National Bank of Serbia risks own goal with the new position on cross-border secured transactions

The National Bank of Serbia (“NBS“) released interpretative guidance regarding the application of the foreign exchange regulations on certain cross-border transactions. Among other things, the guidance responds to a question whether Serbian resident A may pledge a receivable owed to it by Serbian resident B (domestic receivable) for the benefit of non-resident C.

Whereas it acknowledges that “legally speaking, the transfer of receivables and granting pledge are two distinct concepts”, the NBS states in its response that the rules on the transfer of receivables should also apply to the granting of pledge, with the consequence that Serbian legal entities may not pledge to a non-resident their domestic receivables. According to the NBS, this is so because the enforcement of the pledge would have the “same economic effects” as if the Serbian resident transferred its pledged receivable to a non-resident as it would convert a domestic receivable to a receivable owed to a non-resident, “leading to the increase of Serbia’s foreign debt”.

Such reasoning is legally and economically unsound for reasons which we elaborate below. The new NBS position may have implications on the ability of the Serbian borrowers to secure their cross-border financings.

The general rules on the transfers of receivables

The Foreign Exchange Act allows Serbian companies to transfer their receivables to non-residents only if the receivables arise from the sale of goods and services to non-residents (i.e. trade credit on export) or from loans to non-residents. The transfer of receivables, when permitted, must be documented in the agreement containing, among other details, the exact amount of the receivable being transferred. This means it is not possible to transfer future and conditional receivables the amount of which is unknown, even if their legal basis and other elements are determined or determinable.

Security interest in receivables

The Foreign Exchange Act allows Serbian companies to give security for their foreign borrowings, without limiting the type of security that may be given. It has, therefore, been considered that granting security over the receivables in the form of a pledge or a foreign law governed security arrangement akin to pledge is permitted. From a balance of payments viewpoint (which is the primary purpose of the foreign exchange regulations), granting security over the receivables is a neutral transaction in that the payment by the debtor of such receivable to the non-resident lender would automatically and pro tanto decrease the foreign liability of the resident borrower. In that sense, NBS’s reasoning underpinning its position described above is flawed.

The guidance does not explicitly address the scenario where a Serbian resident A pledges or otherwise grant security interest in a receivable owed to it by a non-resident B for the benefit of a non-resident C. Given the NBS’s position that pledge of receivable is akin to outright transfer of receivable, it is now questionable whether NBS also holds that only pledge over receivable arising from cross-border trade or a loan by Serbian company to a non-resident is permitted. Such position would not be justified because the described pledge does not create new external debt. On the contrary. in an enforcement scenario, a resident’s cross-border claim against a non-resident debtor would be effectively netted against the resident’s debt to the non-resident lender.

Flaws and implications of the new NBS’ position on pledge on receivables

The NBS’s position contradicts the long-standing practice of securing cross-border financings in the market. Many projects rely on the cash flows generated from the contracts with residents and non-residents which are not importers of project company’s goods and services. To be bankable, these projects provide for the lender’s security over such cash flows. However, if the NBS’s position described above remains, the project company would be prohibited from granting security over, inter alia, the following claims: (a) under bank accounts; (b) for insurance proceeds; (c) under EPC contracts with domestic or foreign contractor; (d) under EPC performance and advance payment guarantees; (e) under hedging agreements; (f) for lease payments. Such restrictions may effectively shut down the stream of new high-value projects thus hurting the economy. Moreover, there is no policy reason for such restrictive position of NBS because the granting of pledge over local receivables in cross-border context does not have “same economic effects” as outright transfer of domestic receivables to a non-resident and would not lead to “increase of Serbia’s foreign debt”. Enforcement of pledge results in the payment by the debtor of the pledged receivable to a foreign leader, which in turn leads to the decrease of the pledgor’s foreign debt. Economically, the transaction has the same effect as if the pledgor collected the receivable from its debtor and then used it to service its foreign loan debt.

The NBS’ “guidance” is not the law but may have adverse affect on the ability of local debtors of the pledged receivables to transfer money to foreign pledgee as Serbian banks refuse to make cross-border transfers that NBS interprets as prohibited.

Given potentially severe implications on the existing and future transactions and the lack of legal and economic justification for the NBS’ position expressed in the published guidance, the NBS should refine its position and clarify that granting security over the receivables in cross-border context is permitted subject only to the general restrictions on granting security. In the meantime, the borrowers and lenders may want to check their loan documentation to assess whether and to what extent the new NBS’ position affects their secured loan transactions.

Photo by Milad B. Fakurian on Unsplash