As from today the reuse of financial instruments received under a financial collateral arrangement ("FCA") is subject to new rules. These rules stem from Regulation (EU) 2015/2365 of the European Parliament and of the Council of 25 November 2015 on transparency of securities financing transactions and of reuse (the "Regulation"). Below you will find a summary of these rules. For more detail on these rules, and for an overview of the other rules provided for in the Regulation, please refer to our previous newsletter on the subject.
The rules apply to each counterparty that reuses financial instruments received as collateral under an FCA and is established:
in the EU, including all its branches irrespective of where they are located; or
in a third country, where either (x) the reuse is effected in the course of the operations of an EU branch of that counterparty, or (y) the reuse concerns financial instruments provided under a collateral arrangement by a counterparty established in the EU or by an EU branch of a counterparty established in a third country.
The Regulation is limited in this context to FCAs under which financial instruments (such as securities) are received as collateral. This may be the case for both title transfer FCAs and security FCAs (creating a security interest, e.g. a pledge). Examples of customary FCAs that may be subject to the rules are, for instance, the standard master agreements for documenting SFTs (the MRA, MSLA, GMRA or GMSLA) and the collateral arrangements in connection with derivative transactions under an ISDA Master Agreement (the CSA or CSD). The security documentation for prime brokerage clients often constitutes an FCA as well.
The right to reuse financial instruments includes, amongst others, the right to dispose of such financial instruments. Consequently, the right to reuse is inherent to a title transfer FCA, because the collateral taker acquires ownership of the financial instruments transferred thereunder. However, the right to reuse must generally be agreed to with respect to security FCAs.
The Regulation provides that the right to reuse financial instruments received as collateral is subject to at least the following conditions:
the collateral provider has been duly informed in writing by the collateral taker of the risks and consequences that may be involved in one of the following:
- granting consent to a right of use of collateral provided under a security FCA;
concluding a title transfer FCA; and
- the collateral provider has granted its prior express consent, as evidenced by a signature, in writing or in a legally equivalent manner, to a security FCA, the terms of which provide a right of use or the collateral provider has expressly agreed to provide collateral by way of a title transfer FCA.
In addition, the exercise of a right of reuse is subject to the following conditions:
the reuse can only be undertaken in accordance with the terms specified in the FCA; and
the financial instruments received must be transferred from the collateral provider’s account (where such collateral provider is established in a third country and the account is maintained in such third country and subject to the law of such third country, the exercise of the right of reuse may be evidenced by other appropriate means).
New and existing FCAs
As from today the above rules apply to both new and existing FCA's. As a result of this, counterparties must, to the extent necessary, amend existing FCAs under which the collateral consists of financial instruments and which provide for a right of reuse (which, as mentioned above, is inherent to title transfer FCAs, but must be agreed explicitly for security FCAs). With respect to the requirement to notify the collateral provider of the risks and consequences that may be entailed by a right of reuse, we note that the associations ISDA, ICMA, ISLA, AFME, FIA and SIFMA have jointly published a template to assist market participants to comply with that requirement.