The Serbian Financial Collateral Act: Love At Second Sight? – Finance and Banking

Marion Steward


Serbia:

The Serbian Financial Collateral Act: Love At Second Sight?


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February 2022  – The adoption of
the Financial Collateral Act (FCA) in 2018 was widely regarded as a
great addition to Serbia’s financial law infrastructure.
Nevertheless, more than three years later, the FCA’s full
potential has largely remained untapped. The key reason lies in its
narrow scope in terms of covered counterparties and eligible
transactions. Although the FCA delivered adequate protections for
close-out netting in financial transactions among eligible
counterparties (i.e., mostly sovereign and financial sector
entities), it still does not protect close-out netting in
transactions that involve corporate counterparties. Perhaps the
time has come for the Serbian legislature to consider suggested
updates to the FCA so that market participants may give it another
chance.

Netting in Serbia: Status Quo

From 1 January 2019, netting provisions were removed from the
Insolvency Act (Zakon o stecaju) and replaced by the new
netting rules of the Financial Collateral Act (Zakon o
finansijskom obezbedenju
)
(“FCA“).

The FCA and the Decision on Financial Derivatives (Odluka o
obavljanju poslova s finansijskim derivatima
)
(“Derivatives Decision“) issued by the
National Bank of Serbia (“NBS“) both
recognise termination and close-out netting provisions in financial
transactions (“Transactions“) with
eligible Serbian counterparties. The mutual liabilities and
receivables of the parties may be netted in the event of contract
termination as a consequence of agreed events of default and
termination events, in accordance with the standardised master
agreement on financial derivatives customary in business practice
and/or in the manner customary in business practice.

Although the FCA and the Derivatives Decision facilitated
greater legal certainty for close-out netting in Transactions
between eligible counterparties, the FCA as the primary source of
netting legislation in Serbia, does not recognise close-out netting
in Transactions that involve a regular corporate entity, and this
can constrain the ability of corporate counterparties to hedge
interest, currency, FX and other risks. The close-out netting in
such cases is left to the general contract and insolvency rules and
is potentially exposed to the discretion of an insolvency
administrator.

The FCA establishes that close-out netting is recognised and
protected only in Transactions with certain eligible Serbian
counterparties listed in Article 4 of the FCA: the Republic of
Serbia (sovereign counterparty); the National Bank of Serbia (NBS);
banks, broker-dealers, investment funds, insurance firms and other
domestic financial sector entities; the European Union; European
Union Member States; the European Central Bank; the International
Monetary Fund; and other financial institutions.

Upon the opening of insolvency proceedings against a Serbian
corporate counterparty not designated as an eligible entity under
the FCA, the provisions of the ISDA Master Agreement permitting the
non-defaulting party to terminate all Transactions due to such an
insolvency event may be hindered by the insolvency
administrator’s cherry-picking rights. The insolvency
administrator has the right to reject all Transactions onerous to
the insolvent party, while forcing the other party to perform all
Transactions of benefit to the insolvent party, in accordance with
the powers vested in insolvency administrators under the Insolvency
Act. Thus, it might render the close-out netting mechanism largely
inoperable.

Keeping in mind that the close-out netting mechanism with
insolvent corporate counterparties organised in Serbia is no longer
protected by the Insolvency Act, the determination of a single
lump-sum termination amount and the netting of termination values
upon the insolvency of such a counterparty may be interrupted by
the cherry-picking rights of the insolvency administrator and, as a
result, may not be enforceable.

Suggested Improvements

Immediately following the adoption of the FCA, various
interested parties and industry associations approached the NBS;
however such initial initiatives have thus far been unfruitful. The
NBS was not in a rush to amend the freshly adopted statute, and it
also conveyed the impression that mostly banks were voicing their
concerns and that there were no actual complaints from Serbian
corporates.

Still, it may be argued that now, more than three years since
the FCA was adopted, the reasons for keeping the FCA as is have
weakened:

  • sufficient time has passed for the legislature and market
    participants to identify issues affecting the FCA, and also for
    certain, currently non-eligible counterparties, such as local
    corporates, to become familiarised with the FCA’s novel
    concepts (e.g., title transfer type of collateral, financial
    contracts and derivatives, netting, etc.);

  • it is clear that the FCA is not abundantly used in practice,
    apart from the sovereign (Republic of Serbia) and banks; there is
    even a danger that most of the FCA, for most market participants in
    Serbia, will end up as a dead letter; and

  • solutions for the identified issues are rather straightforward,
    and suitable amendments to the FCA would actually increase the
    level of harmonisation between Serbian and EU law.

Accordingly, the following changes/amendments to the FCA are
suggested:

  • Amendments to Article 4, Article 20 paragraph 2, and
    Article 22 paragraph 1 items 1 and 2 of the FCA
    , which
    would permit Serbian corporates (i.e., at least limited liability
    companies and joint-stock corporations) to be parties
    to financial collateral arrangements and other
    financial contracts
     regulated under the FCA, provided
    that they enter into these agreements with an eligible entity
    counterparty listed in Article 4 of the FCA.

  • If the NBS decides to maintain the currently proclaimed policy
    choice to exclude corporates from the scope of Serbian financial
    collateral legislation, it is
    suggested to amend Article 20
    paragraph 2 and Article 22 paragraph 1 items 1 and 2 of the
    FCA
     in order to permit that Serbian corporates may at
    least be parties to financial
    contracts
     and derivatives
    transactions
     regulated under Article 20 of the FCA,
    as they were already entering into such financial contracts before
    the enactment of the FCA in line with the NBS’s Derivatives
    Decision. In particular: (i) the cross-reference to Article 4
    should be removed from Article 20, and (ii) references to financial
    contracts (finansijski ugovor) should be deleted from
    items 1 and 2 in Article 22 paragraph 1 of the FCA.

Perhaps the time has come for the legislature in Serbia to
consider suitable updates to the FCA as suggested above so that
market participants may give it another chance.

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.

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