The Financial Collateral Arrangements (No.2) Regulations 2003

These Regulations implement the European Parliament and Council Directive 2002/47/EC on financial collateral arrangements (“the Directive”). The Regulations apply to England, Wales, Scotland and Northern Ireland.

These Regulations replace the Financial Collateral Arrangements Regulations 2003 (S.I. 2003/3112) which are revoked by Regulation 2 before those Regulations were due to come into force. This revocation was due to a drafting error in the original version of the Regulations which was made and laid before Parliament.

Regulation 3 defines many of the terms used throughout the Regulations. The definition of “financial instruments” refers to “bonds and other forms of instruments giving rise to or acknowledging indebtedness if these are tradeable on the capital market”. The term “capital market” is not defined, the term is used in the Directive where it is also not defined.

Regulations 4, 5, 6 and 7 prevent certain legislative provisions and common law rules which require formalities before an agreement is perfected and enforceable, from applying to financial collateral arrangements. The Directive provides that the only formality which may be required for a financial collateral arrangement to be perfected and enforceable, is that the arrangement be evidenced in writing. Legislation and rules which require signature by a particular person or entry of the arrangement in a register are therefore disapplied from financial collateral arrangements by the Regulations.

Regulations 8 and 9 prevent certain provisions of the Insolvency Act 1986 and the Insolvency (Northern Ireland) Order 1989 from applying to financial collateral arrangements. The provisions which are disapplied are those which prevent enforcement of security interests when a company or partnership is in administration proceedings or subject to a voluntary arrangement. This is because the Directive requires Member States to ensure that financial collateral arrangements are effective and enforceable even where a party to the arrangement enters reorganisation procedures such as administration.

Regulations 10 and 11 prevent certain provisions of insolvency law from applying to financial collateral arrangements so that where such arrangements are entered into or collateral is provided under such arrangements in a prescribed period prior to the commencement of winding-up proceedings, the arrangement remains enforceable once winding-up commences unlike other agreements which the company may avoid.

Regulation 12 provides that a close-out netting provision in a financial collateral arrangement is to take effect in accordance with its terms even if a party to the arrangement is being wound-up or is subject to reorganisation proceedings provided that the other party to the arrangement was not aware nor should have been aware, at the time that it entered into the arrangement, that the party was subject to winding-up proceedings or reorganisation measures. The other party may also not enforce if it had actual notice of certain steps leading to such proceedings or measures at the time when it entered into the arrangement.

Regulation 13 provides that where certain steps in concluding a financial collateral arrangement only occur on the day but after the precise moment of commencement of winding-up proceedings or reorganisation measures, those steps are binding on third parties and the arrangement is still enforceable provided that the other party to the arrangement was not aware, nor should have been aware that the proceedings or measures had commenced.

Regulations 14 and 15 provide that the specific provisions in a financial collateral arrangement regarding the currency in which obligations are to be calculated and the rate of any currency conversions will displace the rules in the Insolvency Rules 1986, the Insolvency Rules (Northern Ireland) 1991 and the Insolvency (Scotland) Rules 1986, on the calculation of debts in a distribution under administration in England and Wales or in a liquidation in the UK, unless the rate set through the arrangement is unreasonable.

Regulation 16 provides that where a security financial collateral arrangement provides a right of use for the collateral-taker over the collateral, that term is to be enforceable. Where a right of use is exercised the collateral-taker is obliged to replace the collateral with equivalent financial collateral, unless he sets off the value of the collateral in discharge of the relevant financial obligations in accordance with the terms of the arrangement. The equivalent financial collateral is to be subject to the same terms as the original financial collateral. Obligations arising under right of use provisions in the arrangement may be the subject of a close-out netting provision.

Regulation 17 provides that where a collateral-taker under a security financial collateral arrangement has a mortgage over the collateral provided under the arrangement it may enforce any right of appropriation of the collateral, which the arrangement provides for, without applying to the court for an order for foreclosure. The Directive requires that any right of appropriation under a financial collateral arrangement should be enforceable without the need for a court order. Regulation 18 imposes a duty on the collateral-taker, if it exercises such a right of appropriation, to value the collateral in accordance with the terms of the arrangement and in any event in a commercially reasonable manner. Where the value of the collateral differs from the amount of the relevant financial obligations the parties are obliged to account for that difference.

Regulation 19 imposes a standard test, set out in the Directive, for deciding which domestic law will apply to book entry securities which are held through one or more intermediaries and provided as collateral under a financial collateral arrangement, where there is a conflict of laws issue to be decided. The test is that the arrangement shall be governed by the domestic law of the country in which the “relevant account” (as defined in regulation 2) is maintained.

A regulatory impact assessment has been prepared in relation to these Regulations. A copy may be obtained from the Financial Stability and Regulatory Policy Team, HM Treasury, 1 Horse Guards Road, London SW1A 2HQ. A copy of the transposition note in relation to the implementation of the Directive may be obtained from the same address. Both documents are also available on the Treasury website (www.hm-treasury.gov.uk). Copies of both these documents have been placed in the Library of each House of Parliament.