Financial Collateral Regulations: a refresher

The Financial Collateral Arrangements (No.2) Regulations 2003 (SI 2004/3226) implemented the EU Directive on Financial Collateral (2002/47/EU) (click here for a copy of the Regulations).  The principal aim of the Directive, and the Regulations, is to make it easier for creditors to take and enforce security over financial collateral, defined as collateral provided in the form of cash and financial instruments (principally shares and securities).  And, by removing "legal obstacles to the use of collateral", the objective is to "enable businesses to access finance more easily". 

The Regulations are helpful to lenders and other collateral takers in that they remove many of the restrictions on the enforcement of security.  However, the attempt to remove some of the legal formalities associated with taking valid security has been less successful.  The lack of certainty over the scope and validity of the Regulations has meant that, in practice, very little has changed in this context.  Consequently, nearly five years on, the regulations are not widely used. 

Financial collateral arrangements can take two forms (i) a security financial collateral arrangement (this category includes security interests over financial collateral such as a mortgage, fixed charge or floating charge that has crystallised) and (ii) a title transfer financial collateral arrangement (e.g. repos, reverse repos and credit support arrangements).   In either case, the arrangements must be in writing for the Regulations to apply.

The Regulations contain provisions which are wider in scope than the Directive.  In particular, the Directive will not apply unless one of the counter-parties to the arrangement falls within one of certain specified categories (including a public authority, financial institution, central bank, clearing house or certain other regulated entities).  The Regulations, on the other hand, apply to financial collateral arrangements between any company or other entity (excluding individuals).  So, they can be relevant in a variety of situations including, for example, rent deposit arrangements involving cash in a charged account.

relaxation of rules applicable to financial collateral arrangements

1) enforcement rights

The Regulations prevent various insolvency provisions from appling to qualifying financial collateral security with the aim of making it quicker and easier for a creditor to enforce his security in insolvency situations.  For example, where a collateral provider is in administration, the creditor retains all rights to deal with the security and the rules that require a creditor to seek permission from the administrator or the court before enforcing the security will not apply. 

2) formalities

The Regulations remove some of the formal requirements for the creation of valid security over financial collateral.  Accordingly, where the Regulations apply: 

• certain statutory provisions requiring the collateral provider's signature will not apply (although the financial collateral arrangement must be in writing); and
• the rules requiring the security to be registered at Companies House to ensure validity (see section 395 Companies Act 1985) are disapplied.

The only formality required by the Regulations is, therefore, that the security is evidenced in writing.  It may, in addition, be necessary to notify certain third parties in order to perfect some types of security, e.g. the debtor where security is given by way of assignment of a debt. 

Despite the apparent simplification of the rules, it would be prudent to adopt a cautious approach when taking any form of security.  Many lenders still typically require that the execution and CA 1985 registration rules applicable before the introduction of the Regulations in 2003 are complied with.  This avoids concerns that:

• the security arrangements fall outside the scope of the Regulations because the collateral is not "financial collateral" – the position of book debts is particularly unclear in this context; and
• the Regulations do not apply because they are not valid under UK law on the basis that they exceed the scope of the terms of the EU Directive.  This point is currently being considered in judicial review proceedings before the UK Administrative Court (the Financial Markets Law Committee has published its view on this issue – click here for a copy of the FMLC's paper).

registration of company charges

The Companies Act 2006 provisions dealing with the registration of company charges and mortgages (see Part 25 of the Act) are due to come into force on 1 October 2009.  The corresponding provisions in the Companies Act 1985 will be repealed at the same time.  The new rules broadly restate the existing law.  However, there will be some changes to the rules for non-UK incorporated companies.

Slavenburg filings

The 2006 Act will repeal the current system for a non-UK incorporated company which has a UK business presence to register charges and mortgages over property in England and Wales (a so-called Slavenburg filing).  The new Act instead, gives the Secretary of State powers to make regulations requiring UK registered overseas companies to register specific charges and mortgages over property in the UK.  Draft regulations were published in July this year (click here for a copy) and it is expected that a further draft will be published before the intended commencement date of 1 October 2009.

The current draft of the Regulations provides that an overseas company will only be required to register a charge or mortgage if:

• it is a security interest which would be registerable by a UK incorporated company; and
• the overseas company is already registered in the UK.

On this basis, and assuming that they are enacted in their current form, the new rules will remove the need for protective Slavenburg filings where security is taken from an overseas company (a practice which has developed under the current system given the difficulty in determining whether or not there is an "established place of business in England and Wales" under the existing rules in section 409 Companies Act 1985).

For more information, please contact Kath Shimmin, head of Blake Lapthorn’s Finance group on 023 8085 7081; email kath.shimmin@bllaw.co.uk.