Financial Collateral Directive
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A word about credit risk mitigation
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The Financial Collateral Directive (2002/47/EC (EUR Lex)) (see also the UK legislation here) is a well-intended piece of EU Regulation that, by common consent, didn’t quite achieve what it set out to, which was to introduce “...a Community framework to reduce credit exposure in financial collateral arrangements” thereby contributing to “the effectiveness and integration of European financial markets, reducing credit losses and thereby stimulating cross-border transactions and competitiveness.”
The Brits copied the regulations into domestic English law as part of the Brexit process.
Now we say the CRD “didn’t quite achieve what it set out to” — but we note quietly that those who make this sort of claim — private practice legal eagles — and the way they make it — in a sort of shoe-shuffly, shoulder shruggy sort of way— we feel is calculated to tweak the spleens of their inhouse-legal clients, knowing how buttoctractic they tend to be. No-one among them has any real interest in the CRD achieving what it set out to achieve, and indeed all have quite a bit of interest, if it did achieve what it set out to achieve, in persuading their internal clients that it might not have. Because that gives them licence to busily do something, thereby ostensibly “adding value” whilst taking zero risk, because in reality it didn’t need to be done, and didn’t add any value.
Overview
The directive was designed to simplify and universalise the process of taking security in financial contracts across the EU – for one thing it would mean that any formal registration or perfection requirements which otherwise would be required (registering the security interest with the registrar of companies for example) do not apply.
Contractual Provisions: The Financial Collateral Directive is a little more vague about what counts as a financial collateral arrangement than is ideal —
“financial collateral arrangement” means a title transfer financial collateral arrangement or a security financial collateral arrangement, whether or not these are covered by a master agreement or general terms and conditions;
— so you may see contractual stipulations that both parties agree their arrangement is intended to be one.
While this is no doubt intended to help, given that, in the final analysis, the person likely to challenge that analysis would be a competing creditor, and the person who would be arbitrating on it would be a liquidqator, if an arrangement were not formally within the definition, then the fact that the parties agreed it was intended to be probably wouldn’t.
What it does
The FCD divides financial collateral arrangements into two mutually exclusive categories:
Title transfer financial collateral arrangements
Under a TTCA a collateral-provider transfers full ownership of the financial collateral to the collateral-taker on terms that It will transfer back equivalent assetswhen the obligations are discharged
“title transfer financial collateral arrangement” means an agreement or arrangement, including a repurchase agreement, evidenced in writing, where—
- the purpose of the agreement or arrangement is to secure or otherwise cover the relevant financial obligations owed to the collateral-taker;
- the collateral-provider transfers legal and beneficial ownership in financial collateral to a collateral-taker on terms that when the relevant financial obligations are discharged the collateral-taker must transfer legal and beneficial ownership of equivalent financial collateral to the collateral-provider; and
- the collateral-provider and the collateral-taker are both non-natural persons;
and
Security financial collateral arrangements
Under an SFCA the collateral provider provides financial collateral by way of security but retains full ownership of the financial collateral remains with the collateral-provider.
“security financial collateral arrangement” means an agreement or arrangement, evidenced in writing, where—
- the purpose of the agreement or arrangement is to secure the relevant financial obligations owed to the collateral-taker;
- the collateral-provider creates or there arises a security interest in financial collateral to secure those obligations;
- the financial collateral is delivered, transferred, held, registered or otherwise designated so as to be in the possession or under the control of the collateral-taker or a person acting on its behalf; any right of the collateral-provider to substitute equivalent financial collateral or withdraw excess financial collateral shall not prevent the financial collateral being in the possession or under the control of the collateral-taker; and
- the collateral-provider and the collateral-taker are both non-natural persons;
Appropriation
As well as disapplying certain formalities to effective security interest, the FCD creates a remedy of “appropriation”, a novel remedy certainly as regards shares, Which was previously unknown to English law:
- Where a legal or equitable mortgage is the security interest created or arising under a security financial collateral arrangement on terms that include a power for the collateral-taker to appropriate the collateral, the collateral-taker may exercise that power in accordance with the terms of the security financial collateral arrangement, without any order for foreclosure from the courts.
Title transfer collateral arrangements
Title transfer collateral arrangements: TTCAs are not security arrangements of any kind, do not therefore require registration, and therefore the Financial Collateral Directive doesn't really apply to them. But contrast differing styles of agreement that cover the same product:
- a 2010 GMSLA is a TTCA, so isn't in scope for the financial collateral regualtions;
- a Master Securities Lending Agreement is a security interest arrangement, and so is in scope.
Interpretation
Helpful Clifford Chance article here
Adoption
- Portugal: It was adopted by Portugal in July 2004 (see in depth article here)
- UK: It was adopted by the UK under the Financial Collateral Arrangement (No.2) Regulations 2003, fondly known to all as the Financial Collateral Regulations.
See also
- Registration of charges
- Re Lehman Brothers International - a long disquisition about the Financial Collateral Regulations.