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 stečaju) and replaced by the new netting rules of the Financial Collateral Act (Zakon o finansijskom obezbeđenju) ("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.
For more information please contact Petar Kojdić, Partner, at .