The Serbian law on financial guarantees: love at first sight?
February 2022 – The adoption of the Financial Guarantees Law (FCA) in 2018 was widely considered an excellent addition to Serbia’s financial law infrastructure. Nevertheless, more than three years later, FCA’s full potential has remained largely untapped. The main reason is its narrow scope in terms of covered counterparties and eligible transactions. Although the FCA has provided adequate protections for close-out netting in financial transactions between eligible counterparties (i.e. mainly sovereign and financial sector entities), it still does not protect close-out netting in transactions involving corporate counterparties. Now may be the time for the Serbian Legislature to consider some suggested FCA updates so market players can give it another shot.
Net in Serbia: status quo
Effective January 1, 2019, netting provisions were removed from the insolvency law (Zakon o stečaju) and replaced by the new compensation rules of the Financial Collateral Act (Zakon o finansijskom obezbeđenju) (“CIF“).
The FCA and the Financial Derivatives Ruling (Odluka o obavljanju poslova s finansijskim derivatima) (“Decision on derivatives“) issued by the National Bank of Serbia (“SNB“) recognize both termination and close-out netting provisions in financial transactions (“Transactions“) with eligible Serbian counterparties. The mutual debts and claims of the parties may be set off in the event of termination of the contract following agreed events of default and termination events, in accordance with the standardized framework agreement on financial derivatives customary in commercial practice and/or in the manner customary in commercial practice.
Although the FCA and the Derivatives Decision have facilitated greater legal certainty for close-out netting in transactions between eligible counterparties, the FCA, as the main source of netting legislation in Serbia, does not recognize close-out netting. -netting in transactions involving a regular legal entity, and this may limit the ability of corporate counterparties to hedge interest, foreign exchange, foreign exchange and other risks. Close-out netting in such cases is left to general contract and insolvency rules and is potentially subject to the discretion of an insolvency administrator.
The FCA establishes that close-out netting is recognized 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, brokers, investment funds, insurance companies and other national financial sector entities; the European Union; Member States of the European Union; the European Central Bank; the International Monetary Fund; and other financial institutions.
Upon commencement 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 in reason for such an insolvency event may be hindered by the insolvency administrator’s selection rights. The insolvency administrator has the right to reject all onerous transactions for the insolvent party, while requiring the other party to carry out all transactions for the benefit of the insolvent party, in accordance with the powers granted to the insolvency administrators under insolvency law. Thus, this could render the close-out netting mechanism largely inoperative.
Bearing in mind that the close-out netting mechanism with insolvent counterparties organized in Serbia is no longer protected by insolvency law, the determination of a single lump-sum termination amount and the netting of termination values in insolvency of such counterparty may be terminated by the insolvency administrator’s selection rights and, therefore, may not be enforceable.
Immediately after the adoption of the FCA, various interested parties and industry associations approached the NBS; however, these initial initiatives have so far been unsuccessful. The SNB was in no rush to modify the newly adopted statute, and it also gave the impression that most banks were expressing their concerns and that there were no real complaints from Serbian companies.
Yet it can be argued that now, more than three years after FCA was adopted, the reasons for keeping FCA as it is have weakened:
- sufficient time has passed for the legislature and market participants to identify the issues affecting the FCA, and also for certain currently ineligible counterparties, such as local businesses, to familiarize themselves with the new FCA concepts (e.g. example, type of collateral with transfer of title, financial contracts and derivatives, netting, etc.);
- it is clear that the FCA is not widely used in practice, apart from the sovereign (Republic of Serbia) and banks; there is even a danger that most FCAs, for most market players in Serbia, will end up a dead letter; and
- the solutions to the problems identified are rather straightforward, and appropriate amendments to the FCA would actually increase the level of harmonization between Serbian law 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, points 1 and 2, of the LCFwhich would allow Serbian companies (i.e. at least limited liability companies and joint-stock companies) to be parties to financial guarantee contracts and other financial contracts regulated by the FCA, provided that they enter into such agreements with an eligible counterparty entity listed in Article 4 of the FCA.
- If the SNB decides to maintain the currently proclaimed policy choice to exclude companies from the scope of Serbian legislation on financial guarantees, it is suggested at modify art. 20, par. 2, and s. 22, par. 1, points 1 and 2, of the CFL in order to allow Serbian companies to at least be party to financial contracts and derivative transactions regulated under Article 20 of the FCA, as they were already entering into such financial contracts before the enactment of the FCA in accordance with the SNB Derivatives Decision. In particular: (i) the reference to Article 4 should be deleted from Article 20, and (ii) the references to financial contracts (finansijski ugovor) should be deleted from points 1 and 2 of Article 22(1) FCA.
Now may be the time for the Serbian legislator to consider appropriate FCA updates, as suggested above, so that market players can give it another shot.