Financial collateral agreement as a key element of the FCA
The FCA sets forth a framework for establishing financial collateral through a financial collateral agreement (Agreement). The Agreement is the key instrument for transferring ownership rights or establishing pledges over financial instruments or credit claims. As with the Directive, the specificity of the FCA is precisely the fact that it applies only to individual entities in the financial system, such as central banks, states, international development banks and all other financial institutions subject to supervision, acting as both collateral provider and collateral taker.
Special feature of the financial collateral – precedence in insolvency
The FCA contains some special features. It takes precedence over the Bankruptcy Act. And its rules on netting and realisation of collateral and the creditor’s right to use the collateralised asset are important.
However, the FCA’s most prominent feature by far is weaved into its rules regulating insolvency (or bankruptcy) of the collateral provider. Specifically, the insolvency of the collateral provider will not influence the financial collateral arrangement, as it would under other, more general bankruptcy-related regulations. The general rule of the FCA is that the financial collateral agreement and the rights stemming from it remain valid even after the initiation and during the insolvency proceedings.
Furthermore, the FCA does not foresee a standard procedure of settlement through bankruptcy or for classes of creditors and their priority in settlement. To the contrary, the FCA allows the collateral taker to independently enforce its financial collateral even after the insolvency proceedings have been initiated. In other words, the FCA allows the collateral taker to circumvent the insolvency proceedings and realise its collateral without being depending on decisions rendered in such proceedings. Moreover, even if the financial collateral was provided to the collateral taker after adoption of the decision initiating insolvency, such collateral will survive if the collateral taker was not aware and was not required to be aware of the initiation of insolvency against the collateral provider.
What to do with the financial collateral?
The financial collateral can be enforced as soon as (and for as long as) the collateral provider defaults on the underlying, collateralised obligation. In such case, the collateral taker has the right (i) (as usual) to sell the pledged financial instrument and use the proceeds to settle its claims against the collateral provider, (ii) to retain the pledged financial instrument in its possession and even (iii) to execute the close-out netting to terminate the financial collateral early.
Using the financial collateral
The FCA gives the collateral taker the right to use the relevant collateral and to dispose of it as if the collateral taker were the owner of the collateralised asset. This right of use ends only if the collateral provider settles its debts or if the collateral is enforced or netted pursuant to the Agreement. But the collateral taker still does not gain the right of use over credit claims as collateralised assets.
Cutting the procedure short
The FCA provides another convenient possibility for the participating parties. If a netting clause was introduced in the Agreement, it would make it possible for all obligations of the parties to be (i) accelerated to become immediately due and expressed as an obligation to pay an amount representing their value or (b) terminated and replaced by an obligation to pay such an amount, or for an account to be taken of what is due from each party to the other, and a balance of such account to be payable by the party owing the larger of those amounts.
As mentioned, the insolvency of the collateral provider will not influence the effect of the netting clause; the close-out netting will be possible even if the collateral provider is undergoing bankruptcy.
The FCA has turned collateralisation into one of the primary risk mitigation mechanisms enabling a better financial environment to develop in Montenegro. In that sense, one of the FCA’s most important points – its precedence over other rules regulating insolvency – may prove to be the decisive step to an improved, modern financial market in Montenegro.
The FCA gives the collateral taker the right to use the relevant collateral and to dispose of it as if the collateral taker were the owner of the collateralised asset.