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IP/01/464

Brussels, 30 March 2001

Financial services: Commission proposes simplified EU legal framework for collateral

The European Commission has proposed a Directive that would create a uniform EU legal framework to limit credit risk in financial transactions through the provision of securities and cash as collateral. Collateral is the property (such as securities) provided by a borrower to a lender to minimise the risk of financial loss to the lender in the event of the borrower failing to meet in full their financial obligations to the lender. Current rules applied to the use of collateral throughout the EU are complex and impractical resulting in uncertainty regarding the effectiveness of collateral as protection in cross-border transactions. Creation of a clear, uniform pan-EU legal framework for the use of collateral would contribute to the greater integration and cost-efficiency of European financial markets by encouraging cross-border business and creating a more competitive European financial market. The proposal is a priority measure under the Financial Services Action Plan (see IP/00/1269), endorsed by the Lisbon and Stockholm European Councils as a key element in the creation of the most competitive economy in the world.

Internal Market Commissioner Frits Bolkestein, said: "This eagerly awaited proposal is the first step towards integration of the financial market for collateral in the EU and so tackling a major disincentive to cross-border transactions. . Market operators currently face fifteen different legal regimes for the provision of collateral, complicated potential conflicts between jurisdictions and uncertainties surrounding the law applicable to cross-border transfers of securities. This proposal would determine which law governs cross-border collateral arrangements and make it possible for market participants to conclude such arrangements in the same manner throughout the EU."

The proposed Directive seeks to resolve the main problems affecting cross-border use of collateral in wholesale financial markets. The Commission proposes to abolish existing administrative burdens and complexities, creating a clear framework of legal certainty in the field of collateral by:

  • ensuring that an effective and simple Community regime exists for the creation of collateral

  • providing limited protection of collateral arrangements from some rules of insolvency law, particularly those that would inhibit the effective liquidation of collateral or cast doubt on the validity of techniques currently used

  • creating legal certainty with regard to cross-border provision of collateral, in the form of book-entry securities, by extending the principles already applied under the Settlement Finality Directive (see below) to determine where such securities are located

  • restricting the imposition of onerous formalities on either the creation or the enforcement of collateral arrangements

  • ensuring effective agreements permitting the collateral taker to re-use the collateral for their own purposes under pledge structures, the classic way of providing collateral. .

This proposal complements the Commission's wide-ranging efforts, in the context of the Financial Services Action Plan (FSAP), to encourage cross-border business in financial services, secure the full benefits of the single currency and develop an optimally functioning European financial market. The Stockholm European Council of 23/24 March 2001 stressed the vital role that financial markets play in the overall economy of the EU and urged the Council of Ministers and European Parliament to accelerate work on the FSAP.

A few figures demonstrate the importance of the collateral market. According to a recent survey carried out by an international organisation, the total value of government securities on loan or "repo" in eight EU Member States was estimated at USD 900,000 million. The market in the US was approximately twice that size. An international association has estimated that the value of collateral-backing transactions in the "over-the-counter" (OTC) derivatives market amounted to approximately USD 250,000 million through the conclusion of over 12,000 collateral arrangements. At the beginning of 2000 the Eurosystem (European Central Bank and natonal central banks of the Member States participating in Economic and Monetary Union) held collateral of around €550,000 million, of which nearly €160,000 million was held on a cross-border basis

Background

The 1998 Settlement Finality Directive (98/26/EC) was a milestone in establishing a sound legal framework for payment and securities settlement systems, as well as the operations of Member States' central banks and the European Central Bank. Implementation of this Directive has brought additional legal clarity to cross-border collateral arrangements previously subject to a confusing array of national laws, for example by establishing clearly which country's law determines which party to an agreement remains the proprietor of the collateral for the duration of the contract.

However, the Settlement Finality Directive does not cover more general transactions in financial markets. National rules relating to the use of collateral throughout the EU are in many instances complex, inconsistent, impractical and even out-of-date. As a result, they can create uncertainty and unpredictability about the effectiveness of collateral as protection against loss, which seriously constrains the efficient use of collateral and needlessly limits the amount of business that could otherwise be done. This in turn restricts access to financial services and raises costs. The mutual acceptance by market participants of cross-border collateral, and its enforcement, is vital for the stability of the EU financial system and for the development of a cost-effective and integrated EU financial market.

The full text of the proposal is available on the Europa website at http://ec.europa.eu/internal_market/en/index.htm (click on What's New).


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