On 8 June 2018, the Serbian Parliament adopted the Law on Financial Collateral ("FC Law") which will become applicable on 1 January 2019. Financial agreements that are not fulfilled by 1 January 2019 will be implemented pursuant to the rules that were in force before that date.
Simultaneously, the Insolvency Law ("Insolvency Law") was amended to support proper functioning of the FC Law and will also become applicable on 1 January 2019. Insolvency procedures that are ongoing as of 1 January 2019 will be finalized pursuant to the rules that were in force prior to that date.
The main reason for enacting the FC Law was the establishment of a unified and effective regulatory framework for the use of special collaterals by participants in the financial market in line with the EU Directive on Financial Collateral Arrangements 2002/47/EC ("Directive"). Although the long awaited FC Law should contribute to the further development of the secured loans, financial derivatives and repo markets, the approach taken by the legislature in amending the Insolvency Law has also brought certain negative aspects.
The FC Law introduces the following main novelties:
- Eligible parties - the group of eligible parties generally follows the scope set by the Directive, including the Republic of Serbia, the National Bank of Serbia, the EU and its member states, third countries, banks, investment funds, broker-dealers, insurance firms and other financial institutions, the European Central Bank, the International Monetary Fund, European Investment Bank and certain other international development banks and legal entities representing the above parties. General corporations are not included. This exclusion of corporations, although compliant with the option which the Directive allows for EU member states, comes as an unpleasant surprise given that the draft provided for the public discussion included both corporates and individuals when dealing with the other eligible participants. The legislators' stance is that at this stage the less experienced and weaker parties, such as corporate entities and individuals, should not be included due to the still underdeveloped financial market in Serbia. The fact that financial collaterals may not be used in transactions with ordinary corporates is particularly limiting for OTC financial derivatives transactions. This seems to be a missed opportunity, especially if the aim is to promote the development of the OTC financial derivatives market for the purpose of hedging risks.
- Financial collateral arrangement modalities –two types of financial collateral arrangements are introduced: (i) title transfer arrangement whereby the collateral taker receives full ownership over the collateral, and (ii) security arrangement whereby the ownership over the collateral remains with the collateral provider. Upon the fulfilment of the financial obligation, the collateral taker shall return the received or equivalent collateral to the collateral provider.
- Collateral categories – the financial collateral arrangement may include cash, financial instruments and credit claims.
- Forex restrictions – the FC Law is expressly subject to the rules of the Law on Foreign Exchange Operations ("Forex Law"). This means that the existing restrictions under the Forex Law will affect application of financial collaterals in cross-border transactions and need to be considered in each case.
- Enforcement of the collateral – the parties are free to define enforcement events upon the occurrence of which the collateral taker shall be able to realise the collateral in an effective and prompt collection. Specifically, the collateral taker may settle its claim in an out-of-court proceeding and/or set off the claims and obligations between itself and the collateral provider without any prior notice, deadline elapse, participation of the court/other authority or a public auction.
- Close-out netting – the parties may agree that upon the occurrence of an enforcement event, automatically or at a party's request: (i) the obligations of the parties are accelerated or terminated and replaced by new monetary obligations, and/or (ii) the mutual claims and obligations are netted so that the net amount is paid by the party from whom the larger amount is due to the other party. The close-out netting regime is generally improved compared to what was regulated so far in the Insolvency Law, but only for eligible participants, as explained below.
- Disapplication of insolvency rules – the rights and obligations under the financial collateral arrangements will be freely performed regardless of the initiation of the insolvency, bankruptcy or reorganisation of the parties. In case the financial collateral arrangement was created or the collateral was provided, acquired, or altered on the day of the initiation of the insolvency or bankruptcy of a party or application of reorganization measure, such legal actions shall be valid and enforceable if the collateral taker proves that it was unaware and should have not been aware of the commencement of said proceedings.
- Application of the FC Law to other financial agreements – the above rules on close-out netting and disapplication of insolvency claw-back rules are also prescribed for other special financial agreements concluded by the participants in the financial market such as financial derivative agreements, the sale and purchase of securities and other financial instruments, forex swap transactions and other financial contracts which may be prescribed by the National Bank of Serbia. As mentioned, regrettably these rules do not govern the transactions entered into with ordinary corporate entities.
- Adjustment of the insolvency for banks and insurance companies - the FC Law further improved insolvency rules by deleting the controversial Article 12 of the Law on Insolvency and Liquidation of Banks and Insurance Companies.
Amendments to the Insolvency Law. To improve the insolvency framework for financial collaterals and other special financial agreements as defined in the FC Law (such as ISDA Master Agreements), the Serbian legislature has undertaken certain amendments to the Insolvency Law. The changes are focused on safeguarding financial collaterals and other special financial agreements defined under the FC Law from the insolvency rules. This includes a number of clarifications and a complete deletion of the earlier special close-out netting provisions and their moving (with certain improvements) to the FC Law. A creditor that settles its claims upon the opening of insolvency proceedings based on a financial collateral agreement or based on a close-out netting under a special financial agreement is bound to notify the court within 8 days from the settlement day.
Whilst this new approach should bring greater certainty for close-out in the financial transactions among eligible participants, it deteriorates the position for close-out netting in financial agreements that involve a regular corporate entity, such as an ISDA Master Agreement between a bank and a company. The close-out netting in such cases is now left to the general insolvency rules and potentially exposed to cherry-picking by the insolvency administrator. Specifically, with the deletion of special rules from Article 82 of the Insolvency Law, close out netting in financial agreements which include a non-eligible participant (such as a general corporate) rely now on the general rules on set-off. To preserve a set-off right in insolvency, the creditor has to (i) acquire the set-off right before submission of the insolvency petition and (ii) register its claim in the full amount together with the set-off statement during the period for registration of claims. Also, protection against claw back claims is no longer available unless the financial agreement is among eligible participants.
To sum up, the FC Law and the amendments to the Insolvency Law deliver valuable and progressive developments for the realization of collaterals for the financial obligations of eligible financial market participants. On the other hand, they hinder the enforceability of ISDA Master Agreements or similar close-out netting agreements against Serbian corporate entities in case of insolvency. Therefore, it remains to be seen how these changes will affect financial derivatives, repo transactions and other similar financial arrangements and if the drawbacks will be identified and rectified by the legislators.
The information in this document does not constitute legal advice on any particular matter and is provided for general informational purposes only.