‘Good faith’ issue, perfection requirements and liquidation of the collateral
‘Good faith’ issue, perfection requirements and liquidation of the collateral are the points that can cause real trouble when spot emission allowances are today used as collateral in cross-border transactions.
It was observed in MEMO/01/108 of 30 March 2001 that the purpose of the bankruptcy legislation is the same in each Member State, but there are important differences concerning the definition of whether a transaction favours a creditor and whether it should therefore be invalidated. In some countries, it depends on whether or not the creditor has accepted the collateral in “good faith”; (i.e. he was unaware that the company was about to go bankrupt). In other countries there are objective rules, according to which all such transactions securing old debt can be invalidated if the transaction was carried out in a certain period before the bankruptcy occurred. Such differences make it difficult for market participants to agree on cross-border transactions, because foreign bankruptcy legislation could have an impact on the validity of an agreement with a foreign counterparty. Thus, market participants have to be aware of the whole range of bankruptcy legislation applied throughout the Community.
The above remarks relate to the situation in which a creditor has been “favoured” shortly before the moment when the bankruptcy occurs. According to bankruptcy legislation this transaction is normally declared invalid by the liquidator (e.g. where an already existing loan has been secured with collateral shortly before bankruptcy, the liquidator can declare that the offering of collateral was invalid).
There are also rules concerning the procedures a creditor must follow to ensure their right to the collateral in the event of bankruptcy of the debtor (and how to ensure priority over other creditors in accordance with the agreement). These procedures are called “perfection requirements” and exist to ensure that the creditor does not illegally benefit from the collateral and to prevent further use of the collateral by the debtor. But collateral takers today must comply with impractical publicity requirements, to ensure that third parties are aware that the assets being provided as collateral would not be generally available in an insolvency situation. Failure to comply can result in the invalidity of the collateral. In addition, the circumstances under which the creditor would be allowed to liquidate the collateral differ substantially from one Member State to another. In some jurisdictions, the collateral can be liquidated immediately, but in others the creditor can be obliged to wait several months.
So regulators, don’t wait, extend Financial Collateral Directive to spot emissions allowances trade immediately!