Financial Collateral Directive

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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 liquidator, 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, and security financial collateral arrangements. This is a matter of legal form, not economic substance, so note that differing styles of agreement covering the same basic product may have a different status. An English-law Global Master Securities Lending Agreement for example, is a TTCA, whereas a New York law Master Securities Lending Agreement is a SCA, and so is in scope. Just to confuse matters, a 2018 Pledge GMSLA is a SCA because, by design, collateral is pledged and not outright title transferred.

(In general, New York law collateral arrangements tend to be by way of pledge and therefore SCAs; English law ones tend to be title transfer and therefore TTCAs, unless there is a specific reason for doing otherwise, as there is for the Pledge GMSLA).

Title transfer financial collateral arrangements

TTCAs are not security arrangements of any kind, do not therefore require registration and so, while it defines them, the Financial Collateral Directive doesn’t really apply to them as such. 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 assets when the obligations are discharged:

“title transfer financial collateral arrangement” means an agreement or arrangement, including a repurchase agreement, evidenced in writing, where—

1. the purpose of the agreement or arrangement is to secure or otherwise cover the relevant financial obligations owed to the collateral-taker;
2. 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
3. the collateral-provider and the collateral-taker are both non-natural persons;

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-provide

“security financial collateral arrangement” means an agreement or arrangement, evidenced in writing, where—

1. the purpose of the agreement or arrangement is to secure the relevant financial obligations owed to the collateral-taker;
2. the collateral-provider creates or there arises a security interest in financial collateral to secure those obligations;
3. 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
4. the collateral-provider and the collateral-taker are both non-natural persons;

Security interest is defined widely:

“security interest” means any legal or equitable interest or any right in security, other than a title transfer financial collateral arrangement, created or otherwise arising by way of security including —

1. a pledge;
2. a mortgage;
3. a fixed charge;
4. a charge created as a floating charge where the financial collateral charged 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; or
5. a lien;

Appropriation

As well as disapplying certain formalities to create effective security interests, 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.

See also

• Registration of charges
• Re Lehman Brothers International - a long disquisition about the Financial Collateral Regulations.
• Helpful Clifford Chance article here