On January 20, 2022, the National Bank of Serbia (the “SNB”) published the Recommendation on the interest rates which would replace the reference interest rates which cease to apply (CHF LIBOR and EONIA) (the Recommendation). The recommendation aims to ensure uninterrupted continuity of the contractual relationship between the borrower or depositor and the bank after the termination of CHF LIBOR and EONIA.

As part of the ongoing global interest rate benchmark reform, CHF LIBOR and EONIA (among other benchmarks) ceased to be published from the beginning of 2022 by their respective administrators (ICE Benchmark Administration and European Money Market Institute). This resulted in the need to introduce new interest rate calculation mechanisms in all loans and other agreements in which the variable interest rate was determined by reference to CHF LIBOR and EONIA. Due to the large number of old contracts based on CHF LIBOR and EONIA in the European Union, in order to preserve financial stability, the European Commission adopted in October 2021 two regulations (Nos 2021/1847 and 2021/ 1848, the “EU regulations”) whereby it prescribed statutory replacement rates for all relevant contracts which were based on such references and where the parties did not agree on an adequate replacement. The SARON compound rate published by SIX Swiss Exchange has been determined as a replacement rate for CHF LIBOR and €STR, a new euro overnight rate administered by the European Central Bank, has been determined as a replacement for EONIA.

Although in Serbia the overall amount of contracts based on these references is not significant, especially due to the earlier enactment of the law on the conversion of indexed housing loans into CHF, there is still a need to resolve these old contracts and to ensure their continuity, which the Serbian regulator has correctly recognized and reacted to by publishing the recommendations. The recommendations relate to two types of instruments – loans and deposits, which presumably results from the assessment that these two groups of contracts are the most relevant to trade in the Serbian market. Following the approach adopted by the European Commission, the SNB recommended to the Serbian banks that in case no other mechanism is agreed for this situation, an offer to conclude an amendment to the loan agreement be made to the borrowers with which a variable interest rate by reference to CHF LIBOR or EONIA has been agreed, whereby: (i) CHF LIBOR (1M/3M/6M/12M) would be replaced by an appropriate compound term structure (1M or 3M) of the SARON rate with a spread adjustment value, and (ii) EONIA would be replaced by the €STR rate with a spread adjustment value. It is recommended to use replacement rates in accordance with EU regulations, which in the case of CHF LIBOR means that a standardized SARON compounded with a duration of 1 or 3 months as published by SIX Swiss Exchange is used, this rate being calculated for the period immediately preceding the relevant interest period according to the so-called “last reset” method. This approach is taken to allow the use of the reference rate which is known before the start of the relevant interest period, as otherwise the compounded value of overnight SARON can only be calculated (and known) at the end of the respective period.

It is also recommended that: (i) borrowers have the possibility, instead of replacing one variable interest rate with another, to choose that the last published LIBOR or EONIA in CHF continues to apply until the repayment of the loan, i.e. it applies as a fixed interest rate, and (ii) this mechanism is applied in the event that a borrower does not enter into the aforementioned covenant or terminate the loan agreement. This “fixed” alternative is a local feature, which seems to be suggested for the sake of simplicity for this limited number of contracts and bearing in mind the current negative values ​​of the reference rate which are favorable to loan users. From the bank’s point of view, this means the transition from a variable rate instrument to a fixed rate instrument, which requires adequate management of financial risks, in particular asset-liability management.

With regard to deposit contracts, the SNB has recommended that banks apply the above reference replacement interest rates in the future, i.e. capitalized SARON with spread adjustment value and EONIA with spread adjustment value, unless the depositor refuses the application of these interest rates and terminates the contract. .

As the SNB provided the guidance, Serbian banks are now required to prepare model fallback clauses in order to offer their clients the aforementioned offers. Although the NBS has provided useful substantive guidance, among the first in non-EU countries in the region, the fallback clauses still need to be carefully drafted to address all the relevant details to enable the smooth functioning of the contracts in the future. This is particularly impacted by the inherent differences between how new compound overnight rates are calculated, which are by nature backward-looking, and LIBOR as a forward-looking rate. For example, one of the questions that fallback clauses will need to answer is how exactly the standardized 1 or 3 month compound rate will be applied when the loan’s next actual interest period turns out to be different from the previous ‘observation’ based on which SIX Swiss Exchange calculated the standardized compound rate, in particular when the actual period turns out to be shorter either due to the difference in the calculation of business/calendar days or due to an interruption period in advance payment.

It should also be noted that in addition to CHF, the LIBOR rate ceased to be published from 1 January 2022 also for the other working currencies – GBP, EUR and JPY for all maturities and USD for 1W maturities and 2M (while other USD maturities are set will be discontinued from June 30, 2023). This means that replacement clauses are also required for contracts based on these other LIBOR parameters. Due to the limited number of old contracts based on these other terminated references, they are not currently covered by the SNB recommendations, nor has the European Commission prescribed statutory replacement rates for such cases. Nevertheless, there is comprehensive guidance for contractual transitions of each of these benchmarks provided by official working groups in each of the respective benchmark centers, which should be considered as international best practice. These private contract solutions must also reflect the requirements of local legislation, particularly in the area of ​​consumer protection, as well as the circumstances of each institution and its clients, which inevitably makes the process complex.

On the other hand, EURIBOR, as a benchmark mainly used for foreign exchange instruments in the Serbian market, was, to everyone’s relief, successfully reformed by its administrator (the European Money Market Institute) and should not be abandoned just yet. Nevertheless, its long-term future is uncertain and EU rules require EU financial institutions to include in their relevant EURIBOR-based contracts robust fallback clauses, providing for a replacement rate that would apply in the event of definitive termination of the EURIBOR or its loss. of representatives. Although Serbia is not yet part of the EU and these rules do not formally apply to the institutions here at the moment, the alignment of local rules with the acquired in this area is foreseen as part of the EU accession process. Fallback clauses also come under risk management and must therefore be taken into account by each institution, which is particularly emphasized for institutions that operate within an international group where other members of the group are already subject to direct regulatory requirements in this area. Since the number of new contracts accumulates daily, it is reasonable to expect that the overall process will be easier for institutions that manage to develop adequate fallback rates sooner rather than later.

*Partner and associate refer to an independent lawyer in cooperation with Karanovic & Partners

The information contained herein does not constitute legal advice on any particular subject and is provided for informational purposes only.