The long-awaited financial collateral legislation in Serbia, the Financial Collateral Act, has been finally adopted and will become applicable on 1 January 2019. Within its narrow scope of application, the legislation incorporates the main features of the EU Directive on financial collateral arrangements (2002/47/EC). We have reported on those features in November 2016 in a newsletter in which we optimistically discussed the then available draft of this legislation. This newsletter is limited to the aspects of the Financial Collateral Act which represent disappointing departures from the draft which was made available to the public and expectations in the business community.
Serbian corporates are not eligible to provide financial collateral
The outcome of the long-lasting legislative effort is suboptimal. Financial collateralization in support of transactions with financial derivatives will be available only with respect to a limited circle of Serbian counterparties: the state; the National Bank of Serbia; financial institutions; and securities clearing and depositories. Most importantly, Serbian corporates are not eligible counterparties.
Eligible foreign counterparties are: the EU; foreign states and their agencies; foreign central banks; international finance and international development institutions; central counterparties, settlement agents or clearing houses, as defined respectively in the EU regulations governing the settlement finality in payment and securities settlement systems; and financial institutions as defined under the EU law.
Serbian Insolvency Act removes all safeguards for financial contracts with Serbian corporates in the event of their insolvency
Exclusion of corporates from eligible Serbian counterparties means not only that Serbian corporates will continue to be unable to provide enforceable financial collateral in support of their obligations under financial derivative transactions, but also that, staring from 1 January 2019, there is no statutory guarantee that close-out netting provisions of the master agreement governing financial contracts will be enforceable in the event of insolvency of Serbian corporate counterparty. This is a result of an unusual choice of the Serbian legislator to entirely remove from the Insolvency Act all safeguards in favor of financial contracts concluded under master agreements, including those that support close-out netting in the event of Serbian counterparty's insolvency, and replace them with a reference to the provisions of the Financial Collateral Act. The safeguards provided in the Financial Collateral Act in the event of insolvency of Serbian counterparty, including those in support of close-out netting, apply not only to contracts for financial collateral but also to underlying financial contracts. However, the notion of financial contract is defined narrowly in the Financial Collateral Act, both in terms of eligible parties and in terms of subject matter. It encompasses only a master agreement concluded between eligible parties as defined in that Act, thus excluding Serbian corporates (see above).
Narrow definition of financial contracts
Subject matter wise, transactions eligible for insolvency-related safeguards are only financial transactions, defined as transactions under which a debtor has a financial obligation and the creditor has the right to a settlement in cash or financial instruments, and limited to: contracts for financial derivatives within the meaning of the capital markets legislation (options, futures, swaps, interest rate forwards etc); contracts for sale and purchase or lending of securities, money market instruments or other financial instruments within the meaning of capital markets legislation, or other financial transactions with such financial instruments; currency transactions; and other financial contracts from a list published by the National Bank of Serbia from time to time (no such list exists as of now). It is therefore questionable whether the protections under the Financial Collateral Act apply to commodity derivatives, while it is clear that they do not apply to commodity spots and other contracts which can be only physically settled.
Potential conflict with foreign exchange regulations
Given that the Financial Collateral Act does not override Serbian notoriously restrictive Foreign Exchange Act, but, on the contrary, affirms its precedence, a number of bylaws implementing the Foreign Exchange Act would have to be amended to accommodate cross-border transfers of financial collateral involving Serbian counterparties.