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Spotlight on the Financial Collateral Regulations

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United Kingdom

This article was included in issue 1 of the Finance Brief.

Collateral-takers may take new comfort from recent amendments to the Financial Collateral Arrangements (No.2) Regulations 2003 (the “Regulations”), which clarify the meaning of “possession” for the purpose of determining whether a security interest will fall within the scope of the Regulations.

The Regulations implemented EU Directive 2002/47/EC – the aim of which was to simplify the process for creating and enforcing financial collateral. The EU Directive was primarily aimed at financial market transactions, however the Regulations are important in the context of secured lending. The types of arrangement covered by the Regulations are title transfer financial collateral arrangements and security financial collateral arrangements – the latter of which encompass mortgages, pledges, fixed charges, floating charges and liens.  The Regulations do not apply where the collateral provider is an individual.

A key feature of the Regulations, is that the collateral-taker under a security financial collateral arrangement will have the right to “appropriate” collateral (i.e. transfer full ownership of the collateral to itself so that the collateral provider no longer has any interest in it), without a court order for foreclosure – provided that the parties to the arrangement have agreed in the documentation that the collateral-taker may appropriate collateral. Other benefits include the disapplication of certain legislative requirements for the registration of charges (i.e. no need to register such charges within 21 days of creation at the UK Companies Registry), as well as modifications to UK insolvency rules, which dis-apply the administration moratorium on enforcement of security (a collateral-taker would not wish to have to seek consent of the administrator or the court before trying to enforce its security over shares in a falling market).

It is important to note that, for a security interest to fall within the scope of the Regulations, the financial collateral must be “in the possession or under the control” of the collateral-taker or a person acting on its behalf. The amendments to the Regulations have given greater clarity to the meaning of “possession” in the context of security comprising intangible assets. In addition, recent case law has considered the meaning of “control” and, in doing so, has highlighted the dangers of falling foul of the requirement. In one example, because the requirements for “control” were not met, the arrangement could not have the benefit of the disapplication of the need to register the charge at the UK Companies Registry and so the arrangement was held to be an unregistered floating charge and void against the collateral-provider’s liquidator.

Whilst interpretation of the requirements under the Regulations is still unclear, it is important for a secured lender to take care when structuring, and documenting, security financial collateral arrangements, so as to safeguard its position and ensure it enjoys to the fullest extent the protections afforded by the Regulations.