The Financial Collateral Directive is an EU provision aimed at facilitating the use and enforcement of financial collateral. It establishes common principles concerning the creation and enforcement of collateral. Typically, collateral is enforced through appropriation without recourse to a court or any formal procedure.
These regulations apply to financial collateral where the provider and recipient of the collateral are:
- A supervised institution like a bank, investment firm, insurance company, or fund manager
- A public authority, central bank, European Central Bank, IMF, European Investment Bank, central counterparty, settlement agent, or clearinghouse operating in futures, options, and derivatives not covered by the Settlement Finality Directive
- A person acting as a trustee on behalf of bondholders or securitized debt institutions mentioned above
- Any other counterparty being a corporate entity of the above.
The legislation applies to financial collateral, comprising cash claims or financial instruments. It does not extend to real property or shares in companies operating the provider’s business.
This legislation aims to eliminate formalities typically involved in creating security. The only required formality is that the financial collateral arrangement is evidenced in writing or another durable medium. The creation, perfection, and enforceability of financial collateral arrangements are not dependent on any formal act such as registration or notice.
Certain arrangements that might otherwise undermine collateral according to ordinary security principles do not apply. Collateral may be attached and returned without triggering special rules applicable to floating securities. Collateral may be substituted by replacing one type of collateral with another, provided the recipient is obliged to return equivalent collateral or its cash equivalent.
The financial collateral arrangement must be possessed or controlled by the collateral taker. This involves delivery, transfer, holding, registration, or designation of ownership, ensuring possession and control by the collateral recipient or their agent. Rights of substitution, excess collateral withdrawal, or replacement do not impair the continuity of possession and control for this purpose.
When an enforcement event occurs, the collateral recipient intended for security is entitled to realize the collateral. This is generally done by selling liquid financial instruments or appropriating cash or claims. Cash may be set off against amounts owed to discharge secured obligations.
Contracts concerning collateral arrangements may proceed as per their terms. If there is an obligation to transfer equivalent collateral and default occurs, payment obligations may be accelerated, set off, or netted out. Netting may take effect despite commencement of winding up or reorganization.
Collateral may be realized without notice, court orders, or grace periods, adhering to contractual terms specified. Collateral can be enforced by appropriating assets per the terms of the contract. If title to the assets is transferred, they may be valued, and credit set off against sums owed.
Financial collateral remains effective even if the provider or recipient enters insolvency. There are restrictions on setting aside collateral security arrangements and winding up, especially within certain periods before winding up where securities are normally subject to potential set-aside. Obligations to provide substituted collateral hold up to the point of winding up or reorganization.
The collateral recipient may reuse security if contractually permitted, with appropriate risk warnings given to the collateral provider. There are obligations on fund managers to include information in fund documentation about their engagement in securities finance transactions and total return swaps, which must also be reported to investors.
Under EU reforms addressing the financial crisis, there are statutory obligations regarding reporting securities financing transactions. These transactions must be reported on the next working day to a registered or recognized trade repository or, if unavailable, to the European Securities and Markets Authority. Specified information must be provided in the report.