20 Pages Posted: 19 Oct 2017 Last revised: 1 May 2018
Date Written: April 24, 2018
Financial collateral is a concept that starts from the idea of traditional security interests and is then developed considerably further. Security interests are restricted in their scope of application and typically impose a number of requirements and limitations on the creditor (security taker) and on the debtor (security provider). The purpose of these requirements and limitations for security interests is to contain the negative impact on other creditors of the security taker, in particular through publicity requirements and strict rules on whether and how security was enforceable in case of insolvency of the debtor.
These rules are however too inflexible to cater for a number of needs of financial market participants. The latter therefore tend to stretch the boundaries of secured transaction imposed by property and insolvency law. As a result, transactions occur that are akin to security interest in terms of protection of the secured creditor but leave much more flexibility to the parties, in particular in terms of economic use of the asset (see the remarks on fix and floating charges, above). However, creating asset backed positions outside the system of recognised security interests entails elevated legal risk, in particular recharacterisation and avoidance risk, should one of the parties become insolvent.
In the last two to three decades the relevant market practice has crystallised and is now commonly called ‘financial collateral’. Legislators in advanced financial markets have recognised this market practice and accordingly removed the legal uncertainty that was associated with it. In the EU, the relevant national statutes are based on the Financial Collateral Directive, commonly called FCD.
Keywords: Security, Financial Collateral, Insolvency, Repo, Securities lending
JEL Classification: K11, K12, K22, K33
Suggested Citation: Suggested Citation