In 2002, the European legislature considered that a legal framework to facilitate financial collateral transactions such as repurchase agreements (repos), securities lending and derivatives would ‘contribute to the integration and cost-efficiency of the financial market as well as to the stability of the financial system’ in the EU. Market practice and industry standards have consistently been facilitated by legislatures across the globe, even when having to derogate from longstanding rules of property and insolvency law. For instance, netting in the context of collateral transactions has been widely protected, also in insolvency, whilst the enforcement and recognition of security rights under these transactions has been liberalized.
However, since the 2007/2008 Global Financial Crisis, international legislators and policymakers acknowledge the major role that collateral transactions may play in connection with undermining (rather than promoting) financial stability. More specifically, repos were instrumental in the failure of Lehman Brothers, while securities lending and derivatives transactions had similar effects in connection with the demise of AIG. Both events were a catalyst in triggering the biggest worldwide recession in decades.
The rules supranational legislators have laid down to both facilitate and restrict collateral transactions relate to several fundamental issues of law: among other things, they concern the creation and priority of security rights, the formalities to transfer securities and cash credited to accounts, the reuse of collateral, recharacterization (of title finance) by the courts and safe harbours in bankruptcy. In other words, prompted by dramatic economic events, legislators have thought it appropriate to re-evaluate fundamental concepts of private law, but these responses have largely been of a public or administrative law nature. This is all the more significant since in only very rare instances private law concepts as fundamental as ownership, its transfer, creditor priority and the creation of security interest are revisited at the supranational level. This is important both as a theoretical and practical matter—not often do international regulators require changes in private law, which ordinarily remains exclusively a national affair.
It is these developments that have prompted the writing of our new book titled ‘Financial Collateral: Law and Practice’, exploring the concept and use of financial collateral from a legal and practical perspective. Yet there is an additional, more economic reason why collateral in international finance transactions should be the topic of current research: financial collateral now has money-like equivalence and has therefore become an increasingly important component in financial markets. For instance, regulators and supervisory authorities across the globe now require that important categories of derivatives are centrally cleared (in the EU under the Regulation on Market Infrastructures (EMIR) and in the US under Title VII of the Dodd-Frank Act), and financial collateral must invariably be posted in the context of such mandatory clearing. Moreover, policy makers and central banks have sought to use the (‘lending’) rate used in repos to inject liquidity into the economy in an attempt to address the severe economic crisis caused by the COVID-19 pandemic.
‘Financial Collateral’ therefore provides practitioners and academics with a comprehensive handbook on the various aspects of financial collateral and its use. More specifically, the main question this book aims to answer is: ‘How should parties to a finance transaction assess their legal position regarding the financial collateral provided in the context of that transaction?’ Importantly, because the market for financial transactions is global, this book adopts an international approach. This international approach is also integrational—current laws are analysed not on a jurisdiction-by-jurisdiction basis—but thematically. Readers will find analyses of US, English and several European jurisdictions in respect of each relevant issue, such as the formalities required for the creation of collateral transactions, the creation of security interests and right of use, recharacterization etc.
Thus, ‘Financial Collateral’ is ambitious in that it not only attempts to give practitioners an in-depth overview and analysis of collateral transactions in international financial markets but also, on a more theoretical level, investigates the relationship between rules of public law and private law. One finding is that the interaction between private and public law rules shows a strong correlation with the interaction between supranational and national law. In general, the regulatory rules that are of relevance for financial collateral transactions are the result of global initiatives. As stated already above, the Global Financial Crisis led to regulatory intervention on the global level. For instance, the EMIR in the EU and the US Title VII of the Dodd-Frank Act directly followed-up on the G20 Pittsburgh Summit of 24 and 25 September 2009. As another example, the Financial Stability Board’s Key Attributes of Effective Resolution Regimes for Financial Institutions, endorsed by the G20 in November 2011, led to the introduction of a harmonized bank resolution regime in both the European Union and United States. In contrast, private law harmonization regarding financial collateral transactions has remained absent at the global level and yielded less than optimal results on the regional (EU) level.
The book shows, for instance, that the private law harmonization envisaged by the Collateral Directive has failed in important respects. More specifically, discrepancies continue to exist between Member States’ laws with regard to key elements of financial collateral transactions even where these fall within the Collateral Directive’s scope, such as the (precise meaning of the) possession or control requirement and the (legal consequences of the) right of use. This means that whereas the regulatory responses to the 2008 financial crisis achieved a significant level of (global) harmonization, this is not so in respect of the private law structure of financial collateral transactions. This is an important conclusion from the perspective of the question how parties to a finance transaction must assess their legal position regarding the financial collateral provided in the context of that transaction because it means that legal diversity remains. It also means that for concrete transactions a conflict of laws analysis of which law is applicable to a financial collateral or of whether securities custody remains necessary. This analysis is and remains highly complex.
The answer to the question ‘how should parties to a finance transaction assess their legal position regarding the financial collateral provided in the context of that transaction?’ thus proves complex in the context of international financial markets, and this complexity is a consequence of the interaction between private law and public law on the one hand and between supranational and national laws on the other hand. In this prism of laws, the multifaceted characteristic of financial collateral makes a fascinating view. The importance of the topic, however, demands that we endeavour to enhance our understanding of it, but also that we continue to improve the law and practice of financial collateral in international finance transactions.
Matthias Haentjens is a professor of law at the Institute for Private Law at the University of Leiden.
Ross Spence is a PhD candidate at the University of Leiden.