The Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements (FCD) does not currently extend its legal protections to financial collateral arrangements relating to the provision of emission allowances as collateral.
The FCD introduced a harmonised framework for the use of financial collateral to secure transactions, by doing so, it contributed to enhancing cross-border use of financial collateral.
European Commission Consultation Document of 12 February 2021 (Targeted consultation on the review of the Directive on financial collateral arrangements) offers some insight into the motives behind the adoption of the FCD.
According to the said document of 12 February 2021, prior to the FCD, only collateral security provided to a central bank or in connection with participation in a payment or securities settlement system covered by the SFD (SFD system) was protected by EU law in the event of the insolvency of the collateral giver.
A more comprehensive approach covering also OTC transactions was deemed necessary because divergent national rules applicable to financial collateral were frequently impractical and often non-transparent.
They resulted in uncertainty as to the effectiveness and enforceability of ‘financial collateral arrangements’, also as a means of protecting cross-border transactions.
The FCD protects collateral takers notably by:
- ensuring that financial collateral arrangements can be mobilised and realisable without delay due to national formalities;
- providing for close-out netting provisions to be enforceable in accordance to their terms and ring-fencing the operation of financial collateral arrangements should one of the parties become insolvent.
Where applicable, these protections may constitute exceptions to the principles of equal treatment of creditors upon the opening of insolvency proceedings and universality of insolvency proceedings.
In such a way, they help to avoid systemic contagion risks throughout the EU.
The FCD does not fully harmonise national laws applicable to financial collateral arrangements but partially harmonises certain provisions whilst dis-applying others.
By doing so, the FCD aims to remove barriers to the timely cross-border creation and operation of such arrangements.
To achieve the FCD’s objective of avoiding systemic risk, the scope of the FCD should cover systemically important collateral takers and providers.
To benefit from the FCD’s protections, the collateral taker and the collateral provider must be covered by the FCD.
The following are within the FCD’s scope: public authorities; central banks; financial institutions; central counterparties; settlement agents and clearing houses.
In addition, a person other than a natural person (including unincorporated firms and partnerships) can also be within the FCD’s scope, provided that the other party to the financial collateral arrangement is one of the aforementioned entities (Article 1(3) FCD).
Member States can opt-out of the latter provision.
By applying this opt-out, Member States are able to exclude from the scope of the FCD financial collateral arrangements entered into by SMEs with their credit institutions for instance, that primarily belong to the retail rather than wholesale financial markets covered by the FCD.
The said Targeted consultation document of 12 February 2021 on the review of the Directive on financial collateral arrangements considers the inclusion into the FCD’s scope the categories of new financial entities that have emerged in the EU capital markets acquis like e.g. payment institutions, e-money institutions or central securities depositories) - currently not covered by the FCD.
Collateral arrangements may take different legal forms, the FCD recognises in that regard:
- “title transfer collateral arrangements”, and
- “security financial collateral arrangements”.
A “title transfer collateral arrangement” (TTCA) is an arrangement under which a collateral provider transfers full ownership of financial collateral to a collateral taker for the purpose of securing or otherwise covering the performance of relevant financial obligations (for example repos).
“Security financial collateral arrangements” stand for an arrangement under which a collateral provider provides financial collateral by way of security in favour of, or to, a collateral taker, and where the full ownership of the financial collateral remains with the collateral provider when the security right is established (for example pledge).
Only some forms of collateral arrangements receive protection under the FCD.
The FCD does not set out a common insolvency law for Member States but, in order to improve the legal certainty of financial collateral arrangements, the legislation requires that EU Member States disapply certain provisions of national insolvency law to financial collateral arrangements falling under the scope of the FCD.
In particular, the FCD disapplies any national insolvency law that would inhibit the effective realisation of financial collateral (Recital 5, Article 4) or cast doubt on the validity of techniques contemplated under the FCD such as bilateral close-out netting, the provision of additional collateral in the form of top-up collateral and substitution of collateral.
Emission allowances‘ applicability
The MiFID II Directive envisages bringing spot emission allowances within the scope of financial regulation in the EU by classifying emission allowances as financial instruments within the meaning of MiFID.
However, separate legislative action will need to be taken to amend the FCD in order to bring EUAs within the scope of the FCD (Interplay between EU ETS Registry and Post Trade Infrastructure, Publications Office of the European Union, 2015, p. 15, 53, 55). It is argued that:
- while MiFID II envisages bringing spot emission allowances within the scope of financial regulation in the EU by classifying emission allowances as financial instruments within the meaning of MiFID II, the FCD does not link its own definition of “financial instruments” to the corresponding definition under MiFID,
- as a result, the extension of MiFID II to cover emission allowances will not be sufficient to bring emission allowances within the scope of the FCD,
- instead, legislative changes to the FCD will be required to broaden its scope to emission allowances.
The FCD is closely related to the Settlement Finality Directive (SFD) - the two issues that are dealt with by the FCD are also important for the SFD: recognition of ‘close-out netting provision’ and ‘financial collateral’ (‘cash’ and ‘financial instruments’ the two most commonly used forms of ‘collateral security’ under the SFD).
12 February 2021
Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on transparency of securities financing transactions and of reuse and amending Regulation (EU) No 648/2012 (SFTR)