Current Developments in Monetary and Financial Law, Vol. 5

Chapter 18 Legal Protection of Payment and Securities Settlement Systems and of Collateral Transactions in the European Union

International Monetary Fund
Published Date:
November 2008
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Since the early 1990s, credit institution insolvencies (Herstatt, BCCI,1 Banesto, Barings, Japanese banks, for example), some of which were sudden and unexpected, have led authorities responsible for the supervision of payment and securities settlement systems, as well as operators of and participants in these systems, to become more careful about the repercussions of insolvency on the functioning of these systems, and in particular on the enforceability of collateral transactions carried out through such systems.

Control of the legal risks associated with the insolvency2 of a participant in a payment or securities settlement system is especially difficult when the insolvent party is subject to a foreign legal system. This occurrence is widespread if one takes into account the participation of branch offices of foreign banks, whether or not incorporated under the law of a member state of the European Union (the EU) or in other national systems. Furthermore, the “remote access” participation of foreign community banks,3 an example of the free provision of services within the European Union area, increases the incidence of foreign participation in EU national systems.

In the past, it was sufficient for national payment and settlement systems to ensure that in the event of the insolvency of a domestic participant in a payment system, the local law applicable to the system would, for example: (1) uphold the validity and enforceability against third parties of the netting of payments (in net settlement systems); (2) uphold the contractual irrevocability of payment orders (in gross settlement systems); (3) exclude any “zero-hour” rules (backdating of the effects of insolvency decisions to the first hour of the day of the pronouncement of the insolvency decision); and (4) uphold the enforceability of collateral arrangements that had been set up.

When a foreign participant enters insolvency today, it is also necessary to ensure that the foreign law applicable to the insolvency will not invalidate the settlement of the cash or securities orders or the collateral arrangements put in place. Such issues fall within the area of cross-border insolvency,4 which has become one of the most complex legal issues facing market participants.

The EU has taken steps to address these issues. The European Directive 98/26/EC of 19 May 1998 on Settlement Finality in Payment and Securities Settlement Systems5 (Settlement Finality Directive, SFD, or the Directive) is devoted to the legal protection of payment and settlement systems as such, including the protection of collateral transactions processed in these systems. A second important instrument at the EU level is the Collateral Directive of 6 June 2002 (Collateral Directive), which aims to harmonize substantive rules on collateral arrangements irrespective of the systems or custodians through which the relevant collateral assets are held.

This chapter examines the main legal issues that may arise in cross-border insolvency, before going on to describe two other EU legal instruments likely to be of relevance. It then addresses the Settlement Finality Directive itself and reviews the provisions of the recent Collateral Directive. The final section reports on three recent legal developments in the fields of clearing and settlement systems: The Hague Convention of 13 December 2002 on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary; the UNIDROIT Draft Convention on Intermediated Securities; and the EU Legal Certainty Group.

Insolvency of a Foreign Participant in a Payment/Settlement System

There are two main approaches used by jurisdictions to address cross-border insolvency:6

  • the principle of the unity of insolvency, by virtue of which there is only one competent court to declare a debtor’s insolvency, that is, the court in the place where the insolvent company has its head office, registered office, or statutory seat. This principle is generally linked to the principle of universality (or universal nature) of insolvency, allowing the insolvency decision to be enforceable and to produce legal effects in other states7 where branch offices or assets of the insolvent party are located (for example, the regimes in Belgium and Luxembourg);
  • the principle of the plurality of insolvencies (or territoriality), which requires a declaration of insolvency in each country where the insolvent debtor has a center of activity or even mere property. Under the territoriality approach, each insolvent branch is governed by its local insolvency law and is administered by its own receiver, and such territorial insolvency only affects assets located in the territory in question (for example, the regimes in France and Denmark).

There are also systems that combine these two approaches in some way. An insolvency pronounced in the state of the insolvent party’s domicile may indeed produce effects outside the territory of that state. On the one hand, the insolvency proceeding reaches other states where the insolvent party’s property is located (universality of the insolvency), but, on the other hand, it is possible to institute a separate insolvency proceeding in the jurisdiction where local branch offices or even mere assets of the foreign debtor are located (territorial insolvency). This is the so-called principle of mitigated universality principle in force (for example, in Germany, Austria, and the United Kingdom).

In the case of insolvency of a foreign participant in a national payment and settlement system, the solution, as far as the jurisdiction of the system is concerned, will depend on the type of insolvency regime that is applied by a court in the jurisdiction of the payment and settlement system (the local court):

  • In states that apply the territoriality principle of bankruptcy, the local court will simply refuse to recognize any insolvency decision handed down in the debtor’s jurisdiction and will not apply the foreign insolvency law (lex fori concursus). In principle, a foreign insolvency should not have any impact on the payment and settlement system.
  • In states that apply the principle of mitigated universality, to the extent that there is an establishment of the foreign debtor, or even mere assets, in the territory, there will generally (but not necessarily) be the opening of territorial insolvency proceedings in the local court limited to local assets. The national insolvency law of the place of the payment and settlement system will then prevail over the insolvency law of the foreign participant.
  • In states applying the unity and universality principle of bankruptcy, the local court should, in principle, recognize the foreign insolvency order by right8 and also apply the foreign insolvency law.

The main qualifications to the automatic recognition of the foreign insolvency decision in such jurisdictions that apply the unity and universality principle will generally be as follows:

  • There will be no judicial recognition if the foreign bankruptcy order is strictly limited by its terms or by nature to the territory of the foreign state.
  • There will be no recognition if the application of the bankruptcy decision or foreign insolvency law is likely to be contrary to the international public policy9 of the state of the payment and settlement system.10 In this case, the local law will overrule the conflicting provisions of foreign law.

Here, the application of foreign insolvency law could be particularly detrimental to the proper functioning of national payment or settlement systems; it may then lead to the local court refusing to recognize the lex fori concursus because it would conflict with public policy.11

It is also worth noting that certain courts may refuse to recognize foreign insolvency decisions issued in countries that do not give reciprocal recognition to their own insolvency decisions.12

One good example of the practical application of the unity and universality approach is the issue of the legal enforceability of collateral that secures the credit (intra-day or overnight) granted by a system operator or a central bank (the creditor) to a foreign participant (the foreign debtor). The enforceability of the collateral against third parties is governed by the law of the location of the collateral. This law, for example, may allow for the realization of the collateral without any prior judicial authorization.

However, in the case of insolvency or of any composition proceedings13 commenced against the foreign debtor in a court in the foreign debtor’s jurisdiction, the foreign insolvency law might overrule the law applicable to the credit transaction and the related collateral because of the public policy nature of insolvency laws. This, of course, assumes that this foreign insolvency law would be recognized in the local court.

This does not mean that the validity of the main credit transaction or the collateral securing the transaction (a pledge, for example) would suddenly be governed entirely by a foreign law. One basic principle of the conflict of laws rules of most states is that a provision of collateral is governed, with regard to its proprietary aspects, in particular the enforceability against third parties and its realization, by the law of the country where the assets are located (lex rei sitae rule). In this case, the local law of the creditor is therefore still applicable to the assessment of the pledge’s enforceability against third parties, with respect to the securities “located”14 in the creditor’s jurisdiction.

However, the foreign debtor’s insolvency law—assuming it would be recognized by the local court—will have sole competence to govern two issues of crucial importance for the effectiveness (not the validity) of the collateral in question:

  • Determination of the ranking of the creditor as collateral taker with respect to the collateral, that is, the order of preference on the proceeds of the assets encumbered by the pledge, vis-à-vis other preferential or ordinary creditors of the insolvent foreign debtor;
  • The possibility of realization of the relevant collateral, that is, whether it is necessary to obtain prior authorization from the receiver or the competent courts before any realization of the assets, as well whether or not there may be a stay on any action by secured creditors, in the interest of insolvency liquidation. (The idea here is to leave a kind of ‘inventory deadline’ in order to freeze any legal action or forced sale by creditors before the receiver has been able to value the assets and liabilities of the insolvent foreign debtor and settle in court the disputable claims.)

These matters are essential for the creditor because in the case of the insolvency of a foreign debtor, it is important to ensure that the foreign debtor’s insolvency law will give priority to the creditor over the pledged assets, without preferring other creditors such as the tax authorities, social insurance bodies, or employees. In addition, the creditor must be able to immediately realize the securities in its possession, or at least as soon as possible, in order to avoid the market risk that arises due to the possibility of a decline in the market value of the securities posted as collateral, independently of any margins which may have been constituted against such a risk. These issues are precisely addressed specifically in the Collateral Directive.

European Legal Instruments Related to the Settlement Finality Directive

In view of the diversity of existing legal systems and the complexity resulting from the combination of several laws potentially applicable to an insolvent participant in a payment or settlement system, a harmonized solution at the European level was considered highly desirable. The Settlement Finality Directive is the binding EU legal instrument that aims at addressing the specific legal issues for payment and settlement systems, including collateral constituted in those systems.

There are, however, two other EU instruments that were adopted after the Settlement Finality Directive (even though they were originally drafted before the Directive), which include provisions relevant for the protection of payment and settlement systems against the insolvency of participants:

  • The European Regulation on Insolvency Proceedings dated 29 May 2000
  • EU Directive (2001/24/EC) on the Reorganisation and Winding-up of Credit Institutions of 4 April 2001

It is appropriate to examine both instruments, as they were various interactions between those texts and the Settlement Finality Directive.

The European Regulation on Insolvency Proceedings Dated 29 May 2000

The work on a European Convention relating to EC insolvency proceedings ended on November 23, 1995, when a definitive text was signed (the Insolvency Convention).15 It was the fruit of five years of intense efforts on the part of an ad hoc working group of national experts (chaired by Manfred Balz). Because it required the signature of all member states, the 1995 Insolvency Convention, following a joint initiative of Germany and Finland, was converted into the EU Council Regulation on Insolvency Proceedings (Insolvency Regulation) pursuant to Article 61 and 67 of the Rome Treaty. The Insolvency Regulation was finally adopted on May 29, 2000,16 with the same provisions as those contained in the Insolvency Convention.17 The Insolvency Regulation entered into force on May 31, 2002.

The Insolvency Regulation is a vast and complex instrument, including 47 articles and three annexes, and a full discussion of it is beyond the focus of this chapter. But it is worth mentioning here that the Insolvency Regulation establishes the principle of the mitigated universality of insolvency by means of a double set of rules:

  • On the one hand, the first chapter of the Insolvency Regulation attributes principal competence to the jurisdiction of the member state where the debtor’s domicile (or center of main interests) is situated18 to commence insolvency proceedings (Article 3)—referred to as “main insolvency proceedings”—and provides that the insolvency law of this state will apply in the other states of the European Union (Article 4). Articles 5–15 of the Insolvency Regulation, however, set out exceptions to the basic competence of the law of the place of the main insolvency proceedings in favor of the laws of other member states called upon to govern certain rights (real estate, employment contracts, rights in rem, etc.). It is within the latter framework that some protective provisions relevant for payment and settlement systems (and collateral) are laid down. Chapter II of the Insolvency Regulation provides for the automatic recognition of the main insolvency proceedings in the other states of the EU.
  • On the other hand, Chapter III of the Insolvency Regulation authorizes other member states to open territorial proceedings—referred to as “secondary” insolvency proceedings—in their territory, if the debtor has an “establishment” there under the meaning of the Insolvency Regulation (see Articles 3.2 and 2(h)). The purpose of those proceedings is to protect such other states against the effects of the main proceedings (independently of the exceptions to the law governing the main proceedings contained in Chapter I). In addition, member states other than the state of the debtor’s head office are also authorized to open territorial insolvency proceedings independently of the opening of any main proceedings (subject to the fairly liberal conditions of Article 3.4). Chapter III organizes relations between main and secondary proceedings (particularly, Articles 31–35).

It should again be noted that the Insolvency Regulation, by harmonizing the rules of conflict of laws and certain procedural rules in matters of international insolvency, is not applicable to the insolvency of credit institutions, insurance companies, investment firms, and collective investment undertakings (Art. 1.2). This exclusion is due to the existence at the time of specific draft EU instruments designed to cover the insolvency of these categories of financial institutions (particularly for banks and insurance companies), which takes into account the specific features of the financial sectors in which the categories of financial institutions operate and the principle of home country control, as the key rule of supervisory control for activities in such sectors.

In view of this, it is obvious that the Insolvency Regulation has only a limited effect on payment and settlement systems because most of the participants in these systems are excluded from its scope of application. The fact remains that these provisions of the Insolvency Regulation may govern systems which may admit nonfinancial institutions, as well as to relations between a financial institution that participates in a system and its clients, which are ordinary commercial undertakings. The same debate about the scope of application emerged during the Collateral Directive’s discussions. Recital 27 of the Insolvency Regulation states explicitly that the Settlement Finality Directive must be considered as lex specialis and overrules the Insolvency Regulation as lex generalis.

Three provisions of the Insolvency Regulation are likely to concern payment and securities settlements systems or collateral, to the extent defined above:

  • Article 5 relating to rights in rem;
  • Article 6 relating to set-off;
  • Article 9 relating to payment and settlement systems and financial markets.

As indicated above, these provisions act as a limitation of the exclusive application of the law of the main proceedings with certain rights governed by the law of another member state.

Rights in Rem

The first paragraph of Article 5 of the Insolvency Regulation states:

The opening of the insolvency proceedings shall not affect the right in rem of creditors or third parties in respect of tangible or intangible, movable or immovable assets—both specific assets and collections of indefinite assets as a whole which change from time to time—belonging to the debtor, which are situated within the territory of another member state at the time of the opening of proceedings.19

The aim of Article 5.1 of the Insolvency Regulation is to ensure the maximum protection of the holders of rights in rem for assets located in other member states, in view of the effects of the main insolvency proceedings opened in the country of the head office (or of the center of main interests) of the debtor. The holder of the right in rem may thus realize the assets and claim a right of preference on the proceeds of this realization without being hindered by any restrictive rules (or conferring on him a lower rank than that of other creditors) of the law governing the main insolvency proceedings. Thus one can see the importance of this provision for situations where securities are provided as collateral (in relation or not to participation in a payment or settlement system) (compare, in this sense, Article 9.1 of the Settlement Finality Directive discussed below).

By doing this, the Insolvency Regulation also entitles the holder of the right in rem (or of the collateral) not to be hindered by any restrictive rules that apply in the case of insolvency under the law governing the right in rem itself. Applying the lex rei sitae rule, the law applicable to the right in rem normally corresponds to the law of the place of the assets subject to the right in rem.

In other words, the expression “does not affect” actually grants the holder of the right in rem the right to exercise its prerogatives (and particularly the right to realize the asset) in accordance with “ordinary” rules of the local law. The restrictive rules laid down in the local law (lex situs) for the insolvency of the debtor are thereby excluded.

In concrete terms, therefore, if (1) the debtor is domiciled in country A and is declared insolvent in country A, and (2) the creditor is domiciled in country B and is the recipient of a pledge of securities located in country B, the creditor may realize the collateral and be paid in accordance with the law of country B. However, the creditor in country B will not be bound by the mandatory rules ordinarily applicable in the case of insolvency of any pledgor (debtor) under law B (such as, for example, the necessity to obtain a judicial authorization prior to realization).

By adopting the “does not affect” formula, the Insolvency Regulation grants to the holder of the right in rem or of the security interest concerning an asset located in another country an even more favorable status than it would have under any relevant legislation in country A or country B applicable to its right in rem or its collateral since it “is not affected” at all by the opening of the insolvency proceedings.

This interpretation is confirmed in the draft explanatory report of the former Insolvency Convention.20 Under paragraph 98, the draft report stated:

The rule “does not immunise” rights in rem against the debtor’s insolvency. If the law of the State where the assets are located allows these rights in rem to be affected in some way, the liquidator (or any other person) empowered to do so may request secondary insolvency proceedings be opened in that State if the debtor has an establishment there. The secondary proceedings are conducted according to local law and allow the liquidator to affect these rights under the same conditions as in purely domestic proceedings.

This passage thus clarifies the scope of the rule contained in Article 5 of the Insolvency Regulation:

  • In the case of a main insolvency proceeding against the debtor, the creditor may exercise its rights in rem on local assets as if the insolvency proceedings did not exist.
  • In order to apply any possibly restrictive provisions laid down in case of insolvency under the law of the state where the assets in question are located, a secondary insolvency proceeding must be opened. Failing this, these restrictive provisions are not applicable.

To sum up, Article 5 of the Insolvency Regulation enables the holder of collateral not only to be protected against an unfavorable “importation” of the insolvency law of the foreign debtor, but also of “not being affected” by this insolvency, so that the holder will be able to realize its collateral as if no insolvency had been opened, as long as no secondary proceedings are initiated in the country where the assets are located.


Article 6.1 of the Insolvency Regulation states:

The opening of [main] insolvency proceedings shall not affect the right of creditors to demand the set-off of their claims against the claims of the [insolvent] debtor, where such a set-off is permitted by the law applicable to the insolvent debtor’s claim.21

This provision authorizes a set-off after the opening of the main insolvency of the debtor on the basis of claims arising previously,22 even if this post-insolvency set-off would be forbidden under the insolvency law of the jurisdiction in which the main insolvency proceedings have been commenced,23 provided that such a set-off is authorized by the law governing the insolvent debtor’s claim24 (of course, this assumes that the applicable law is different from the law of the main insolvency proceedings).

This means, in the financial area, that the contractual set-off governed by a law that authorizes post-insolvency set-off could be successfully claimed against the receiver of the (main) insolvency proceedings of a foreign debtor, despite the restrictions which might apply under the lex fori concursus25 (compare Article 3 of the Settlement Finality Directive, commented on below, under paragraph 24 or Article 8 of the Collateral Directive).

Payment Systems and Financial Markets

Article 9, paragraph 126 of the Insolvency Regulation states as follows:

Without prejudice to Article 5, the effects of insolvency proceedings on the rights and obligations of the parties to a payment or settlement system or to a financial market, shall be governed solely by the law of the member state applicable to that system or market.

This article substantially ensures the protection of payment and securities settlement systems and the financial markets27 because when a foreign participant is insolvent, the effects of the insolvency proceedings on its rights and obligations in the system or market in question will be governed exclusively by the law applicable to the system, to the exclusion of foreign insolvency law.

Consequently, the validity of “netting” in the case of insolvency or of gross payments settled in real time in a real-time gross settlement systems (RTGSS) or, again, the existence or not of a “zero-hour” rule for transfers executed in the system, are to be assessed only according to the law of the system.28 The same applies, for example, to the validity of margin calls or transfer of positions (in favor of a nonbankrupt participant, as it is organized in certain options or futures markets). This rule is also reflected in Article 8 of the Settlement Finality Directive (commented on below).

The preservation of the effect of Article 5 of the Insolvency Regulation aims at avoiding the “blind” application of Article 9, that is, the exclusive application of the law of the payment system to collateral which constitute rights in rem (in particular, a pledge) on assets located in a member state other than the one whose law governs the system.29 These collateral rights will still, in principle, be governed by the lex rei sitae and will not be affected, in the sense of Article 5 indicated above, by the opening of the insolvency proceedings.

EU Directive (2001/24/EC) on the Reorganisation and Winding-up of Credit Institutions of 4 April 200130

In 1985 the Commission presented a draft directive, formally modified in 1988,31 with the aim of harmonizing the reorganization of credit institutions and their winding-up, according to the same principles of centralization in the home country. Furthermore, the directive will ensure mutual recognition of the measures taken by other member states, along the lines of the basic regime that exists for the creation and exercise of banking activity within the EU, by virtue of the two so-called banking coordination directives.32 The directive relating to deposit guarantee schemes33 had, moreover, completed the structure by organizing the mandatory affiliation of credit institutions to a deposit-guarantee scheme of the home member state, also for its branch offices established in host member states.

After a hiatus of several years, work on the reorganization/winding-up directive began again in 1993, and ended34 with a Common Position at the EU Council level in May 2000. After the final amendments of the European Parliament, the EU Directive on the Reorganisation and Winding-up of Credit Institutions (the WUD) was finally adopted on April 4, 2001, which has now been implemented by member states since May 5, 2004 (Article 34.1).

The WUD is based on the principle of the exclusive competence of the administrative or judicial authorities of the home country of the bank in difficulty. These authorities are solely entitled to decide on the adoption of reorganization measures or the opening of a winding-up proceedings (in the broad sense) with application of the home country’s law. The authorities in the host member state must recognize the effects of these measures, without being able, on their part, to take reorganization measures locally or to open territorial insolvency proceedings against the branch offices set up in their territory.

For the European banking sector (as well as for the insurance sector), therefore, the WUD applies the principles of unity and universality of bankruptcy, and thus differs quite substantially from the approach adopted by the Insolvency Regulation, which is based on mitigated universality (that is, there is a main insolvency proceeding accompanied by secondary insolvency proceedings in each state where an establishment of the debtor is located).

However, the European Council felt it necessary to depart to some extent from the application of the home country’s law in favor of the law of other member states, in order to govern certain rights. This means not only providing a compromise to territorial states but, above all, also avoiding a situation in which the generalized application of the home country’s law might prove to be seriously detrimental to legal certainty, particularly for financial transactions and the participation of the credit institutions in question in payment or settlement systems.

The WUD thus sets out a series of exceptions to the law of the home country, including those which deal specifically with the protection of financial transactions and payment or settlement systems. The most important provisions for the purposes of this chapter are Articles 20–33 of the WUD, which adopt a similar approach to that of the Insolvency Regulation35 in the sense that, as waiver of the home country law, the effects of the reorganization measures or winding-up proceedings on certain rights, contracts, or systems concerning the insolvent bank will be exclusively governed by another law, that is, the one applicable to these rights, contracts, or systems.

The validity of contractual netting36 and repurchase agreements, or repos,37 will indeed be governed exclusively by the lex contractus.38 The enforcement of proprietary rights in book-entry securities, recorded on a register, an account, or in a centralized deposit system held or located in a member state, will be exclusively governed by the law of the member state where the account, the register, or centralized deposit system in which those rights are recorded, is held or located.39 Transactions carried out in the context of a regulated market shall be governed solely by the law of the contract governing such transactions.40

The WUD also applies the same regime as the Insolvency Regulation in the treatment of rights in rem, which “shall not (be) affect(ed) by the adoption of reorganisation measures or the opening of winding-up proceedings” when the relevant assets are “situated within the territory of another member state at the time of the adoption of such measures….” (Article 21).

Because the opening of insolvency proceedings in the home member state “does not affect” the holder of the right in rem, there will be an “immunization” of the holder of such a right in rem, taking into account the absence of any possibility of opening secondary insolvency proceedings in other member states. In such a regime, the holder of the right in rem should thus be exempted from any restrictive rules intending to avoid abuses to the detriment of other creditors—whether under the insolvency law of the home member state or under the law of other member states applicable to the holder’s right in rem or security interest.41 This is also what the Collateral Directive is aiming to achieve (see in particular Articles 4, 8, and 9 of the WUD.

The Settlement Finality Directive42

The Settlement Finality Directive (Directive or SFD) is the product of a group of member states’ experts who worked under the aegis of the European Commission. The group was established in 1993 to study the legal aspects of cross-border payments.43

The Directive proposes legislation at the EU level to eliminate, as far as possible, the legal risks to which payment systems and securities settlement systems are exposed,44 taking into account the systemic risk45 inherent in such systems.

The goal is, first of all, to require member states—if they have not already done so—to ensure that their domestic law ensures the satisfactory functioning of payment and settlement systems, whether operated on a net basis, in which case the validity of netting must be ensured, or on a gross basis, where the contractual irrevocability of orders needs to be guaranteed. There is also the need for the removal of any zero-hour rule in the case of the insolvency of a participant.

A second objective, equally important, is to ensure that the functioning of the relevant system, once its domestic law has been strengthened, cannot be threatened by the application of foreign insolvency legislation, in the case of participation of an institution from another member state or even from a non-EU country.

Once these protections are in place, financial institutions (mainly credit institutions and investment firms) should be able to settle their transactions in euro or other currencies without major legal risks, not only by means of national systems for domestic transactions, but also by means of cross-border payment systems such as the TARGET system46 managed by the national central banks of the euro system and the European Central Bank or by the EURO 1 system47 for cross-border transactions in the euro area.

The same applies to securities transactions that can be settled on a cross-border basis, either in an international central securities depositary (CSD), such as Euroclear or Clearstream, or by means of connections between national central securities depositaries, in order to allow securities held, for example, in country Y to be transferred from party A to party B, both located in country X.

Finally, monetary policy or exchange transactions of central banks—and particularly those which are members of the European System of Central Banks within the euro area—should also benefit from the legal protection brought by the Directive. The collateral provided to these central banks to guarantee, for example, extensions of credit should no longer run the risk of being rendered ineffective or unenforceable in the case of the counterparty’s insolvency. This also includes intra-day credit, which is important for the satisfactory functioning of payment systems.

Scope of Application of the Settlement Finality Directive

Ratione Materiae

The provisions of the Directive apply to any payment or securities settlement system within the meaning of Article 2(a) of the Directive, that is:

  • a formal arrangement (comprising common rules and standardized arrangements) between three or more participants48 for the execution of transfer orders (on cash or securities) between the participants;
  • designated as a “system”49 by each member state, which must notify such to the Commission “after that member state is satisfied as to the adequacy of the rules of the system.” Each national system must be assessed on the basis of an “accurateness” criterion, which is subject to the satisfaction of each member state. In reality, this provision is a compromise between those that favored harmonized supervision of payment and settlement systems50 and those opposed to any harmonization on this point, who consider that the Directive should just focus on reducing the legal risks associated with these systems.

Each member state is also free to designate as a system, on a case-by-case basis, a formal arrangement (as defined above) that only includes two participants—which can cover a correspondent banking relationship—provided that this designation, in the opinion of the member state concerned, is warranted on grounds of systemic risk.51

In the same vein, each member state may also treat an indirect participant (or sub-participant)52 as if it were a direct participant in a system as defined above, in order to apply the protective provisions of the Directive to bilateral relations between the direct participant and the indirect participant, provided the following conditions are fulfilled:

  • The “indirect participant” must be a credit institution.
  • The direct participant must be an institution that participates in a payment system. (Securities settlement systems have been excluded.)
  • There must be a contractual relationship between the direct participant and the indirect participant.(On these three first conditions, see Article 2(g)).
  • The inclusion of indirect participants in the category of “participants” in the sense of the Directive must be warranted on the grounds of systemic risk, in the opinion of the member state concerned (Article 2(f)).
  • The indirect participant must be “known” to the system in which it participates via its direct participant (Article 2(f)). The system must also disclose to the member state in question (the one whose law is applicable) the participants in the said system, including any possible indirect participants, as well as any change in them (Article 10).

Ratione Personae

According to Article 2(b), direct participants in a system may be (1) credit institutions as defined in the First Banking Co-ordination Directive,53 (2) investment firms as defined in the Directive on Investment Services,54 (3) public authorities and publicly guaranteed undertakings, or (4) any undertaking whose head office is outside the EU and whose functions correspond to those of the EU credit institutions or the aforesaid investment firms.

Central counterparties, settlement agents, and clearing houses are also included in the scope of application of the Directive (see Article 2(c), (d), and (e)).

All these categories of institutions are included in the general concept of “participant” in the sense of Article 2(f).

Rationae Territoriae

Contrary to the initial proposal of the Commission, the Directive is limited to EU systems, that is, those governed by the law of a member state chosen by the participants (Articles 1(a) and 2(a), second indent),55 even though, of course, these systems may include participants with a registered office established in a non-EU country, acting through a branch office located in the EU. Recital no. 7 states, however, that member states may apply the provisions of the Directive to their domestic institutions that participate directly in non-EU payment and securities settlement systems.

The Directive has various effects on relations between EU institutions and systems and institutions or systems of non-EU countries.

First of all, the power left to member states to apply the Directive to their institutions that participate in non-EU systems does not mean that such non-EU countries would be bound by the Directive. The Directive is only binding on member states of the EU in order to ensure that their domestic law satisfies the objectives of legal soundness and certainty. However, in the case of insolvency of EU institutions participating in a system operating in a non-EU country, the non-EU system will be entitled to rely on the protective effects of the Directive. In this case, the Directive extends its effects to the domestic law of a member state, insofar as its provisions (concerning netting, irrevocability of transactions, zero-hour rules, and collateral) will also be binding on the (domestic) receiver of the insolvent institution in order to prevent the invalidation of the operations of the non-EU system. Such a regime should favor the participation of EU institutions in American, Japanese, or Swiss systems, for example.

On the other hand, in the case of insolvency of non-EU institutions participating in an EU system, the protective provisions of the Directive should prevent the receiver of the non-EU country from challenging the operating rules of the EU system or any collateral arrangements, on the grounds, for example, of their incompatibility with the mandatory rules of the insolvency law of the non-EU jurisdiction (assuming of course, that the insolvency proceedings of the non-EU country would be, as a starting point, recognized in the member state where the system is located). One should consider, in such a case, the protective provisions in question (introduced into domestic law of each member state when implementing the Directive) as part of the international public policy of the member state where the system in question is operated, preventing the application of conflicting rules of the non-EU country’s law.

The Directive also authorizes member states to designate “systems” securities settlement systems, which allows “to a limited extent” the execution of orders concerning financial instruments other than “securities” as defined in Article 2(h). (See Article 2(a)); what is intended here are, for example, transfer orders on gold or other commodities, which are covered under the concept of “commodity derivatives.”) A system that grants access to nonfinancial institutions can also be designated as a “system” (for example, large companies (“corporates”) carrying out financial transactions), provided that, for such cases, the system in question is a securities settlement system supervised in accordance with national legislation (see Article 2(b), final paragraph). In both cases, designation as a “system” must again be warranted on the grounds of protection against systemic risk.

As one can see, Article 2 of the Directive refers to systems’ criteria (“formal arrangement,” justification of “systemic risk,” verification “of the adequacy of the rules of the system,” etc.) that appear to be fairly vague and general and therefore require a formal designation by each member state, in its implementing legislation or by means of subsequent enforcement regulations, independently of the notification of the national systems to the European Commission, required by Article 10, paragraph 1 of the Directive.

Provisions of Material Law Aimed at the Legal Protection of Payment and Settlement Systems

Article 3 of the Directive is one of the most ambiguous provisions (with Recital 13; see below)—and one of the least well drafted, from a strictly legal point of view—of the whole text of a directive not known for its clarity. The ambiguity is the result of a political compromise aimed at merging two initially separate texts, one devoted to the validity of netting, the other to the validity of transfer orders in general. The result is text that may undermine the very legal certainty which it was meant to provide.

The first objective of Article 3.1 is to ensure the validity and, particularly, the enforceability against third parties of the “netting of payments,” in the event of the insolvency of a participant in a payment or settlement system operating on a net basis. Both bilateral netting and multilateral netting, by set-off, novation, or any other technique (the German “skontration,” for example), are included in this provision. (See the rather economic definition of “netting”56 in Article 2(k), referring to the conversion of reciprocal claims into a “single net” claim.57) Netting of forward contracts (swaps, repurchase transactions, etc.), known as “obligation netting,” could also be caught, at least indirectly, if operated within the framework of a system in the sense of the Directive. One good example was the ECHO system managed in London by the ECHO Clearing House, which has now been replaced by the CLS system. The Collateral Directive is now aiming at expressly validating close-out netting provisions (as stipulated in market agreements such as the ISDA Swap Master Agreement, ISMA, Global Master Repurchase Agreement, and European Master Agreement), notwithstanding insolvency proceedings against a counterpart (Article 7).

The way in which Article 3.1 is drafted (“Transfer orders and netting shall be legally enforceable and … shall be binding on third parties provided that transfer orders….”could be interpreted, first of all, as limiting the scope of this paragraph only to the netting of transfer orders—in other words, as applying only to payment or settlement systems that operate a liquidation on a net basis, to the exclusion of transfer orders executed in gross settlement systems (RTGS systems, for short, which operate an individual settlement of each order for its initial gross amounts, without netting).

Article 3.2, which only protects netting (without reference to transfer orders) against preferences rules (transactions during the “suspect period”) would appear, at first sight, to confirm this narrow interpretation. This is corroborated by Recital 11, which stipulates that “transfer orders and their netting should be legally enforceable….”

Although this concept may have been in line with the Commission’s initial proposal for a directive, this was definitely not the objective sought by most, if not all, member states, which wanted to protect transfer orders generally against the effects of insolvency, whether these orders would be settled on a net (which is becoming less frequent) or on a gross basis.

It is therefore appropriate to adopt a broad and reasonable interpretation of Article 3.1 that applies not only to the netting of transfer orders, but even to transfer orders, independently of any subsequent netting. But the scope of this provision is still unclear:

  • If the first paragraph of Article 3.1 aims at ensuring the validity and enforceability against third parties of transfer orders entered into a system before the opening of insolvency proceedings (which is the basic hypothesis), what does this mean? Is it a protection against a revocation or against a zero-hour rule in the case of insolvency? If so, then of what use would be Articles 5 and 7, which deal specifically with these cases?
  • Is it, on the other hand, a matter of ensuring that a payment order entered into a system before insolvency can always be settled validly after this time? Can one, in particular, infer from the text of the first paragraph of Article 3.1 that a payment order entered into an RTGS system before the insolvency but which is not settled immediately (after being placed in a “waiting queue” for example) can, however, be processed and settled without any hindrance after the insolvency? One should answer this question in the affirmative to the extent that the text of the first paragraph of Article 3.1 renders the validity and enforceability against third parties of transfer orders solely contingent on their prior entry into the system, which must take place before the opening of the insolvency proceedings against the participant concerned. To make any sense, this should imply the admissibility of the subsequent settlement of such previous orders.

The second paragraph of Article 3.1 deals with the case of transfer orders carried out on the day of opening of such proceedings but entered after the opening of insolvency proceedings.58 This second paragraph was introduced in the Directive in order to remedy the legal uncertainty affecting the fate of payments orders made between the time of insolvency and the moment of its knowledge by the participants and operators of the systems concerned. It goes without saying that participants who are debtors of the insolvent participant following a bankruptcy order that was issued, for example at 11:00 AM on a working day, may be led to make further orders after this moment, being unaware of the occurrence of this insolvency. Also, it is possible to imagine that the insolvent participant orders payments after its insolvency. For example, the payments could have been entered with an order of delayed execution or the orders could have been passed by another participant in the system representing the defaulting institution, at the time when this direct participant does not yet know about the insolvency of the defaulting institution.

These orders subsequent to the declaration of insolvency are declared legally enforceable and binding on third parties “only if, after the time of settlement, the settlement agent, the central counterparty or the clearing house can prove that they were not aware, nor should have been aware, of the opening of such proceedings” (paragraph 2 of Article 3.1; emphasis added).

In case of dispute about transfer orders entered after the opening of insolvency proceedings against the participant, it is up to the settlement agent or the operator of the system to prove its legitimate ignorance of the insolvency at the time of settlement. The settlement agent or operator must be able to justify its legitimate ignorance by demonstrating that at the time of the orders and their execution, the competent authority in accordance with the rules stated in Article 6 of the Directive did not provide the settlement agent or operator with the news of the insolvency of the relevant participant, nor was the insolvency known to the markets (through, for example, reference to announcements in the press or on Reuters, Telerate, or Bloomberg screens).

In the same way and under the same conditions as for the transfer orders themselves, Article 3.1 allows for the protection of netting of transfer orders provided that:

  • either the transfer order to be netted is entered into the system before the moment of opening of the insolvency proceedings;
  • or the transfer order was introduced and settled on a net basis after the moment of opening of insolvency proceedings, to the extent that the operator of the system can prove its legitimate ignorance of the opening of such insolvency proceedings.

Article 3.2 deals with the protection of the effects of netting59 against the possible damaging impact of rules on fraudulent transactions carried out during a certain period (six months, two years, etc.) before the opening of the insolvency proceedings (referred to variously as the “suspect period,” fraus pauliana, regime of “preferences,” “fraudulent conveyance”). It is stipulated that netting may not be unwound as a result of these rules.

Article 3.3 states that for the purposes of applying Article 3.1, the moment of entry of a transfer order into a system is defined by the operating rules of the system. This appears to be rather obvious. Unfortunately, the text adds that if the national law itself defines this moment, the rules of that system must be in accordance with such conditions. At this point, one may question the usefulness of the first sentence of Article 3.3.

Article 4 of the Directive allows member states, despite the insolvency of a participant, to authorize the debit (in cash or securities) of a settlement account of this participant60 in order to allow for the settlement of its final position or of its transfer orders. This could be carried out either by the debit of cash amounts or securities already credited on such an account or even by means of a withdrawal on a credit line extended to the defaulting participant by the central bank or the operator of the system. In the latter case, the central bank or the operator of the system is required to obtain the prior authorization of the receiver as regards this use of credit facilities. However, the relevant credit facility so used has to be already secured by means of “available existing” collateral, taking the form of collateral security as defined under Article 2(m).

Article 5 aims to ensure the irrevocability of transfer orders. In most cases, this will be provided for in the rules of the system, which should then be protected against any rules of internal law61 that could invalidate this irrevocability, including in the case of the insolvency of a participant. Pursuant to Article 5, from the moment of irrevocability defined in the rules of the system, a transfer order can no longer be revoked by a participant or by a third party.

Section III of the Directive contains three provisions (Articles 6–8) that deal with the opening of insolvency proceedings against a participant of a system.62

Article 6.1 defines the opening of insolvency proceedings as the moment when the relevant judicial or administrative authority “handed down its decision.” This definition is useful for the interpretation of Article 3 (protection of netting and transfer orders entered into the system) and Article 7 (protection against any zero-hour rule).

When a decision opening insolvency proceedings is handed down by the relevant authority (for example, by a commercial court), the relevant authority must immediately transmit that decision to the appropriate authority designated by its member state to receive such notification (Article 6.2). This national authority (which may be the central bank), must in turn immediately pass this news to other member states (the authority in question must in practice notify the decision taken in its country to its foreign counterparts).63 member states are also obliged to inform the Commission of the authorities which they have appointed for this purpose (Article 10, paragraph 1).

One must not lose sight of the fact that however useful this notification system may be, the moment of opening of insolvency proceedings remains, in principle, when the relevant authority of a country hands down its decision, not the moment when this decision is notified to the appropriate authority of that country nor the moment when the decision is passed on to the other member states, subject, of course, to the rules of national law applicable in each member state concerned.

However, a degree of protection is conferred by the rules that protect transfer orders executed (without knowledge of the insolvency) between the time of insolvency and the moment when this news is widespread on the markets (see paragraph 2 of Article 3.1, described above).

Article 7 aims at neutralizing the rules of some insolvency regimes under which an insolvency decision is deemed to have retroactive legal effects from the first hour of the day of its pronouncement (the zero-hour rule). Zero-hour rules result in the insolvent party being deemed to have lost its legal capacity from the first moment of the day on which the insolvency decision was handed down. Therefore, the transactions and payments that it carried out between the first hour of the day of insolvency and the moment when the decision declaring its insolvency was handed down, are void or voidable, and at least not enforceable against the receiver.

Zero-hour rules are of course totally inappropriate for interbank transactions at the beginning of the twenty-first century. It is imperative, especially in a gross settlement system, that a recipient can consider a payment received as final and then be able to freely dispose of or transfer it in favor of third parties. Article 7 states therefore that an insolvency proceeding cannot have retroactive effects on “the rights and obligations of a participant arising from, or in connection with, its participation in a system.” This provision mainly concerns the validity of transfer orders executed and of collateral provided before the opening of the insolvency proceedings. The same type of rule is also proposed in the Collateral Directive (Article 8.1.). This rule is of general application, whatever the type of system (net or gross).64

This neutralizing of the zero-hour rule in the case of insolvency of a participant in a system, could, however, be subject to qualification arising from Recital 13, which states that “nothing in this Directive should prevent a participant or a third party [for example a receiver] from exercising any right or resulting from the underlying transaction which they may have in law to recovery or restitution in respect of a transfer order which has entered a system, e.g., in case of fraud or technical error, as long as this leads neither to the unwinding of netting nor to the revocation of the transfer order in the system.”

As the title of the Settlement Finality Directive indicates, the idea of some member states was to ensure the finality, or rather the definitive character of the settlement (settlement finality) of transfer orders processed in payment or settlement systems, and not the finality or definitive status of the payments themselves (payment finality or receiver/beneficiary finality). Under this view, reflected in Recital 13, the netting of transfer orders and the orders themselves can no longer be invalidated or unwound (paragraphs 1 and 2 of Article 3.1), a transfer order can no longer be revoked after the time authorized by the system (Article 5), and insolvency proceedings against a participant can no longer retroactively affect its rights and obligations linked to its participation in a system (Article 7), as far as the system is concerned. But in this narrow interpretation the participant who gives the order, or its receiver, might always act directly against the beneficiary participant (or a subsequent beneficiary) outside the system in order to claim back or to recover the amount transferred (cash or securities) in the system. This would not only be possible in case of mistake65 or fraud,66 which goes without saying, but also, in all other circumstances67 in which such a recovery claim could be available pursuant to national law.

In other words, if one took a particularly narrow view, Recital 13, together with the wording of some provisions of the Directive (Articles 3, 5, 7, 9), could be interpreted as meaning that a receiver would be authorized to act outside the system—for example by claiming back the sums paid as a consequence of a netting carried out on the day of insolvency—as long as the netting itself is not called into question “in the system.”

Yet again, the payments made by the insolvent participant on the day of its insolvency but prior to the declaration of the insolvency order could be subject to recovery actions by the receiver against the beneficiaries on the grounds that the participant had retroactively lost the right to dispose of its assets. Consequently, these payments—not invalidated as such “in the system”—would be null and void or nonbinding and, therefore, subject to restitution “outside the system.”

Such a narrow interpretation would be particularly shocking because it would actually go directly against the spirit and the text of the Directive, which aims precisely at avoiding, for example, the application of such a zero-hour rule or the invalidation of a netting or a transfer order (see Articles 3, 5, and 7). Furthermore, a recital cannot overrule or contradict the provisions of a directive. Member states are responsible for ensuring that the implementation into their national legislation leaves no room whatever for doubt as regards the protection granted to transfer orders executed in their systems.

Article 8 of the Directive is a conflict of laws rule stating that in the event of the insolvency of a participant in a system, the effect of the insolvency proceedings on the rights and obligations of such participant arising from, or in connection with, its participation in a system will be determined by the law of the jurisdiction which governs the system. In spite of a slightly different formulation, this rule is close to the one stipulated by Article 9.1 of the Insolvency Regulation.

This provision is important because, first, it determines by reference to the law of the system the rights and obligations of an insolvent participant for matters which are not specifically covered elsewhere in the Directive. One can refer, for example, to a transfer of contracts or of positions organized by the relevant system, in accordance with local law.

Second, and most importantly, Article 8 sets out a conflict of laws rule (for the EU judge) by stating that, in the event of insolvency proceedings being opened against a defaulting participant (incorporated in the EU or not) in an EU system, the participant’s rights and obligations toward the system for matters governed by the Directive (transfers orders, netting, irrevocability, zero-hour, etc.) will be determined by the law governing that system and not by the insolvency law of the defaulting participant. In other words, additional conditions under legislation in the insolvent participant’s jurisdiction regarding netting, irrevocability of payments, or the effects of the insolvency decision, will not apply if they differ from the conditions of the law of the system.

The same should apply to the exclusion of a zero-hour rule contained in the insolvency law applicable to a foreign participant to a system: it is the law governing the system, including its rules on the finality of payments in the case of the insolvency of the participant, that will exclusively govern the validity of payments made via this system, as “rights and obligations arising from the participation (of the insolvent party)” in the system in question.

Section IV of the Directive, consisting of Article 9, is devoted to the insulation of rights with respect to collateral security granted to a participant or a central bank of a member state (collateral taker), in the event of the insolvency of the collateral provider.68

Article 2(m) defines collateral security as “all realisable assets provided under a pledge …, a repurchase or similar agreement, or otherwise,[69] for the purpose of securing rights and obligations potentially arising in connection with a system, or provided to central banks of the member states or to the (future) European Central Bank.”

There is a need to differentiate between, on the one hand, the actual insulation of the collateral security against the insolvency of the debtor, which is the goal of Article 9.1 of the Directive, and, on the other hand, the determination of the law applicable to collateral on book-entry securities recorded in an account, as laid down in Article 9.2.

Insulation of Collateral Security Against Insolvency of the Collateral Provider

The aim of Article 9.1 of the Directive is twofold. Its first goal is to protect the holders of collateral security in relation to participation in a payment or securities settlement system against the negative effects of the law governing the insolvency of a foreign participant (whether or not originating from the EU).

The second objective of Article 9.1 is to ensure the legal effectiveness of collateral security to the extent that it will not be “affected by insolvency proceedings” against the debtor, whether it is a foreign or even domestic insolvency proceeding. The Directive adopts the rule introduced in the Insolvency Regulation (Article 5.1), which allows the collateral taker to realize its collateral without being “affected” by the opening of the debtor’s insolvency.70 The Directive goes even further than the Insolvency Regulation to the extent that a collateral taker will not be affected by the opening of an insolvency, even if the assets provided as collateral (a pledge for example) are located in the same member state as the one where the insolvency proceedings have been opened. By contrast, the Insolvency Regulation (or the winding-up directives) supposes that the pledged assets, in order to benefit from the “non-affected” rule, must be located in a member state other than the country where the insolvency proceedings have been opened. The creditor may, under this hypothesis, realize the collateral as if insolvency proceedings would have simply not been opened, without being bound by the restrictive domestic rules applicable to the realization of collateral in the case of insolvency. This is also the solution adopted in the Collateral Directive (see Articles 4 and 9).

In other words, supposing the insolvency of a participant is governed by the same national law as the one governing the system itself, Article 9.1 means that the collateral taker can realize its collateral (also located in the same jurisdiction) without having to obtain the prior authorization of the receiver or of the competent court, should the national law require this in the case of insolvency of the collateral provider. But it goes without saying that the collateral taker must always comply with the rules under the applicable general law to collateral with respect to the procedures of realization of its collateral—for example, the necessity to sell in an organized market, or at the best possible price. On a similar rule, see Article 4.6 of the Collateral Directive.

The same rule applies to collateral provided to central banks of member states (or to the European Central Bank) by their counterparties, without there being any requirement to have any connection whatever with “a system”71 or that the counterparty should have the quality of “participant” in the sense of the Directive. The idea is to apply the insulating rule of Article 9.1 to all collateral security transactions of central banks acting in this capacity (see Recital 10)—including monetary policy transactions, interventions on exchange markets, or transactions linked to the management of their external reserves—whether the secured transaction is formally carried out or processed in a system. The same extension is offered for the relations between financial institutions or between financial institutions and their clients in the context of the Collateral Directive (see Article 1.2 (e) and 1.3).

Determination of the Law Applicable to Collateral Security on Book-Entry Securities

The aim of Article 9.2 of the Directive is to determine the law applicable to collateral provided in the form of book-entry records that represent securities accounts or rights in securities (this is the case of physical securities circulating by way of book-entry transfers or dematerialized securities solely represented by book-entry records on accounts). This issue of applicable law is particularly crucial and complex, especially when securities are held on account with a financial institution in one country and then held through a chain of intermediaries with a custodian in another country, which itself then holds such securities with the CSD system where the underlying securities have been directly issued and are primarily held.72

Should (1) the law of the country where the underlying securities are issued, or at least where the underlying certificates are ultimately held, be applied, or (2) should one apply the law of the country where the interest in the book-entry securities held on an account is recorded with an intermediary? Article 9.2 of the Directive opts for this second solution, which has been recommended for several years by several international financial market associations.73 This is also the approach proposed by the Collateral Directive (Article 9) by reference to the place of the relevant intermediary (the one maintaining the account where the collateralized assets are recorded). This rule (PRIMA) is also proposed (with, however, a refined connecting factor referring no longer to the place of the account but, as a rule, to the law governing the account agreement) at the international level by the Hague Conference on Private International Law in its Convention on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary.74

Article 9.2 of the Settlement Finality Directive thus aims at ensuring that if a participant (or a central bank of a member state) holds securities as collateral security in a register or an account75 held with an intermediary situated in a member state, its rights as collateral taker will be governed by the law of the member state where the register or account (recording the provision of collateral)76 is held.77, 78

As “local law” (the law of the jurisdiction where the relevant assets subject to collateral are located), the law of the intermediary maintaining the collateral account will govern the nature of the rights of the collateral taker on the securities, the enforceability vis-à-vis third parties (perfection governed by lex rei sitae) and the realization rules (see also Article 9.2 of the Collateral Directive).

Article 9.2 of SFD appears to be designed for collateral security in the form of book-entry securities, taking the form of a pledge for example. In the case of secured transactions in the form of a repo, this rule should mean, that the validity and enforceability against third parties of the transfer of ownership (with respect to the book-entry securities) will be governed by the law of the member state where the interests representing the securities transferred are recorded, without prejudice to the application of the law governing the transaction itself (applicable as lex contractus) with respect to the counterparts’ various contractual obligations.

The implementation of the Directive into domestic law was due by December 11, 1999, and today all EU and EEA countries have implemented the Directive in their national laws, even though most EU countries seem to have followed a narrow interpretation of the Directive (in particular with respect to Article 9, by restricting its application at national level to collateral constituted in favor of a central bank or of the system’s operator, but not to collateral between participants). A revision of this Directive is presently considered by the EU Commission.

Directive 2002/47/EC on Financial Collateral Arrangements of 6 June 2002

The importance of collateral transactions for the smooth and efficient functioning of domestic and international financial markets is obvious today. According to the preparatory report prepared by the EU Commission on 15 June 200079:

  • As of the beginning of 1999, the total value of government securities on loan or repo in the majority of EU countries was estimated at US$900 billion. The size of the market in the United States was approximately twice as large.
  • An ISDA80 collateral survey concerning the size and complexity of the market for collateralized over-the-counter (OTC) derivatives estimated that the value of the collateral held in the OTC derivatives market at the end of 1999 amounted to approximately US$250 billion.
  • At the beginning of 2000, the European Central Bank held collateral of around €550 billion, of which nearly €160 billion was held on a cross-border basis.

Collateral in the form of pledge or transfer-of-title arrangements is used by financial institutions, corporations (major commercial companies active on the financial markets), central banks, and other financial public entities for trading, investment, and financing purposes as a way to manage their credit risk on counterparts and the market risks on the various assets subject to such collateral transactions, especially if the use of collateral81 can lead to regulatory (“Basle ratios”) and tax/accounting favorable treatment (neutralization of any capital gain or accrued income deriving from a transfer of assets in favor of the collateral taker that has to transfer back the assets once reimbursed at the end of the transaction).

It is therefore paramount to use collateral techniques that benefit from sound legal protection, in order to allow the collateral taker to recover in case of default (in particular in insolvency situations) the amount of its exposures on the defaulted counterpart. Such legal soundness is generally required by banking regulators for capital adequacy purposes,82 but it is also strictly necessary from a risk-management and audit viewpoint, and carefully monitored by rating agencies as part of their credit assessment of the relevant institution acting as collateral taker. Collateral instruments must therefore be valid and binding between parties, enforceable (or good) against third parties, and the assets so provided must be easily and rapidly realized (by way of sale or appropriation or by way of set-off in the case of claims), notwithstanding any insolvency proceedings affecting the collateral provider.

This legal robustness should not only be ensured at the domestic level (assuming that both collateral taker and collateral provider would be situated in the same country, dealing domestically without any cross-border aspects) but also at the cross-border level for transactions between institutions from different countries making a collateral transaction under an agreement governed by the law of another jurisdiction related to assets located83 or held with an intermediary CSD, international CSD, global custodian, local agent/custodian) operating in a fourth country. In such a case, the collateral taker will have to take into account the regime of at least three different laws to assess the legal soundness of the transaction:

  • The law governing the collateral agreement (lex contractus), generally the law explicitly selected by the parties according to the Rome Convention in the EU and to basic principles of conflict of laws of most countries, as regards the validity and the binding character of the agreement between parties, which will govern the contractual aspects of their collateral arrangements;
  • The law governing the proprietary aspects of such collateral transaction (being, in case of a security interest in the form of a pledge, the formalities to create a right in rem of the type agreed to by the parties, giving a preferential right over unsecured creditors on the proceeds of the pledged assets, and in the case of a transfer of title, the method to transfer the ownership of the assets as agreed to by the parties), including the formalities required, if any, to perfect84 the collateral in order to make it enforceable against third parties. Such law will be determined, generally pursuant to the lex rei sitae (or lex situs in the Anglo-Saxon terminology), by reference to the local law where the assets pledged or transferred are located. This law will also govern the realization of the assets that are the subject matter of the collateral.
  • The law governing the possible insolvency—whether under the form of a reorganization (aiming at restoring the financial soundness of the debtor) or of a bankruptcy proceeding (aiming at liquidating the assets of the debtor)—of the collateral provider, which will generally be determined by reference to the law of the country where the head/main office of the insolvent debtor is situated. But local insolvency proceedings may also be opened in other countries where the insolvent collateral provider may have branches or assets.85 Such insolvency law(s) may affect the collateral, either by invalidating the collateral arrangement as constituting a preference (or a fraudulent conveyance) if made during a certain period before the bankruptcy order, or by freezing any foreclosure or realization of the assets during a certain period after insolvency, which will be subject to prior authorization of the receiver (stay), or by subordinating the preferential claim of the collateral taker to other special classes of preferred creditors (employees or tax authorities, for example), downgrading as a result the expected ranking of the collateral taker.86

With regard to these cross-border aspects of collateral transactions, the chapter has reviewed above87 the European legal context already in place for achieving legal certainty for collateral (especially in case of insolvency of the collateral provider), which consists in particular of the Directive 98/26/EC of 19 May 1998 on Settlement Finality in Payment and Securities Settlement Systems 88 (in particular Article 9) as well as of Directive 2001/24/EC of 4 April 2001 on the Reorganisation and Winding-up of Credit Institutions 89 (in particular Articles 21, 23–27 “WUD”), the Directive 2001/17/EC of 19 March 2001 on the Reorganisation and Winding-up of Insurance Undertakings,90 and the Council Regulation (EC) No.1346/2000 of 29 May 2000 on insolvency proceedings91 (in particular Articles 5, 6 and 9). (About this legal framework, see also the fourth recital of the Collateral Directive.)

With respect to the substantive rules governing collateral transactions once being determined by application of the conflict of laws rules, without application of foreign insolvency laws of the collateral provider, it is worth mentioning that in the early 1990s most OECD countries started a general review of their domestic financial laws, generally under the pressure of G-10 or EU bodies92 or of their national market players, in order to improve their collateral regime on the different aspects mentioned above. This trend was enhanced with the establishment of the European Central Bank in 1998, which wanted to ensure that an adequate legal framework was in place in the EU for the development of ESCB monetary policy transactions as of January 1999.

But despite such improvements at the domestic level, the collateral regime of several EU countries remains either unfavorable to the extent that (1) domestic laws would leave open some risks of recharacterization of a repurchase transaction or transfer of title into an irregular unenforceable pledge or (2) would still establish undue constraints on the establishment, use, or perfection of a pledge, or on its realization. Netting of claims by way of novation or set-off may also in some countries be void after insolvency. In addition, negative impacts of suspect period rules (in insolvency situations) may still endanger the validity of collateral transactions made in a pre-insolvency period.

This situation led the EU Commission in 1999 to create a working party, the Forum Group on Collateral, which contributed substantially to the definition of the industry’s need for legal certainty for collateral transactions. Under the leadership of Mr. Guy Morton and Richard Potok, the Forum proposed a draft directive.93 After a consultation process, on March 27, 2001, the EU Commission presented a proposal for an EU directive on financial collateral arrangements.94

This proposal was intensively discussed under Swedish, and more especially Belgian, EU Council presidencies, which succeeded in reaching a common position at the Brussels ECOFIN of December, 13, 2001 (only nine months after the initial proposal, which is indeed remarkably fast in EU legislative matters). After a quick and constructive co-decision process with the EU Parliament during the first half of 2002, the directive was adopted in final form on June 6, 2002.95

This section discusses the provisions of EU Directive 2002/47/EC on Financial Collateral Arrangements (hereafter the Collateral Directive)96 and describes its rationale (which is also well described in the detailed recitals of the Directive, which read like a kind of “user guide”97 to some provisions of the Collateral Directive.98) The discussion provides a first commentary of the Collateral Directive rather than a detailed exposition in a comparative law manner.99 The following discussion reviews the scope of the Collateral Directive, the removal of collateral formalities, the pledge’s provisions, provisions for the transfer of title, the provisions common to both collateral instruments, and the applicable law. It concludes by looking at the foreseeable achievements of the Collateral Directive.

The Scope of the Collateral Directive

The scope of the Collateral Directive was among the most sensitive topics during the consultation process and discussions at the EU legislative level. Indeed, while almost all members states’ representatives were of the opinion that such a directive was necessary to remove remaining legal risks from substantive laws within the EU for the benefit of financial markets and transactions, there were also diverging views with respect to the assets to be covered and more importantly about the type of counterpart qualifying as a protected collateral taker and collateral provider.

Relevant Types of Collateral Instruments

Pursuant to Article 1.1, the Collateral Directive applies to “financial collateral arrangements” (hereafter collateral) that take the form of either a “security financial collateral arrangement” or a “title transfer financial collateral arrangement” as defined in Article 2.1. This definition covers basically any type of contractual100 security interest (especially a pledge) where the collateral provider remains the owner of the pledged assets, and transfer of title for security purposes (including in particular repurchase transactions), where assets are transferred (against others) in full ownership but with the duty to retrocede equivalent assets at the maturity of the transaction.101 Additional constitution of collateral by way of margin calls (“top-up” collateral aiming at marking-to-market the value of the assets to cover both parties against any market risk deriving from changes in the market value of the assets) is also protected (see, in particular, Article 8.3).

Relevant Assets

The Collateral Directive applies to collateral relating to cash or financial instruments (Article 1.4 (a)). By cash, the Collateral Directive is referring to cash credited to an account (Article 2.1 (d)), which means that in most countries the subject of a pledge of cash will be the claim in reimbursement against the institution holding the cash account, since the cash itself will become the property of the intermediary as a result of the fungibility of cash deposits, unless otherwise organized by the law governing the cash account. Banknotes as such are explicitly excluded, according to Recital 18.

By financial instruments (hereafter securities), the Collateral Directive means:

Shares in companies and other securities equivalent to shares in companies and bonds and other forms of debt instruments if these are negotiable on the capital market, and any other securities which are normally dealt in and which give the right to acquire any such shares, bonds or other securities by subscription, purchase or exchange or which give rise to a cash settlement (excluding instruments of payment), including units in collective investment undertakings, money market instruments and claims relating to or rights in or in respect of any of the foregoing. (Article 2.1 (e))

This definition is intended to cover all debt and equity instruments (including warrants, options, and futures) as well as the securities entitlement organized in some jurisdictions (Belgium, Luxembourg, and the United States) giving to the holder of a securities account not direct and traceable property rights on the underlying securities held abroad via sub-custodians, but co-ownership rights on a pool of fungible securities. (The co-ownership right does not apply directly on each of the underlying securities held on a fungible pooled basis but on the book-entry interests in securities as recorded in the books of the intermediary.) In such systems, what is transferred or pledged is not the underlying securities but the co-ownership rights of the collateral provider on the pool of book-entry fungible securities vis-à-vis the intermediary holding the securities account. This is the sense of the term right in or in respect of any of the foregoing.102

Claims against the intermediary holding the securities account in question in relation to (actual or future) delivery of securities to be recorded on the account are also covered by the definition and may be subject to collateral arrangements under the Collateral Directive.

Type of Protected Counterparts

Several countries (possibly under the pressure of their ministry of justice) did not want to extend the benefit of the protective regime to nonfinancial institutions (a fortiori not to natural persons), while others were more favorable to the inclusion of commercial companies active on financial markets, at least those having a certain size in terms of capital/own assets and which could not be regarded as a weak party when dealing with financial counterparts.

This last conception was proposed by the Commission in its initial proposal that included a “person … whose capital base exceeds EUR 100 million or whose gross assets exceed EUR 1000 million at the time where financial collateral is actually delivered….” (Article 2.4 (c)). But the common determination of the financial base—and the thresholds—in relation to a specific collateral transaction was too complicated in view of the above divergence of approaches.

In order to reach an agreement on the Collateral Directive, a compromise was finally found in the scope of Article 1.2. (a) to (e), including:

  • All financial institutions (credit institutions, insurance undertakings, collective investments firms, investment firms, other financial institutions) under the meaning of applicable directives;
  • Public bodies (including treasury agencies, financial institutions of public nature), central banks, the European Central Bank (plus the Bank for International Settlements, International Monetary Fund, European Investment Bank, etc);
  • Central counterpart in clearing systems (Clearnet, LCH, etc) and settlement agent or clearing house under the meaning of the Settlement Finality Directive (operators and transfer/paying agents in securities settlement systems designated by each member state) and assimilated representatives (see Article 1.2 (d));
  • “A person other than a natural person,103 including unincorporated firms and partnerships, provided that the other party is an institution as defined” above.

Commercial undertakings are therefore included as possible counterparts in financial collateral arrangements without requiring any minimal financial conditions. However, Article 1.3 reserves the faculty for a member state to exclude from the scope of the Collateral Directive financial collateral arrangements where one of the parties is such a nonfinancial person, at the request of those countries that were opposed to such inclusion. (On the consequences of such opting-out, see below in Conclusions).

Subject to the above possible exclusion, the Collateral Directive will apply if both collateral provider and collateral taker(s) belong to the above categories (Article 1.2) if both are financial institutions or at least one financial institution dealing with one nonfinancial legal person (e.g., a company).

Removal of Collateral Formalities

One goal of the Collateral Directive is to simplify the various formalities prescribed by some national laws, especially in pledging arrangements, for the creation or the validity of a pledge between parties (such as, e.g., written agreement, delivery of the assets, certification by way of notarial/public registration), its perfection or enforceability against third parties (delivery of the pledged assets, notification, publicity by way of registration of the pledge agreement in a public register (filing as foreseen, for example, by Section 395 of the UK Companies Act 1985) that can be required in the country where the assets are located and/or in the country of the incorporation of the collateral provider, etc) or even its admissibility as evidence (notarial document, stamp, deed).

To that end, Article 3 states that “member states shall not require that the creation, validity, perfection, enforceability or admissibility in evidence of a financial collateral arrangement or the provision of financial collateral under a financial collateral arrangement be dependent on the performance of any formal act.” Recital 10 gives a nonexhaustive list of such formal acts.104

This removal of external formalities relating to pledging and transfer of title arrangements does not mean, however, that financial collateral can be established by mere oral agreement between collateral provider and collateral taker without any externalization of their will to create such collateral. There are indeed two types of mitigating factors that are foreseen by the Collateral Directive:

  • There is still a practical need to deliver the assets subject to a pledge or a transfer of title to the collateral taker, either in its account or in an account held on behalf of both parties by a third party (which can be the operator of a settlement system or any other custodian) or even to keep the assets in the account of the collateral provider but pledged in favor of a collateral taker with adequate measures to block the taking of such assets by the intermediary holding the account. Otherwise, the collateral taker would be in a situation where in case of default of the collateral provider, the collateral might have lost its object—and therefore its goal—because of the previous transfer of the assets to another party (assuming the good faith of the latter, which should be usually the case, especially in the absence of any publicity measures) if no blocking measure was put in place.This is why the Collateral Directive is only applicable to collateral “once it has been provided” (Article 3.2; see also Article 1.5), which means once “delivered, transferred, held, registered or otherwise designated so as to be in the possession or under the control [emphasis added] of the collateral taker or of a person acting on the collateral taker’s behalf (Article 2.2; see also Recital 9). A typical example is the usual practice of identifying assets as being pledged through the use of designated pledged securities and cash accounts—in the name of the collateral taker or even in the name of the collateral provider as long as the assets posted in such pledged account can be blocked up to the amount of the guaranteed claim or exposure of the collateral taker—held with an intermediary. A certain form of dispossession is therefore required under the Collateral Directive (see Recital 10), which should give some comfort to those jurisdictions that were either reluctant to completely remove collateral formalities or wish to preserve this traditional feature of pledging arrangement linked to their right in rem’s nature implying as a rule dispossession (as in French or Belgian law).
  • The second mitigating factor is the requirement of written evidence for both the collateral agreement (the Collateral Directive refers to an “arrangement,” without defining what it means, which seems broader that just the pledge or transfer of title agreement, but in practice one may wonder what it is intended to cover) and the provision of such collateral (Articles 1.5 and 3.2)105The Collateral Directive specifies that such evidence of the provision of collateral “must allow for the identification of the financial collateral to which it applies. For this purpose, it is sufficient to prove that the book entry securities [evidenced by entries in a register or account maintained by or on behalf of an intermediary: Article 2.1 (f)] provided as collateral have been credited to, or form a credit in, the relevant account [as defined under 2.1 (h); see below] and that the cash collateral has been credited to, or forms a credit in, a designated account” (Article 1.5, second paragraph).The Collateral Directive adopts a modern approach by allowing consideration of book-entries evidenced “by electronic means and any durable medium” (Article 2.3) and more generally any evidence “legally equivalent” to written evidence (Article 3.2) that seems to refer to other admissible evidence (see in that sense Recital 11: “in any other legally enforceable manner” foreseen by the lex contractus) under some national legislations as in commercial matters, where a court may in its discretion determine if an obligation is established, including by way of testimony and assumptions.

Security Financial Collateral Arrangement (Pledging)

Two provisions of the Collateral Directive address pledging arrangements: Article 5, establishing a right of use of the pledged assets by the collateral taker, and Article 4 on the enforcement of such pledging arrangements.

Right of Use (Article 5)

Such right of use (or reuse) on the side of the collateral taker (sometimes also known as rehypothecation, especially in U.S. practice) seems rather revolutionary for jurisdictions influenced by the French Code Napoleon to the extent that under these laws a pledgee cannot as a rule dispose in any manner of the pledged assets (especially by using them in the course of another transaction with a third party), since this is not regarded as an admissible right for a collateral taker,106 who should instead take care of the assets still belonging to the debtor who has the right to recover them back upon payment of the secured claim of the pledgee. In case of infringement of such prohibition, the pledgee may even lose the rights held as secured creditor on the reused assets (“déchéance pour abus de jouissance” see Article 2082 of French civil code).

However, in the international financial markets, such right of use is common among many players (especially with U.S. counterparts), who consider this latitude as a prerequisite to mobilize efficiently their collateral portfolio instead of freezing it in the framework of “classical” pledges, in cases where, for any reason,107 transfer of title (implying by nature a transfer of full ownership with the associated right of reuse for the transferee) may not be available. The downside is, of course, that by allowing the use of the pledged assets by the collateral taker for the purposes of other transactions with third parties (outright sales, repo, margins, pledges, loans), the initial collateral provider is exposed to a credit risk on its creditor since it would have no guarantee that once fully reimbursed, the collateral taker will be able to transfer back equivalent assets to those initially pledged and reused in the meantime.

In order to give European financial institutions the same flexibility enjoyed already by some market players, it was agreed to introduce such right of use for the collateral taker in pledging arrangements under the following conditions:

  • The terms of the collateral arrangement must provide for such right (Article 5.1).
  • The collateral taker must incur an obligation (which can then be set-off; see the following bullet point) to transfer equivalent collateral108 (to the one used) at the latest on the due date for the performance of the secured obligations (Article 5.2).
  • On that date, either the initial pledged assets will be replaced by equivalent assets, or the value of such assets in replacement due by the collateral taker will be set-off against the amount of the secured claim owed to it by the collateral provider, in order to give to the latter a certain protection against pledgee’s default.
  • The equivalent collateral shall not give rise to a new pledge (that may be challenged as preference or by virtue of any suspect period rules), but instead will continue to be governed by the initial security financial collateral arrangement provided at the same time as the initial collateral (Article 5.3).
  • Such right of use can no longer be sanctioned by a “déchéance” or any termination of the pledge or of the rights of the pledgee (Article 5.4).
  • In case of default, close-out netting should be allowed in order to give effect, if necessary, to the set-off laid down in Article 5.2, second paragraph.

Enforcement of pledge arrangements (Article 4, paragraphs 1–4)

Contrary to the heading of the provision, the first four paragraphs of Article 4109 aim at addressing enforcement only of security financial collateral arrangement (pledging) by requiring members states to ensure that in case of default of the collateral provider (defined by the concept of “enforcement event”110), the collateral taker shall be able to realize the assets pledged in accordance with the terms of the collateral agreement through one of the following methods:

  • For securities, by way of sale or appropriation111 of the assets;
  • For cash (and securities if any), by way of setting off the amount of cash (or the value of the securities) against the amount of the secured obligations due to the collateral taker (Article 4.2).

As one can see, appropriation of the assets is foreseen in addition to the classical way of enforcing rights of a pledgee through the sale of the assets. This is also quite revolutionary for some jurisdictions (again generally those inspired by French civil law112), where appropriation of the pledged assets by the pledgee is traditionally not allowed (it is even a public policy prohibition: see Article 2078 of the French Civil Code and Articles 4 and 10 of Belgian law relating to commercial pledge) since it is viewed as eluding the formal requirement to seek the prior authorization of the competent court before realizing the assets—which is the normal rule—or, as an exception, by appropriating them113 again upon prior judicial authorization. But such formal requirement to obtain prior judicial authorization before any enforcement has been gradually removed in the collateral laws of most countries over the past ten years, so that appropriation as such should no longer be regarded as conflicting with the key features of pledging arrangements, especially in the financial area.

It is again open to member states that did not allow appropriation on the date of the Collateral Directive (June 27, 2002) to refuse to implement in their legislation such an appropriation mechanism for pledge arrangements and accordingly—which is more debatable in our view—not to recognize it when laid down in pledging arrangements governed by another law that would organize such a technique (Article 4.3). This is another opting-out provision introduced for the sake of compromise.

All enforcement techniques (sale, appropriation, and set-off) of pledging arrangements must take place in accordance with the terms of the pledge agreement, without being subject to any other external requirement that would be laid down in national law—such as to give prior notice, to seek prior judicial authorization, to organize a public auction, or to observe a certain time period (Article 4.4)—before realizing the pledged assets in order to be paid on the proceeds (or as a result of the appropriation or set-off). As mentioned above, this simplification of the enforcement proceedings was already introduced in many European and U.S. laws in the past few years, and the objective is now to impose such simplified realization proceedings within the EU, beyond the scope of the Settlement Finality Directive focusing on designated systems and their participants. With the Collateral Directive, the aim is now to encompass all collateral transactions between financial institutions (and even with commercial companies, subject to EU member states’ opting-out) whether or not made through a system.

Protection of Transfer of Title Arrangements (Article 6)

Article 6.1 states very simply that “member states shall ensure that a title transfer financial collateral arrangement can take effect in accordance with its terms,” which means that the validity of a transfer of title for security purposes can no longer be put in question through its recharacterization by a court into a pledge (see Recital 13).

In the 1980s the validity of a repurchase transaction (repo)—a spot sale of securities against cash coupled with the reversed forward sale transaction where the initial buyer, in turn, resells equivalent securities to the initial seller—was challenged in the United States114 because of the economic purposes of such a transaction, which can be regarded as credit in cash secured by way of securities transferred as collateral (one could also see it as a loan of securities secured by cash), while from a legal point of view it is a sale implying a full transfer of ownership of the securities to the buyer, even if it is a transfer of ownership for security purposes. This economic approach is generally the one adopted from a tax and accounting viewpoint that tends to analyze the transaction as a secured credit, the securities remaining accounted as belonging to the seller, who is also the beneficial owner of the income attributed during the life of the repo, unless otherwise agreed. Such an analysis was then used to challenge the legal qualification of (double) sale to recharacterize the repo into a pledge (in view of its economic purpose) generally void or nonenforceable because of nonfulfilment of the formalities required for the creation or the perfection of such pledge.115

The same debate took place almost everywhere in Europe and generated a wave of legislative reforms in order to remove such legal risk of recharacterization and to organize specifically the rights of the nondefaulting party in case of failure of the other party (the right to sell the assets or to purchase equivalent securities, depending on the position of the non-defaulting party; the right to keep the assets as a result of the transfer of ownership; and close-out netting of the reciprocal obligations by set-off).116 Besides a true repo, there are other types of transfer of ownership for security purposes (transfer of title) that face the same kind of legal risks and for which it was necessary to achieve legal certainty.

Article 6.2 deals with the hypothesis of a default of a counterpart (enforcement event) triggering the application of a close-out netting, which is a setting-off of all117 the reciprocal obligations to deliver cash and securities, including assets provided as margins, to mitigate the exposure of the nondefaulting party vis-à-vis the party in default, organized to take place automatically in case of bankruptcy or upon notice. The specific purpose of Article 6.2 is not clear because Article 7 deals more extensively with close-out netting provisions in all collateral arrangements.118

Common Provisions Applicable to Both Pledge and Transfer of Title: Close-out Netting and Insolvency (Article 4, paragraphs 5 and 6; Articles 7 and 8)

Article 7 aims to ensure that close-out netting provisions, stipulated in pledge and transfer of title arrangements, may apply and will remain valid and enforceable notwithstanding the opening of insolvency proceedings, either reorganization or bankruptcy, against one of the parties (Art. 7.1 (a)) or the occurrence of any competition between creditors imposing, in certain jurisdictions, an equality of treatment (pari passu ranking) (Art. 7.1 (b)). Such close-out netting provisions must apply in accordance with their terms without being subject to external requirements such as a prior notice or the need to obtain prior approval from a courts, unless otherwise agreed.

In the same vein, Article 4.5 stipulates the same regime for financial collateral arrangements as a whole, which must take effect in accordance with their terms notwithstanding the opening of insolvency proceedings, either reorganization or bankruptcy, against one of the parties.

Article 4.6 also states that enforcement of rights (including close-out netting) of the collateral taker as organized under Articles 4, 5, 6, and 7 “shall be without prejudice to any requirements under national law to the effect that the realization or valuation of financial collateral and the calculation of the relevant financial obligations must be conducted in a commercially reasonable manner” in order to allow for an ex post control by the court on the manner by which the collateral taker enforced its rights (see Recital 17) and to hold him liable for any abuse in the exercise of such rights. An example of such an abuse would be the sale of the relevant assets at a substantial discount from their market value when it would have been possible, without major damage for the creditor, to proceed to such realization in a different manner.119

Article 8 deals with the neutralization of certain insolvency rules (mainly in a bankruptcy situation because the rules in question are generally not foreseen in reorganization proceedings) to provide collateral arrangements with more legal certainty and predictability. First of all, Article 8.1(a) aims to protect both the collateral agreement and subsequent provision of assets (constituting the pledge or achieving the transfer of ownership in transfer of title) against the rules of some insolvency regimes under which an insolvency decision is deemed to have retroactive legal effects from the first hour of the day of its pronouncement—the zero-hour rule.

As indicated earlier, zero-hour rules result in the insolvent party being deemed to have lost its legal capacity from the first moment of the day on which the insolvency decision was handed down. Therefore the transactions and payments carried out between the first hour of the day of insolvency and the moment when the decision declaring its insolvency was handed down are void or voidable, and at least not enforceable against the receiver. In the United Kingdom, for instance, certain transactions (property dispositions) may be voided if they have been made between the introduction of a winding-up petition and the day when the final winding-up resolution is taken by the general assembly of creditors or shareholders as ratified by the court.120 In the financial area, most countries where such zero-hour rules still apply have enacted special legislation to exclude its application with respect to financial transactions (see also Article 7 of the Settlement Finality Directive), but some uncertainties remain in certain jurisdictions.

It is now laid down in Article 8.1(a) that such zero-hour rules can no longer invalidate the collateral agreement or provision entered into or made on the day of the insolvency but prior to the moment when the insolvency decision being handed down. The same protection is extended by Article 8.2121 to a collateral agreement or provision entered into or made on the day of the insolvency of one party but after the moment of the insolvency decision, provided that the collateral taker can prove that it was not aware, nor should have been aware, of the commencement of such proceedings or measures. A protective rule for parties acting in good faith was adopted in Article 3.1 second alinea122 of the Settlement Finality Directive for payment orders and their settlement in payment and settlement systems.

The second important rule, which has some precedent in the Settlement Finality Directive (Article 3.2)123 aims to exclude the application of preference rules (or, in French law, the “suspect period” rules) in order to avoid collateral agreements or subsequent provisions of collateral being declared invalid or unenforceable just because they would have been entered into or made in a certain period of time (six months, two years, and so on) preceding the insolvency order (Article 8.1.(b)). This type of protection is a major derogation to the normal insolvency regime of all member states where, in order to protect the general creditors against any last-minute attempt to defraud them, certain acts of the debtor are deemed to be fraudulent or detrimental to the general creditors and therefore are void or voidable. Those types of preference rules (applicable by reference to certain acts if carried out during a certain period) will no longer apply to collateral arrangements or provisions. (See Article 8.1: “collateral may not be declared invalid … on the sole basis that….”). But this does not remove fraudulent-conveyances rules or other types of suspect period rules based on fraud (“Fraus pauliana”) that will continue to apply (see Article 8.4) if evidence of fraud is demonstrated. The broad wording of such a provision may well appear to contradict the rules laid down in the previous paragraphs of Article 8, but in order to give some sense to this Article, paragraph 4 should be read as reserving only suspect period rules that do not apply automatically and for which evidence of fraudulent intention is required (see Recital 16).

The same protective regime against zero-hour and preference rules is made applicable to the provision of additional collateral (margins) in order to adapt constantly the contractual value of the collateralized assets to their current market value (marking-to-the-market) that takes place by providing—or delivering back to the collateral provider, if the market value would be higher than the agreed value—additional cash or securities (top-up collateral) (Article 8.3 (a)). The same also applies (Article 8.3.(b)) to substitutions of the initial assets by new ones (which may completely differ from the previous assets transferred as collateral) of substantially the same value (see, for instance, the regime of margins and substitutions in Articles 4 and 8 of the 2000 Global Master Repurchase Agreement).

Article 8.3(ii) specifically protects margin transfers and substitutions against the risk of being qualified as a new pledge created during the suspect period to cover pre-existing claims, which is generally void under certain insolvency legislations. (Transfer of title generally does not give rise to the same issue unless it is first recharacterised into a pledge.) This protection is still subject to a fraud exception according to the interpretation this chapter gives to paragraph 4 of Article 8.

Conflict of Laws (Article 9)

The aim of Article 9 is to determine the law applicable to collateral provided in the form of book-entry securities recorded in securities accounts for the purposes of the lex rei sitae (or lex situs124) rule. The issue of applicable law is particularly crucial, especially when securities are held on account with a financial institution in one country and then held through a chain of intermediaries with a custodian in another country which itself then holds such securities with the central securities depositary system where the underlying securities have been directly issued and are primarily held.125 In that context, one must take into account the type of entitlement that is granted on the basis of the intermediary’s books to reflect such indirect holding of securities though sub-custodians and CSDs. Usually, in cross-border holdings, the securities accounts of the investor with its intermediary recording a deposit of foreign securities will represent not the underlying securities themselves126 but a securities entitlement consisting of interests in the underlying securities127 (or rights in such securities) that may be protected by law to give the investor a co-ownership right in a book-entry pool of fungible securities of the same kind as those recorded in the investor’s account.

Should the law of the country where the underlying securities are issued, or at least where the underlying certificates are ultimately held, be applicable? Or should one apply instead the law of the country where the interest in the book-entry securities held on an account is recorded with an intermediary? As mentioned earlier, Article 9.2 of the Settlement Finality Directive opted for the second solution. This is also the approach chosen in Article 24 of the Directive of 4 April 2001 on the Reorganisation and the Winding-up of Credit Institutions.128 This is also the rule set by the Collateral Directive (Article 9) for book-entry securities collateral (see definition under Article 2.1 (g)) by reference to the law of the country129 in which the relevant account is maintained).

The relevant account is defined under Article 2.1 (h) as “the register or account—which may be maintained by the collateral taker—in which the entries are made by which that book entry securities collateral is provided to the collateral taker,” meaning the account where the assets (securities or rights in the securities) are recorded as being pledged or transferred, which is not so far from what Article 9.2 of the Settlement Finality Directive already stated or implied.

Since Article 9 of the Collateral Directive aimed to mirror the latest draft Convention of the Hague Conference (at the time of the EU council’s works), and since it appeared that the Collateral Directive was likely to be adopted before the finalization of the work on the Hague Convention, the EU Council then decided130 “…to establish the place of the relevant intermediary (PRIMA) principle in the Directive, without going into further details at this stage” with the intention “that, when the Conference has been finalised, Article 9 may have to be reviewed in the light of the outcome of the Convention.”

Conclusions on the Collateral Directive

The Collateral Directive has been an important step forward in the realization of a single, harmonized European financial market since following its implementation it has led a number of member states to improve the legal framework of collateral transactions within the EU as a continuation of the notable progress already made in this field with the Settlement Finality Directive, the Directive on the Reorganisation and Winding-up of Credit Institutions, the Directive on Insurance Undertakings, and the Insolvency Regulation.131 In particular, the Collateral Directive improved the substantive regime132 of pledge and repurchase transactions and removed most of the legal risks and undue constraints on the establishment or the perfection of a pledge, or on its realization, that still existed in some EU jurisdictions.

In addition, the Collateral Directive has introduced some flexibility, especially for the benefit of pledging arrangements, by allowing the collateral taker to use the pledged assets (while protecting at the same time the collateral provider against credit risk on the pledgee) and to appropriate them in case of default, features that had been regarded as specific to transfer-of-title arrangements. By doing so, the Collateral Directive has erased the differences between pledge and transfer of title and the reasons for opting for one technique over the other. One could wonder whether in the long run these two instruments in the financial area will not merge with each other.

That being said, the Collateral Directive may suffer from the political compromise that enabled its rapid adoption by including various options for opting-out that allow some member states not to implement or even not to recognize in their national regime the inclusion of nonfinancial companies or the appropriation regime in pledging arrangements. Such dual regimes will certainly penalize the market players in the jurisdictions that would not implement such rules and also maintain a certain degree of complexity and legal uncertainty in the EU collateral framework, which is neither desirable nor expected as a result of this Directive.

The EU Commission will probably have to help member states coordinate closely in the implementation process to make sure things will evolve in the right direction.133 Consistency in the implementation of the other EU instruments (SFD, WUD, and the Insolvency Regulation) will also have to be taken into account, as well as with other international conventions finalized or under negotiation (the Hague Securities Convention and the draft UNIDROIT Convention on Intermediated Securities).

New Developments Relating to Conflict of Laws and Harmonizations of Securities Legislation Relevant to Payment and Securities Settlement Systems

Since 2002, initiatives have been taken at the international level to enhance legal certainty for transactions on book-entry securities, in terms of applicable law (the finalization of the Hague Securities Convention at end-2002) or with respect to their substantive regime (UNIDROIT and the EU Legal Certainty Project).

The Hague Securities Convention on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary

The Hague Convention on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary (the Securities Convention), adopted in first instance by the 19th diplomatic session of the Hague Conference on Private International Law134 on December, 13 2002, aims to provide greater legal certainty and predictability in cross-border transactions on book-entry securities held through intermediaries.

Unlike the EU instruments discussed above (which refer to the jurisdiction in which the relevant account is held or maintained), the Securities Convention adopts a subjective approach to determine the applicable law by reference namely to the law selected to govern the account agreement (or, if different from the custody law, by reference to the law agreed to govern proprietary aspects relating to book-entry securities) provided that the intermediary in question has an office (e.g., a branch) in the country engaged in securities accounts’ business as defined (see Article 4.1 of the Securities Convention).

Until now there has been a considerable degree of legal uncertainty at the international level as to the national law governing securities credited to an account with an intermediary in a cross-border dimension due to the variety of possible governing laws (law of the issuer, law of the place where the underlying paper certificates in bearer form may be physically deposited or held, law of the register, law of the issuer CSD, law of another intermediary at upper or lower level, etc). This legal uncertainty generates, in turn, legal risks for the securities industry and the investors to the extent that the law governing the book-entry securities will determine the protection offered to the holder in case of insolvency of the intermediary as well as the formalities to comply with to create, perfect, and enforce collateral arrangements on such securities. The application of another law than the one expected by the parties to the custody relationship might indeed jeopardize the ownership rights of the investor or invalidate its collateral transactions if the requirements of such other laws were not fulfilled.

There have been ways to mitigate such legal risks—for example, collection of legal opinions confirming the application of the intermediary’s law under the laws of the country where the underlying securities are deposited and/or under the laws of the collateral provider—but they remain, in a number of countries, still uncertain in case of litigation. At the EU level, some directives have been enacted since 1998135 with provisions helping to eliminate this uncertainty, but these new rules, even though they substantially increase the level of legal certainty, remain limited to the EU without addressing the rest of the world (United States, Japan, Canada, Switzerland, China), nor all the aspects of securities holdings, nor even all market players. This is what the Hague Securities Convention aims to achieve.

This Convention was “technically”136 signed at end-2002 by delegates of 53 states that are members of the Hague Conference, including the United States, the EU member states, Japan, Australia, Argentina, Brazil, China, and the Russian Federation. It was signed jointly by the United States and Switzerland on July 5, 2006,137 and has officially become the [Hague] Convention of 5 July 2006 on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary. It now has to be formally executed by one other government to enter into force. In the EU, the Hague Securities Convention’s adoption should imply amendments to some EU directives already adopted.138 However, a formal signing ceremony by the EU was suspended in 2005 because of the opposition by some circles in the EU.

Certain EU member states (essentially France, Spain, Italy, Sweden, and Poland) and the European Central bank have opposed the Securities Convention, arguing that it could lead to more legal uncertainties due to the greater flexibility offered by the Convention in the determination of the law governing the book-entry securities, by reference to the law agreed to govern the account agreement, instead of focusing on the place “where the account is (in fact) maintained.”

In June 2005 the EU Council requested that the Commission conduct an impact study on the Hague Convention in relation to its scope, its impacts on third parties, securities settlement systems and public policy legislation. There was quite an intense debate about the pros and the cons of the Securities Convention in 2005,139 which might have contributed to the resulting impact study, “Legal assessment of certain aspects of the Hague Securities Convention,”140 which was presented by the EU Commission on July 3, 2006. In a nutshell, the Commission staff recommended that EU member states sign the Securities Convention with an adjustment to the Settlement Finality Directive, to ensure that the freedom given by the Hague Convention to select the law governing the proprietary aspects of book-entry securities will be restricted, for securities systems, to the choice of a single law applicable to the entirety of the securities-accounts part of the relevant system (which seems obvious in our view).141 EU member states will now have to consider the findings of this study and take a position on the signature and the proposed adjustment of the related EU framework.

The EU Legal Certainty Group

In April 2004 the EU Commission promulgated a communication on clearing and settlement,142 as a follow-up to the Giovannini reports,143 listing a number of barriers (including legal and regulatory barriers) in this domain. The Commission suggested a framework directive on clearing and settlement to ensure freedom of services and full right of access to clearing and settlement services providers.144 After a deep analysis of the market and active discussion with market players, the Commission finally concluded there was no need for such a Directive but called for a Code of Conduct which was adopted by securities market infrastructures (stock exchanges, clearing houses and central securities depositaries) on November 2006.145

In parallel, the Commission has set up three advisory working groups:

  • The Advisory and Monitoring Group (CESAME) to review the barriers listed in the Giovannini reports and discuss with the Commission topics of harmonization and definitions of certain concepts, such as CSD, settlement, clearing, core or added-value services;146
  • The Legal Certainty Group (LCG), composed of experts in each EU country but appointed on a personal basis, to identify needs for legal harmonization of substantive securities legislation;147 and
  • The Fiscal Compliance Experts Working Group (FISCO) to focus on the identification of tax barriers such as certain national laws requiring foreign intermediaries carrying out business on a remote basis to still use a domestic intermediary as withholding tax agent.148

In 2006 these working groups produced reports identifying barriers and possible ways to harmonize securities and tax regimes in the EU. It is now up to the Commission to decide whether it will translate all or part of those recommendations into a Community instrument (recommendation, directive, or regulation). In particular, the Legal Certainty Group released a report dated 28 July–11 August 2006,149 which recommended to:

  • Adopt new EU legislation harmonizing the legal effects of book entries made on securities accounts, on topics similar to UNIDROIT works;
  • Defer the harmonization of the rules applying to the moment of transfer of ownership until there is further progress on other EU initiatives relating to corporate actions;
  • Remove legal and regulatory barriers relating to the issuer’s ability to choose the location of its securities, meaning that in some jurisdictions there are mandatory contraints imposed on the issuer to deposit or register its securities in that country with the national CSD, with limits on the ability for foreign intermediaries to serve similar functions.

Complementary to these recommendations, there is a proposal by the EU Commission, dated January 5, 2006, on the exercise of voting rights,150 which presents certain links with the works of the LCG with respect to relations between the intermediaries and their clients and the issuer, particularly in intermediated holding patterns. Article 13 of this proposal states that an omnibus account should be possible in all member states without the need to segregate securities in the name of a particular beneficial owner to exercise voting rights and have access to the general meeting.

Such reforms would constitute a major improvement in the EU because a number of countries (Greece, Spain, and Portugal, for example) do not currently recognize the concept of nominee holdings through an omnibus account (which could prohibit the voting through nominee), or they prevent or penalize the holding of securities in fungible form, continuing to treat the intermediary as sole shareholder for the total position recorded on the omnibus account. Others countries, such as Sweden and Denmark, require segregation for voting purposes.

Harmonization of Market Practices and of Related Legislation and Regulation

Along with these EU initiatives, market players and infrastructure members are also conducting reviews of securities practices (ESCDA, Euroclear, for example) and have offered some harmonization proposals.151 On the legal side, discussion is focused on barriers relating to nominee holdings, requirements for local presence, direct access to CSDs, treatment of market claims, and harmonization of record date (date of entitlement to dividends and right to vote when securities are transferred).

The need for legal harmonization can also be found in the differences in the transfer of ownership on securities. Legal transfer of ownership may be treated as taking place on the trade date (which was the case until March 2005 in France for stock exchange transactions), while other types of transactions may entail transfer of ownership only on settlement date in the relevant CSD. The latter is the common rule in most EU countries.152 This variety of regimes has a substantial cost for market claims and tax processing, as every difference results in a different procedure. This could also generate legal risks to the extent that insolvency of a counterparty occurring between transfer of ownership on trade date according to home stock exchange rules and settlement date in a foreign settlement system where the settlement of the same transaction actually takes place, may lead to questions about ownership rights.

The UNIDROIT Draft Convention on Intermediated Securities

In 2002–2003, UNIDROIT undertook a project to create an international convention to harmonize the substantive regime applicable to intermediated book-entry securities. On the basis of a draft convention prepared by an ad-hoc working group, in April 2005 UNIDROIT convened an international conference in Rome to discuss a first draft.153 After interim meetings on specific topics convened in Bern, Sao Paulo, and Paris, the plenary UNIDROIT conference met in March 2006, November and May 2007 and produced a revised draft convention.154 A diplomatic conference should finalise the Convention in the course of September 2008 in Geneva.

Similar to the Commission’s communication of April 2004 and its Legal Certainty Project, UNIDROIT is seeking to further enhance legal certainty in intermediated holdings of securities by addressing the following issues:

  • Legal protection of account holders enforceable in case of insolvency of the relevant intermediary;
  • Determination of the rights of the account holder with respect to the securities credited to its account, in particular vis-à-vis the issuer in terms of economic (cash payments, redemption) and noneconomic rights (voting rights), including the recognition of nominee-pooled holding of securities;
  • Protection against misappropriation;
  • Protection against upper-tier attachment proceedings at the level of the intermediaries of the relevant intermediary;
  • Protection of good-faith purchasers/transferees;
  • The introduction of a specific regime for Collateral transactions (see Chapter VII of the draft Convention). This part has been designed as a model law to be used especially by emerging markets.

At the EU level, the adoption of the UNIDROIT convention would require a correction of possible inconsistencies in the various EU legal instruments adopted on book-entry securities matters. The EU Commission will, however, be negotiating on behalf of the Community on points of “acquit communautaire”—matters already covered by EU legislation, in particular the Directives on Settlement Finality and Collateral arrangements.

It is fair to note that on a worldwide basis, only a few jurisdictions today offer an adequate legal framework for holding and transferring book-entry securities in a cross-border environment. For example, most jurisdictions may provide investors with a sound ownership regime on domestic securities held directly with the domestic CSD or with domestic intermediaries. But only a few legal regimes have enacted specific rules for holding and pledging, under domestic law, securities primarily issued and deposited abroad through an account of the relevant intermediary with the foreign issuer’s CSD or with a local custodian.155

The current UNIDROIT draft convention also defines the duties of the intermediary towards the account holder (entries to the account, reversals, finality, securities shortfalls, loss sharing) in a way that sometimes overlaps with current regulatory regimes in place at the international or national level.

Regulatory Developments Relevant for Clearing and Settlement Activities

In November 2001 the Committee on Payment and Settlement Systems (CPSS) of the central banks of the Group of Ten countries and the Technical Committee of the International Organisation of Securities Commissions (IOSCO) published a set of standards, the “Recommendations for Securities Settlement Systems.”156 The objective of the 19 CPSS-IOSCO recommendations is to contribute to financial stability by strengthening the securities settlement systems (SSS) that are an increasingly important component of the global financial infrastructure. The CPSS-IOSCO also developed an assessment methodology157 for the recommendations, which aimed to provide a clear and comprehensive methodology for the assessments made on the basis of the recommendations.

In November 2004 the CPSS and IOSCO published their “Recommendations (15) for Central Counterparties” (CCP/clearing institutions), following the same design of those applicable to securities systems with the adaptations required for the activity of a CCP that uses netting by novation to interface traders and manages its credit risk through margin requirements and marking-to-market procedures.

Depending on the locale, there are two or three types of regulatory standards applicable to a clearing or settlement system:

  • The oversight standards aiming at regulating securities systems to avoid systemic risk. This is the subject of the above-mentioned CPSS-IOSCO recommendations adopted at the G-10 level in 2001 and 2004 and of the new 19 ESCB-CESR Standards adopted at EU level in October 2004 (based on CPSS-IOSCO recommendations with EU adaptations), which are currently on hold because of divergences of views between regulators concerning the so-called functional approach.
  • In the Eurozone, the nine ECB/EMI users standards adopted in 1998 for the use of securities systems in ESCB monetary policy operations. They should be reviewed soon.
  • National regulatory standards, where applicable.

Such standards aim at establishing best practices for clearing and settlement operators with respect to legal soundness, clearing or settlement efficiency and transparency, risk management (including credit risks where relevant), cash operations, finality, operational reliability, corporate governance, participation/access, and links with other systems.

The oversight standards are not law and are generally not directly binding on securities systems. They are adopted by the community of regulators (central banks as overseers,158 and securities/CSDs supervisors) at G-10 or at EU level as the basic common rules to carry out their supervisory functions, without prejudice to any additional national regulatory standards that may exist.

The sanctions attached to the noncompliance with such standards (or with the resulting recommendations made by competent regulators to achieve compliance) are generally of an indirect nature:

  • Regulators may make noncompliance public,159 which will obviously affect the image of the system vis-à-vis the clients, foreign regulators, and others.
  • Foreign regulators may also invoke the system’s noncompliance with international standards to infer negative consequences for the approval of certain projects for which compliance with international standards is required.
  • Under domestic legislation, specific sanctions (such as fines) may be foreseen if a system does not comply with the applicable standards.

There is a risk that such co-existence or superposition of different sets of regulatory rules with sanctions could be perceived by the market infrastructures and their clients as a source of confusion and uncertainty in the regulatory treatment of their activities. Such a perception will not improve if the current text of the UNIDROIT Convention (which also contains provisions of a regulatory nature) is adopted as it stands. If proposed, an EU directive on clearing and settlement should probably also contain provisions that will translate all or part of the ESCB-CESR standards adopted in 2004 and which are currently on hold.

Note: This paper is based on several studies published by the author, in particular, “Collateral transactions in Payment and Securities Settlement Systems: the EU framework” in Revue de Droit bancaire et financier 2002, p. 10–27; “The Directive 2002/47/EC on Financial Collateral Arrangements of 6 June 2002” in “Mélanges en hommage à Jean-Victor Louis” (Tribute to Professor Louis), Vol. II (Bruxelles: Editions de l’Université de Bruxelles, 2003) with relevant updates where appropriate. The opinions expressed are strictly the author’s own.
1See Banque & Droit, April 1996, a special issue devoted to the insolvency of BCCI.
2For convenience, the term “insolvency” will be used. However, other proceedings based on a debtor’s insolvency, or, more generally, on an agreement or moratorium between creditors, such as, in particular, judicial or amicable composition, voluntary winding-up, attachment proceedings, etc., must also be considered.
3See Directive 93/22/EEC of 10 May 1993 on securities investment services, Official Journal of the European Union [hereinafter Official Journal], L141, 11 June 1993, at 27.
4Or, if one prefers, the private international law (conflict of laws) rules of each State; on cross-border insolvency, see in particular M. Giovanoli and G. Heinrich, ed., International Bank Insolvencies : A Central Bank Perspective (Kluwer Law International, 1999).
5Official Journal L166 of 11 June 1998, p. 45 and following.
6Regarding these principles, see under Belgian law esp. Rigaux, Droit international privé, II (Bruxelles : Larcier, 1993) n° 1102 to 1104; N. Watté, “La faillite internationale…,” note under Cass. 12 January 1990, RCJB 1993, at 454 and following, particularly page 457 n° 8; M. Delierneux, “Les succursales face à la faillite” in Les succursales bancaires(AEDBF Belgium 1996), at 214 discussing the respective merits of the various existing solutions.
7Subject, of course, to the recognition by these states of the insolvency decision and its effects on their territory, pursuant to the rules of private international law of the relevant court.
8Without, for example, formalities of exequatur (judicial recognition of foreign judgements).
9International public policy has a variable content, determined most often by jurisprudence, by reference to the “essential interests of the State or of the collectivity” or to the “legal bases on which the economic or moral order of the State relies,” to take the Belgian example (Cass. 25 March 1968, Pas. I, 885).
10To the extent this recognition would likely affect the payment or settlement systems, with adverse consequences for other participants, so as to result in the possibility of systemic risk. The argument of international public policy, however, has never, to the best of the writer’s knowledge, been invoked or upheld in case law in such a context. This legal argument may be regarded as underpinning, in the writer’s opinion, Article 8 of the Settlement Finality Directive.
11One may also think about the nonenforceability of payment orders concerning the defaulting participant on the day of its insolvency, either for payments made before the insolvency (zero-hour rule) or for those made between the time of the insolvency and the settlement of transactions of the insolvent participant.
12In this sense in Belgium, see Comm. Brussels 20 June 1975, J.T. 1975, at 641, which refers to the status of international public policy of the principles of unity and universality of insolvency; however this has been criticised by Rigaux, Droit international privé (Bruxelles, 1968), II, no. 1103–end.
13“Concordat,” moratorium, “redressement judiciaire,” receivership, suspension of payments, etc.
14As there are more and more securities that are essentially dematerialized, that is, represented exclusively from the outset by book-entries, one may consider (although hardly considered by legal doctrine so far) that the place of location of these securities is the place where the accounts, recording the relevant rights, in such securities, are held and operated; see in this sense Article 9.2. of the Settlement Finality Directive; see also the Convention of 5 July 2006 adopted by the Hague Conference on Private International Law on the Law Applicable to Certain Rights in respect of Securities held with an Intermediary (see R. Potok, “The Hague Conference on Private International Law …,” Journal of International Banking and Financial Law (April 2001), at 166; R. Potok and C. Bernasconi, “PRIMA Convention brings certainty to cross-border deals,” International Financial Law Review (January 2003), at 11.
15The Insolvency Convention was signed by all member states except the United Kingdom, Ireland, and the Netherlands. Ireland and the Netherlands signed after the explanatory report of the Insolvency Convention was finalized. The United Kingdom, however, did not sign the Convention due to a conflict with other member states over the so-called “mad cow” crisis. Under the Convention, the deadline for signature expired on May 23, 1996.
16Official Journal, L 160 of 30.06.2000, at 1–13.
17Recitals have been added in order to give some limited explanations, replacing, in a limited way, the draft explanatory report of the Insolvency Convention.
18This is the application, first of all, of the principle of unity of insolvency.
19The other paragraphs of Article 5 define rights in rem with reference to the attributes generally attached to these rights: right of realization (pledge, mortgage), right to recover a claim assigned for security purposes, right of recovery, right to receive income (“fructus”), etc.
20Version of 8 July 1996, doc 6500/1/96, commentary on Article 5 under paragraphs 94 et seq., pages 70 et seq.
21Article 6.2 preserves the right of the receiver or liquidator to commence actions for avoidance of transactions because of actual fraud to rights of the creditors or because of rules based on a “suspect period” (“preferences” or “fraudulent conveyances”).
22According to the explanatory report, no. 110, at 77.
23As is the case under the law of certain member states (France, Belgium, Luxembourg), apart from notable exceptions (particularly concerning connected claims or for claims between financial institutions, for example).
24On the reasons of selection of the law applicable to the insolvent’s claim, see Report, no. 108, at 76.
25The report explicitly confirms this interpretation. See no. 110, at 76.
26As for the two other dispositions, paragraph 2 reserves the actions for fraudulent or prejudicial acts to the creditors but, contrary to Articles 5 and 6, Article 9.2 states that these actions will be governed not by the law of the (main) insolvency proceedings, but by the law applicable to the system or market concerned.
27The notion of “financial market” is defined by the Report (no. 120, at 82) and is similar to the one used in the Directive on Investment Services.
28In principle, this law will be the law of the member state where the operator of the system is situated, which will, moreover, be generally stipulated contractually as lex contractus.
29See also the Explanatory Report, no. 124, at 82.
30Official Journal, L 125 of 5.5.2001, at 15
31Official Journal, C 36 of 8.2.1988, at 1.
32Directive 77/780/EEC of 12 December 1977 (Official Journal, L 322 of 17.12.1977, at 30) as modified by the Second Directive 89/646/EEC of 15 December 1989 (Official Journal, L 386 of 30.12.1989, at 1).
33Directive 94/19/EC of 30 May 1994 (Official Journal, L 135 of 31.5.1994, at 5.
34It was rumored that the work on the draft Directive had then been placed on hold due to a dispute between the United Kingdom and Spain concerning the application of this Directive to Gibraltar.
35See Articles 5–15 of the Insolvency Regulation concerning exceptions to the application of the law of the main insolvency proceedings.
36Article 25.
37Article 26.
38Subject, for repurchase transactions, to the enforceability against third parties of the transfer of ownership as determined by the law of the country where the relevant securities are transferred (this is the meaning of “without prejudice to Article 24”—referring to the lex rei sitae rule with respect to book-entry securities—introduced in Article 26).
39Article 24 (lex rei sitae). Compare with Article 9.2 of the Settlement Finality Directive or the rule proposed in the Hague Convention (see hereafter).
40Article 27, again subject to lex rei sitae as laid down in Article 24.
41Compare with Article 9.1 of the Finality Directive, which has also adopted such a rule of exoneration.
42Official Journal, L 166 of 11 June 1998, at 145; the initial proposition concerning “the finality of settlement and guarantees” was presented by the European Commission on May 30, 1996 (Official Journal C 259 of 18 July 1996, at 13) and later amended, following the first opinion of the European Parliament (JO C 259 of 26 August 1997, at 6); on the Directive, see D. Devos, Euredia: European Banking & Financial Law Journal 2 (1999), at 149–85; J. Richards and M. Evans, “The Settlement Finality Directive—The End or the Beginning of the Story,” Travers Smith Braitwaite, 16th Annual Seminar on International Financial Law, International Bar Association, (May 21, 1999); M. Vereecken, “Reducing systemic risk in payment and securities settlement systems,” 6 Journal of Financial Regulation and Compliance (May 1998), at 107 et seq.; P. Bloch, “The Directive 98/26/CEE concerning the finality of settlement in the payment and securities settlement systems,” Banking and Financial Law (Mélanges AEDBF-France), II (1999), which undertakes a comparative analysis of the Settlement Finality Directive and French law on the subject.
43For background on the work of this group of experts, see my study on “The European Directive 97/5 of 27 January 1997 Concerning Cross-border Credit Transfers,” Revue Banque (1998), at 43 et seq., particularly note 7 at 47.
44See Recitals 1, 2 and 4 of the Settlement Finality Directive.
45That is, the risk that the insolvency of a participant in a payment or settlement system, or a financial market, might in turn cause the insolvency of other participants.
46Target is a connection of national payment systems operating a real-time settlement of gross amounts, without netting. On the Target system, see J. Lachand, “The Target System,” Bulletin de la Banque de France (June 1995), at 97 et seq.
47A net payment system in euros managed by an inter-banking association named “Eurobanking.”
48Not including a settlement agent, clearing house, or any other intermediary party of this type.
49The Settlement Finality Directive adds: “without prejudice to other more stringent conditions of general application laid down by national law” on the meaning of these terms, see hereafter in the main text.
50See also Article 10.3 indicating that member states may impose supervision or authorization requirements on systems. See in this respect the regulatory standards applicable to securities settlement systems laid down in the “Recommendations for Securities Settlement Systems” of November 2001 adopted by the Committee on Payment and Settlement Systems (CPSS) together with the Technical Committee of the International Organisation of Securities Commissions (IOSCO).
51Article 2(a), final paragraph.
52That is, a credit institution or another financial institution that processes its cash or securities orders by the intermediary of a direct participant, being the member of the system in which these orders are settled.
53Directive 77/780/EEC of 12 December 1977, Official Journal, L 322 of 17 December 1977, at 30. Article 1.1.
54Directive 93/22/EEC of 10 May 1993, Official Journal, L 141 of 11 June 1993, at 27, point 2 of Article 1.
55It is fairly bizarrely stated, in the second indent under Article 2(a), that “participants may only choose the law of a member state in which at least one of them has its head office.”
56Translated as “compensation” in the French version of the Directive.
57On the legal aspects of “netting,” see P. R. Wood, Principles of Netting : A Comparative Law Study (Amsterdam : Nederlands Instituut voor het Bank–en Effectenbedrijf, 1994); see also my study on the matter with regard to Belgian law in Revue Banque (1994), at 162 et seq.
58On this point, see comments below on Article 6 of the Directive.
59To the exclusion of the transfer orders, not covered under the terms of this paragraph.
60For example, a current account opened at the central bank or with the system’s operator.
61For example, based on the revocability of the agency/mandate.
62In reality, all the provisions of the Directive particularly deal with the incidence of insolvency proceedings opened against a participant, as shown also by Articles 3, 4, and 9, even if the bankruptcy or insolvency in general is not the only relevant possibility.
63There is a discrepancy here between the English text of the Directive (the original text) simply referring to “other member states” and the French text pointing more specifically to the “other member states concerned.” The idea here was in fact to require the national authority of countries where the insolvency is opened to notify all the other member states of this news, without the national authority being required to assess which member states are “concerned” and therefore should receive notification.
64One points out, however, that it does not cover the fate of payments made after the moment of opening of insolvency proceedings, but in the ignorance of the latter, except to apply Article 3.1, paragraph two, to them.
65The well-known issue of undue payments or payments erroneously transferred to a wrong beneficiary.
66The well-known issue of fraudulent payments made particularly in infringement of the rules concerning a “suspect period” or immediately prior to the day of insolvency.
67See the words “for example” contained in Recital 13.
68On the legal protection offered to collateral by the Euroclear system already before the implementation of the Directive, see L. De Ghenghi and B. Servaes “Collateral held in the Euroclear System: a Legal Overview,” Journal of International Banking and Financial Law (March 1999), at 83; see also Diego Devos, “Protection juridique des systèmes de paiement et de règlement-titres en Belgique,” Revue Banque (2000), at 313–326.
69This expression more generally aims at covering any other type of security interest legally recognized in a member state, such as, for example, statutory liens on specific assets or transfers of ownership for security purposes (transfer of title) (see in this sense, Recital 9).
70As mentioned earlier in the text, this is also the solution finally adopted in the directives on reorganisation and winding-up of credit institutions and insurance undertakings.
71Contrary to collateral security in favor of a participant that must be provided “in connection with a system” by another participant, becoming insolvent (first section of Article 9.1). One will note that Article 2(m) of the Directive, concerning the definition of collateral security, also refers to the security of “rights and obligations potentially arising in connection with a system” without any further explanation. What is surely being intended here is, first, to catch collateral security provided in favor of the system operator, but also all collateral security provided “in connection with a system” (see Article 9.1 and 9.2) “in favor of a participant,” whoever that participant may be. Article 9 applies therefore to collateral security provided in a system, to participants in that system. We consider in this respect that the EU Commission’s Explanatory Memorandum of the initial draft Collateral Directive, to the extent it seems to imply that the Settlement Finality Directive, as well as the other EU legal acts described above, would not apply to collateral between participants (section 1.2, second and fifth paragraphs) but only to central banks and operators of systems, is incorrect.
72This is the daily management of securities held with international central securities depositaries systems such as Euroclear or Clearstream. One may also think of the case of links between national central securities depositaries; on Article 9.2, see Richard Potok, “Legal certainty for securities held as collateral,” International Financial Law Review (December 1999), at 12; see also “The Oxford Colloquium on Collateral and Conflict of laws,” held at St John’s College, Oxford University, Journal of International Banking and Financial Law (September 1998).
73See in particular Randall D. Guynn, “Modernising Securities Ownership, Transfer and Pledging Laws,” published in 1996 by the Capital Markets Forum (Section on Business Law of the International Bar Association); for further details on this problem, see also the Explanatory Memorandum of Belgian law of 28 April 1999 implementing the Directive, Doc. Chambre, session 1998–1999, no. 1999/1, at 23 and 24.
74See the preparatory report of the Hague Convention prepared by Christophe Bernasconi, First Secretary at the Hague Conference’s Permanent Bureau, available on the website of the Hague Conference at; see R. Potok, “The Hague Conference…” Journal of International Banking and Financial Law (2001), at 166, particularly see footnote 15.
75See in this respect, Article 8.2 of the Belgian Act dated 28 April 1999 implementing the Finality Directive in Belgium (Moniteur Belge, 1 June 1999, 19563); see my study on this Belgian law in Revue Banque (2000), at 313.
77See, however, Recital 21 of the Directive, which seems to reserve, in fairly sibylline terms, the application of the law of the member state where the securities are issued or in which they are originally located as regards the basic regime applicable to these securities.
78Which is the jurisdiction where the intermediary holding the relevant account is located.
79EU Commission: “Working document on Collateral from the Commission to relevant bodies for consultation,” C4/PN D (2000).
80International Swaps and Derivatives Association, Inc.
81This chapter use hereafter the term collateral to cover the type of transaction (pledge, repo, transfer of title, margins, etc) rather than the assets subject to the security arrangement, unless otherwise required by the commented provision.
82See EU Directive 96/10/EC of 21 March 1996 amending Directive 89/647/EEC as regards recognition of contractual netting by the competent authorities, Official Journal, L 85, of 3.4.1996, at 17, in particular the revised Annex II, Article 3 (b), (ii) and (iii).
83The underlying securities related to the book-entry collateral transaction may also be held/located in other countries (where they have been initially issued and deposited) via sub-custodians (home CSD, local depositaries), which is common practice in cross-border securities business.
84Perfection is broadly equivalent to the French concept “opposabilité aux tiers.”
85See Richard Obank, “Outlining Insolvency Practice in Europe,” Journal of International Banking and Financial Law (1999), at 437 ; P. Wood, Principles of Interantional Insolvency (London: Sweet & Maxwell, 1995), sections 5–17, p.94; see also section 13–1.
86On this distinction, see Joanna Benjamin, The Law of Global Custody (London : Butterworths, 1996), chapters 6 and 7, at 49 et seq.; see also Richard Potok, Cross-Border Collateral: Legal Risks and the Conflict of Laws (London: Butterworths, 2002). All the various national reports in Potok’s book are based on the same collateral fact pattern (covering both a pledge and transfer of title arrangement).
87See also D. Devos, “La directive européenne 98/26/CE concernant le caractère définitif du règlement dans les systèmes de paiement et de règlement des opérations sur titres,” Euredia (1999), at 149 et seq; D. Devos, “Collateral Transactions in Payment and Securities Settlement Systems: The EU Framework,” Revue de Droit bancaire et financier (2002), at 10–27; Devos, “The European Directive of 19 May 1998 on Settlement Finality in Payment and Securities Settlement Systems” in Ferrarini and Hopt, ed., Capital Markets in the Age of the Euro (New York: Kluwer Law International, 2002), 361–388.
88Official Journal L 166, 11.6.1998, at 45.
89Official Journal, L 125, of 5.5.2001, at 15; on the WUD, see in particular Jean-Pierre Deguée, “La directive 2001/24/CE sur l’assainissement et la liquidation des établissements de crédit: une solution aux défaillances bancaires internationales?” Euredia (2002), at 241.
90Official Journal, L 110, of 20.4.2001, at 28.
91Official Journal, L 160, of 30.6.2000, at 1. This regulation entered into force on May 31, 2002.
92The so-called Lamfalussy Report, “Report of the Committee on Interbank Netting Schemes of the Central Banks of the Group of Ten Countries” (BIS, November 1990); Committee on Payment and Settlement Systems “Cross-border Securities Settlements” (BIS, 1995); “Standards on the use of securities settlement systems for the purposes of ESCB monetary policy transactions” (EMI, 1998), etc. On this influence of international standards set by regulatory bodies, see Mario Giovanoli, “A new architecture for the global financial market: legal aspects of international financial standard setting,” in M. Giovanoli, ed., International Monetary Law, Issues for the new millennium (Oxford: Oxford University Press) at 3 et seq.
93See the various position papers produced by members of the Forum Group attached to the Working Document on Collateral (containing a first draft directive prepared by the Commission on the basis of the draft made by the Forum group) circulated to members states and to market participants in the course of a consultation organized on June 15, 2000. See also attached to this consultation the converging report prepared by a special working group (with market lawyers) established by the ECB.
94Official Journal, C 180 E, 26.6.2001, at 312 with an explanatory memorandum. This memorandum contained, however, several statements concerning the interpretation of the 1998 Settlement Finality Directive (second and third paragraphs of section 1.2) to which we can not subscribe since it contradicted this last Directive itself by giving a narrow scope of application that was not favored by the services of the Commission themselves (on this discussion, see “Collateral Transactions,” Revue de droit bancaire et financier (2002), at 26 , footnote 73).
95Official Journal L 168, 27.6.2002, at 43.
96See also Spyros Economou, “La proposition de directive européenne sur les contrats de garantie financière,” Bulletin Joly Bourse (2002), chron., 1; Clifford Chance, Securities Newsletter May/June 2002; Dermot Turing, “The EU Collateral Directive,” Journal of International Banking and Financial Law (2002), at 187 G. Morton, “Modernization of EU financial law : the directive on financial collateral arrangements,” 1 Euredia (2003), at 11; H. Seeldrayers “De Europese Richtlijn inzake zekerheidsovereenkomsten—Krachtlijnen en artikelsgewijze commentaar” T. Fin.R., 2003–1, at 337 and 2003–2, at 420; F. T’Kint and W. Derjcke, “La directive 2002/47/CE concernant les contrats de garantie financière au regard des principes généraux du droit des sûretés,” 1 Euredia (2003), at 41; H. De Vauplane and J.-J. Daigre, “Chronique financière et boursière” Banque & Droit,.(mai-juin 2003), at 30, spéc. p. 38; W. Bossu, “De Richtlijn betreffende financiëlezekerheidsovereenkomsten: inhoudelijke analyse” in M. Tison (ed.), Sûretés bancaires et financiers—Bancaire en financiële zekerheden, Série: Cahiers AEDBF/EVBFR-Belgium no. 15, (Bruxelles: Bruylant, 2004), at 227.
97See, for example, Recital 14.
98See Article 2.1(n) on the definition of “close-out netting provision” that is inspired by Section 10 of the 1995 GMRA (Global Master Repurchase Agreement) on repo transactions elaborated by ISMA (compare with the same provision in the 2000 version of the same GMRA); on the PSA/ISMA GMRA, see G. Morton, “Cross-Border Securities (Repo, Lending and Collateralisation),” Tyson-Quah, ed., FT Law & Tax, at 31.
99See, however, the remarkable study of JP Deguée, already quoted above (footnote 98), which contains elements of comparative law on collateral-related matters.
100Excluding therefore a security interest that is only created by operation of law, such as statutory liens that are also used in some jurisdictions as collateral technique by financial institutions and operators of payment and settlement systems.
101On this type of collateral, see D. Devos “Protection juridique des systèmes de paiement et de règlement-titres en Belgique,” in Revue Banque (2000), at 318 and 319, n° 12; see also my study on « Les effets externes des conventions en matière financière » in Les contrats et les tiers (Ed. ABJE, Jeune Barreau de Bruxelles, Vlaams Pleitgenootschap bij de Balie te Brussel, 1995), at 213 n° 18.
102One will find the same expression, aiming at encompassing explicitly the same type of securities entitlements, in Article 9.2 of the Settlement Finality Directive (“rights in securities”), in Article 24 of the WUD (“other rights in such instruments”) and in the Hague Convention on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary (Article 1.1 “any interest therein,” and “rights…. resulting from a credit of securities to a securities account” see also the notion of “interest in securities” in Article 2.1(d), (e), (f.). On this last expression, see Johanna Benjamin, Interests in securities (Oxford University Press, 2000) n° 1.05, 2.21 et seq.; J. Benjamin, “Conflicts of Law and Interests in Securities,” in “Cross-Border Securities (Repo, Lending and Collateralisation)” by K. Tyson-Quah, F.T Law & Tax (1997), n° 2.3 et seq., and at 16; in the context of Belgian Royal Decree n° 62 of 1967 relating to book-entry circulation of securities, governing the rights of participants in the Euroclear system, see L. De Ghenghi and B. Servaes “Collateral held in the Euroclear System: a legal overview,” Journal of International Banking and Financial Law (March 1999), at 85–87; Bart Servaes, “Het immobiliseren van effecten: Het Belgisch juridisch kader,” in “Nieuw vennootschap-en financieel recht 1999” (Jan Ronse Instituut-KU Leuven), at 513. See also our commentary of Article 9, above.
103One will note that some EU countries have implemented the Collateral Directive beyond its terms (based on the analysis that the Directive was setting up minimal harmonization rules) by applying the new collateral regime even to natural (physical) persons. See, for example, the Belgian Act dated 15 December 2004 relating to financial collateral; on this new law, see, e.g., J.P. Deguée and D. Devos “La loi relative aux sûretés financières du 15 décembre 2004—Lignes directrices,” Revue de Droit bancaire et financier (2005), at 155–163 and the following studies in the same publication.
104This Recital 10 specifies that acts that are required for the transfer or the creation of a security interest on physical securities not held in book-entry form, like endorsement for security purposes of instruments to order (bills of exchange, etc) or registration of a pledge directly on registered securities in the issuer’ books, should not be regarded as such formal acts.
105One will find several times in these two provisions the requirement that arrangements and provision of the collateral must be evidenced in writing, duplication that appears more as a “credo” inserted to ease adoption process but this does not really seem justified from a legislative point of view.
106We should, however, point out that it is agreed, even in French law jurisdictions, that with the consent of the pledgor, a pledgee may of course validly use the pledged assets (De Page, Traité de droit civil, VI, n° 1088-B in fine); to compare with the situation under English Law, see J. Benjamin, Interests in Securities: a proprietary law analysis of the international securities markets (Oxford: Oxford University Press, 2000), n° 5.46 et seq., also promoting the reform of English law’s equitable rules traditionally restricting rehypothecation of collateral.
107Reasons may be linked, e.g., to considerations of tax, accounting, capital adequacy, risks management, and legal risk; see Dermot Turing, 5 Journal of International Banking and Financial Law (2002), at 188.
108The term “collateral” here is used to refer to the assets and not to the legal form of the arrangement.
109The two last paragraphs are common to both pledge and transfer of title arrangements and will be addressed in the following section of this paper.
110“Enforcement event” means an event of default or any similar event as agreed between the parties on the occurrence of which, under the terms of a financial collateral arrangement or by operation of law (as it is organized, for example, in German law for transfer of title), the collateral taker is entitled to realize or appropriate financial collateral or a close-out netting provision comes into effect (Article 2.1 (l)).
111Appropriation is only possible if contractually foreseen, including with respect to the valuation of the assets (Article 4.2).
112See Fabrice Leduc, “Le gage translatif de propriété: mythe ou réalité,” RTD civ. 1995, at 307, where the author concludes that pledge under French law cannot lead to a transfer of ownership on the pledged assets in favor of the pledgee.
113On this issue, see our above-mentioned study on the Belgian regime protecting payment and settlement systems, Revue Banque (2000), at 318 and 319, with the references quoted in the footnotes.
114See M. Stigum, The Repo and Reverse Market (Dow Jones-Irwin, 1989), especially chapter 19 (by L. Stremba), at 333; on French law, see. Luvel-Jurgensen et Guéranger, “Le réméré, la pension et le prêt de titres,” Banque, 1992, at 144 and 246; P. de Lapasse, “Le nouveau régime juridique des opérations de pension,” Bulletin, Banque de France, no. 7 (July 1994), at 67; A. Perrot, “Pension de titres et transfert de propriété,” Revue de droit bancaire (1994), at 252.
115On this issue, see J. Benjamin, “Recharacterisation risk and conflict of laws,” Journal of International Banking and Financial Law (1997), at 513 and its updated version in the Oxford Colloquium on Collateral and Conflict of Laws (same review, special supplement, 1998, at 29); Fentiman, “Cross-border securities collateral; Redefining recharacterisation risk,” Oxford Colloquium, 1998, at 38.
116On this issue, see our above-mentioned study, supra note 62, Revue de la Banque (2000), at 318–319.
117By encompassing all the reciprocal exposures and claims, such close-out netting provisions aim at reducing the total credit risk on the failed counterpart to the minimal net amount, avoiding cherry-picking from the liquidator of the insolvent counterpart, that is, the selection of the favorable contracts from a general creditor’s viewpoint (those in which the noninsolvent party is debtor—which are maintained and for which performance is sought—to repudiate the others, unfavorable to the insolvent party and its creditors, for which the counterpart in such last contracts would only then have an unsecured claim to lodge in the insolvency proceedings. By setting-off in case of insolvency all the contracts (that are interrelated in practice, like swaps and/or repos and/or loans) without distinction, one avoids such unbalanced treatment. On netting, see P.R Wood, English and International Set-off (London: Sweet & Maxwell, 1989); same author, “Principles of Netting: A Comparative Law Study,” NIBE-Bank Juridische reeks, no. 20 (1994); see also my study “Le netting en droit belge,” Revue Banque 1994, at 162.
118In addition, in a repo at least, not only the collateral taker but also the collateral provider may fail to transfer the due assets. Both failures should trigger a close-out mechanism, but this is probably the intended meaning in Article 6.2 by referring only to the collateral taker since both parties have in fact the capacity of collateral taker, each for the assets transferred to him.
119For an example, see Belgian Act of 2 January 1991 on public debt instruments, specifically Article 8 organizing simplified realization proceedings for pledge of dematerialized securities with the comments made in the Explanatory Memorandum of this provision as amended in 1996, Doc. Chambre, Session (1995–1996), 501/1, at 7–8.
120See Mark Evans, “Recent and prospective developments in settlement, part 2,” Journal of International Banking and Financial Law (1999), at 425, about the zero-hour rules in the UK before the implementation of the Settlement Finality Directive and its impact on collateral provided in systems like Crest; on the impact of the new Insolvency Act 2000 concerning small companies on this UK insolvency regime, see M. French and H. Staniland, “The Insolvency Act 2000,” Journal of International Banking and Financial Law (2001), at 174.
121The French translation of Article 8.2 (in fact, of the whole Directive (see also, e.g., Recitals 8 and 9, Articles 2.2 and 9.2)) could be improved (“… à la date….mais après l’ouverture…”).
122See also in that sense Article 157.2 of Belgian Banking Law of 22 March 1993 on zero-hour rules and close-out netting.
123“No law, regulation or practice on the setting aside of contracts and transactions concluded before the moment of the opening of insolvency proceedings, … shall lead to the unwinding of a netting.”
124See also Christoph Keller, “Die EG-Richtlinie 98/26 vom 19.5.1998 über die Wirksamkeit von Abrechnungen in Zahlungs-sowie Wertpapierliefer-und-abrechnungssytemen und ihre Umsetzung in Deutschland,” 26 Zeitschrift für Wirtschafts-und Bankrecht (2000), at 1269 et seq., proposing the concept of lex conto sitae (even though we do not share the restrictive view suggested by the author for the application of Article 9.2 of the Settlement Finality Directive; see p. 1274).
125This is the daily management of securities held with international central securities depositaries systems such as Euroclear or Clearstream. Global custodians and certain other custodians are also acting through the same holding pattern. One may also think of the case of links between national central securities depositaries; see R. Guynn and N. Marchand, “Transfer of pledge of securities held through depositories,” in The Law of Cross-border Securities Transactions, (Sweet & Maxwell, 1999), at 47; Richard Potok, “Legal certainty for securities held as collateral,” International Financial Law Review (December 1999), at 12; see also “Oxford Colloquium on Collateral and Conflict of laws held at St John’s College, Oxford University,” Journal of International Banking and Financial Law (September 1998).
126Such underlying securities may consist either in physical certificates kept in the vaults of a CSD or of a local custodian and circulating by way of book-entry transfers in the local CSD; or in registered securities, the title of which is noted in the issuer’s books, circulating in the books of the local CSD through the intermediation of nominees (of the local CSD or of the intermediaries, in order to make the registered securities fungible for book-entry transfer purposes) that appear as the legal owners of such registered securities in the issuers’ books, holding the securities in trust on behalf of beneficial owners which are the relevant intermediary’s clients; or in dematerialized securities, solely represented by book-entry records on accounts held with the local CSD.
127See Roy Goode, “Security Entitlements as Collateral and the Conflict of Laws,” Oxford Colloquium 1998, Journal of International Banking and Financial Law, at 22 and especially 25 and 26; see also J. Benjamin, Interests in Securities, no. 1.05 and 2.21 and following (see also no. 14.02–14.27).
128“The enforcement of proprietary rights in instruments, or other rights in such instruments the existence or transfer of which presupposes their recording in a register, an account, or a centralized deposit system held or located in a member state, shall be governed by the law of the member state where the register, account or centralized deposit system in which those rights are recorded, is held or located.”
129Excluding, however, any rules of renvoi that may be applicable under the national law so determined (Article 9.1, last sentence), in order to avoid referring to another law that would apply a different solution, which would undermine the legal certainty and predictability wished on this issue.
130Statement of the Council’s reasons, Doc 5530/3/02 of 5 March 2002, at 12 and 13.
131See our study, “Collateral Transactions in Payment and Securities Settlement Systems: The EU Framework,” Droit bancaire et financier (2002), at 10–27; J. P. Deguée, “La directive 2001/24/CE sur l’assainissement et la liquidation des établissements de credit,” Euredia (2002), at 241.
132While the previous EU legal instruments mentioned were more focused on conflict of laws aspects, except the Settlement Finality Directive, which also contains substantive protection rules (for payment orders and settlement and for collateral) in the scope of designated systems.
133See Article 10 of the Directive relating to the establishment by the Commission of a report on its application by 27 December 2006 at the latest. A report is currently in preparation after a consultation process that ended on March 31, 2006 (see
134The Hague Conference is an intergovernmental body established in 1955 to work on harmonization of private international law (conflict of laws). It is based in the Hague (Netherlands) and has produced more than 35 international conventions on the law applicable to sales, trusts, judicial litigations, torts, agencies, and family matters. See the text of the Convention and the Explanatory Report prepared by Professors Goode, Kreuzer, and Kanda with the assistance of Ch. Bernasconi, on the Hague conference website:
135Settlement Finality Directive of 1998; Insolvency Regulation of 2000; Directives on the Reorganisation and the Winding-up of credit institutions and insurance undertakings of 2001; Collateral Directive of 2002.
136The signing of the Hague Convention on December 13, 2002, was only meant to signify the end of negotiations and to propose a final text to the formal signature of contracting states.
138See footnote 138 supra.
139See in favor of the Convention, K. Kreuzer, “Das Haager Übereinkommen über die auf bestimmte Rechte in Bezug auf Intermediär-verwahrte Wertpapiere anzuwendende Rechtsordnung,” in Le droit international privé : esprit et méthodes, Mélanges Paul Lagarde, (Paris: Dalloz, 2005), at 523 ; J. Rogers “Conflict of Laws for Transactions in Securities Held through Intermediaries,” Boston College Law School Research Paper No 108 (2005); Bernasconi and Sigman, “Myths about the Hague Convention debunked,”International Financial Law Review (November 2005), at 31; D. Devos, “The Hague Convention on the Law applicable to Book-entry Securities—Relevance for the European System of Central Banks,” Liber Amicorum Paolo Zamboni Garavelli (Frankfurt: European Central Bank, 2005), at 157; Deguée and Devos, “La loi applicable aux titres intermédiés: l’apport de la Convention de La Haye de décembre 2002,” Revue de droit commercial belge (2006), at 5–32; Financial Markets Law Committee, “Issue 58-Hague Convention…,” which is a legal assessment produced in November 2005, available on FMLC website at; see against, the Hague, Opinion of the European Central Bank dated 17 March 2005, OEJC, no. C 81 of 2 April 2005, at 10; H. De Vauplane and P. Bloch “Loi applicable et critères de localisation des titres multi-intermédiés dans la Convention de La Haye,” in Mélanges AEDBF France IV, Revue Banque Édition (2004), at 469, also published in J.D.I., 1/2005, at 3; W.A.K. Rank, “Vaststelling Hague Securities Convention: meer rechtszekerheid in het internationale effectenverkeer?” NiPR 2005, at 249.
141See D. Devos, “The Hague Convention on the Law applicable to Book-entry Securities—Relevance for the European System of Central Banks,” Liber Amicorum Paolo Zamboni Garavelli (Frankfurt: European Central Bank, 2005), at 157; Deguée and Devos, “La loi applicable aux titres intermédiés: l’apport de la Convention de La Haye de décembre 2002,” Revue de droit commercial belge (2006), at 5–32.
142“Clearing and Settlement in the European Union—The Way Forward,” Communication of 28 April 2004 from the Commission to the Council and the European Parliament, COM (2004) 0312.
143Alberto Giovannini complained about the insufficient progress made so far in the follow-up of the recommendations of his group; see Financial Times (May 16, 2005), at 17.
144Several EU jurisdictions retain “national-oriented protection” rules relating to the physical location of securities activities such as:
  • requirements to open or maintain a local office in order to be entitled to act as withholding agent, act as general clearing member, or to act as a recognized CSD or otherwise provide settlement and custody services to local residents;
  • requirements to locate register (for registered securities) or accounts physically in the country of the issuer;
  • requirements (in law or practice) that restrict local membership in CSD to local intermediaries only.
These requirementscan be imposed through laws or regulations, but also through disproportionate requirements to be fulfilled obliging de facto a nonresident firm to act in the local market through a local intermediary.
147Documents and minutes of meetings are available on the LCG website at
150“Proposal on the exercise of voting rights by shareholders of companies having their registered office in a member state and whose shares are admitted to trading on a regulated market,” adopted by the Commission on 5 January 2006, COM (2005) 685.
151See, e.g., the Euroclear consultation paper, “Harmonisation Fundamentals” (June 30, 2004), in particular section 8 and appendix 1 on legal and regulatory barriers, especially in the UK, France, Netherlands, and Belgium.
152In France the transfer of ownership (TO) for stock exchange trades (the situation depends on the type of trades) is organized by law (French Monetary and Financial Code, Article 431-2) by reference to the credit of the buyer’s account but “at the date and in the conditions defined by (French) market rules.” The Euronext Paris market rules then organized the TO at trade date. Because of the harmonization discussions, this rule has changed in France with the adoption of Decree no. 2005–303 dated 31 March 2005, which refers to the settlement date (with the crediting of the buyer’s account) as the moment of transfer of ownership. This new rule is, however, still dependent on the revision of the rules of the French market supervisor (“Autorité des marches Financiers”); on this complex regime, see H. de Vauplane, “Transfert de propriété des titres cotés: la réforme achevée … ou presque!” Revue Banque (May 2005), at 87.In Belgium and the Netherlands, no specific law has been laid down to organize specifically the transfer of ownership for stock exchange or OTC trades. In these two countries it is the application of the ordinary rules of commercial legislation that leads to the transfer of ownership at settlement date.Irish and UK laws provide for transfer of securities based on transfer of legal title on registration. The regulations covering each regime (England and Wales, Scotland, Northern Ireland—all UK—and Ireland) provide for electronic book-entry transfer of title effected pursuant to settlement of a properly authenticated dematerialized instruction attributable to one or more members (in accordance with the rules of the securities settlement system). Registration (with associated transfer of ownership) takes place at the point of settlement for the UK jurisdictions. For Ireland, a statutory equitable interest arises in favor of the transferee at the point of settlement and is extinguished (usually minutes, but no more than two hours, later) by transfer of legal title in his favor on an issuer register.
153The draft Convention is available on the UNIDROIT website at
155This generally supposes that the interest in such foreign securities is treated as a specific entitlement governed by the national law of the relevant intermediary (under the Hague Convention rules) distinct from any directly traceable entitlement to the underlying foreign securities, which remain governed by local ownership law.
156“Recommendations for Securities Settlement Systems,” CPSS-IOSCO, November 2001, available on the web site of the Bank for International Settlements at in the CPSS publication section.
157“Assessment Methodology for the Recommendations for SSSs,” CPSS-IOSCO, November 2002, available on the web site of the Bank for International Settlements at in the CPSS publication section.
158See the CPSS (BIS) report, “Central bank oversight of payment and settlement systems” (May 2005).
159The main conclusions of the assessment of clearing and settlement systems against CPSS-IOSCO recommendations are normally published even though there are not many assessments currently available. The National Bank of Belgium published its main findings in relation to the Euroclear System in its Financial Stability Review in 2005, at 105–113.

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