting transactions in Malaysia, since lower capital may now be set aside to meet regulatory requirements which will then lower the cost of transactions, effectively enabling financial institutions to undertake more transactions, trade in financial instruments more efficiently, and develop the capacity to provide new and innovative financial products to consumers. This will also enable banks to deal more competitively with foreign counter parties worldwide, consequently improving the efficiency of financial markets.

LEGAL IMPEDIMENTS Despite all efforts to ensure legal certainty on the enforceability of the Act, there are several impediments to closeout netting, and these are found in section 29A³ and section 41⁴ of the Pengurusan Danaharta Nasional Berhad Act 1998, and section 346C⁵ of the Capital Markets and Services Act 2007.

CONCLUSION It is hoped that the recognition of Malaysia as a netting-friendly jurisdiction would give confidence to international financial institutions to deal with Malaysian financial institutions, thus facilitating further development and competition in the local financial markets.

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PRICE CHECK! The amendments⁶ ("the Amendments") to the Price Control and Anti- Profiteering Act 2011 which came into force on 1 September 2014, were passed as an assurance to Malaysian consumers that local traders and suppliers will not unreasonably and excessively increase prices of goods and charges for services.

These Amendments are now in the limelight, especially with the recent imposition of the Goods and Services Tax.

This article highlights the Amendments and the Price Control and Anti Profiteering (Mechanism to Determine Unreasonably High Profit) (Net Profit Margin) Regulations 2014.

KEY AMENDMENTS TO THE ACT One of the key amendments to the Price Control and Anti- Profiteering Act 2011 ("the Act") is the provision for the Minister of Domestic Trade, Co-operatives and Consumerism to determine the mechanism to assess if profits are unreasonably high as well as to determine a period during which there shall be no increase in the net profit margin of any goods and services. This is done by formulating different types of mechanisms, taking into consideration factors such as tax imposition, supplier's cost, any cost incurred in the course or furtherance of business, supply and demand conditions, the conditions and circumstances of the geographical or product market, or any other matters relevant to the prices of goods or charges for services.

It is also illegal to include any credit for input tax that a business is entitled to claim under the Goods and Services Tax ("GST") Act 2014 and any refund of sales tax under the GST Act 2014 as "part of the price of the goods or charge for services". Such violation will attract the penal provision in the Act, the newly incorporated section 10A.

THE REGULATIONS The Price Control and Anti Profiteering (Mechanism to Determine Unreasonably High Profit) (Net Profit Margin) Regulations 2014⁷ ("the Regulations") was passed by Parliament on 24 December 2014. According to the Regulations, retailers or traders are not allowed to increase their net profit margin for any goods or services for 18 months, from January 2015 to June 2016. This, however, does not mean that every time prices go up, there is profiteering. The focus is the "net profit margin".

The Regulations provide details on how the net profit on 1 January 2015 should be calculated if the goods or services are new or are on sale. Detailed formulae have also been provided in the Regulations to determine if there has been increment in the net profit margin of any goods or services within the specified period.

The Regulations 2014 prescribe that profit is unreasonably high for the period from 2 January 2015 to 30 June 2016 if there is an increment in the net profit (in Ringgit Malaysia) of any goods or services as compared to the net profit of the same description of goods or services as at 1 January 2015. However, the profit will not be regarded as unreasonably high during the above period if the increment in the net profit is due to the reduction of costs and that there is no increase in the selling price of the goods or services. The Regulations 2014 prescribe that profit is unreasonably high for the period from 1 April 2015 to 30 June 2016 if there is an increment in the net profit (in Ringgit Malaysia) of any goods or services as compared to the net profit of the same description of goods or services as at 1 January 2015⁸.

However, the profit will not be regarded as unreasonably high during the above period if the increment in the net profit is due to the reduction of costs, and such reduction is not due to the changes from the tax imposed under the Sales Tax Act 1972 and the Service Tax Act 1975 to the tax imposed under the GST Act; and after excluding any tax imposed under the GST Act, there is no increase in the selling price of the goods or services.

Footnotes

1 Akta Penghasilan Bersih Perjanjian Kewangan 2015.

2 A qualified financial agreement is defined under section 2 of the Act, and must have certain features as prescribed by section 5 of the Act.

3 According to section 29A of the Pengurusan Danaharta Nasional Berhad Act 1998, 'the appointment of a Special Administrator under the Danaharta Act shall not be regarded as giving rise to a right for a person to terminate an agreement or accelerate the performance of an obligation'.

4 According to section 41 of the Pengurusan Danaharta Nasional Berhad Act 1998, 'on the appointment of the Special Administrator, a moratorium for a period of 12 months shall take effect during which no steps may be taken by any parties to set off any debt owing to the affected person in respect of any claim against the affected person except with the prior written consent of the Corporation'.

5 According to section 346C of the Capital Markets and Services Act 2007, 'the Securities Commission may issue a directive requiring any person to take any measure as the Commission may consider necessary in the interest of monitoring, mitigating or managing "systematic risk in the capital market"'.

6 Price Control and Anti-Profiteering (Amendment) Act 2014

7 P.U.(A) 347/2014.

8 Paragraph 3(1) of Part III of the Regulations 2014.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.