Belgium has introduced new legislation1 that entails a series of important changes to the statutory rules designed to facilitate close-out netting and financial collateral arrangements. The new legislation was published on 10 November 2011.
Credit claims as financial collateral
As required by the EU Directive 2009/44/EC2, the Belgian Financial Collateral Law3 will extend to the use of credit claims from now on either by way of a pledge over such claims or the transfer of title (assignment) thereof for the purpose of creating security.
The main effect of this extension is twofold: (i) to protect, in the event of bankruptcy or other insolvency situation relating to the collateral provider, such types of collateral arrangements using these types of assets and (ii) to provide for the same certainty, in terms of recharacterisation risk, as was already provided for financial instruments or cash. As far as pledges over credit claims are concerned, this extension of the scope of application will also apply to the simplified forms of enforcement of a pledge, i.e., sale of claims without particular formalities, and the right to enforce by way of appropriation of title by the pledgee.
The Belgian definition of “credit claims” is substantially wider than what is required under the EU Directive 2009/44/EC. It includes not only loans made by credit institutions, but also loans made by institutions duly licenced to provide consumer credit or residential mortgage loans. Moreover, for the avoidance of any doubt, the law specifies that the claim must originate from loans or credit facilities provided by any such institution.
For the Financial Collateral Law to apply, no particular formalities or requirements need to be complied with. A mere pledge or transfer agreement having terms that identify, or allow for the identifying of the relevant credit claims, will suffice in making the collateral arrangement qualify for the enhanced protection provided by this legislation. There is therefore no need to deliver possession of or control over the claims to the collateral taker or its representative. A notification to the borrower will only need to be considered to make the pledge or assignment fully effective against the borrower as a matter of general civil law.
Where a credit claim is secured by a mortgage over real estate (hypotheek/hypothèque), general civil law would require that any pledge or transfer be registered with the competent local mortgage register on the basis of a notarised deed. The amended Financial Collateral Law will eliminate the need for such expensive formality, but instead, will impose an obligation on the collateral provider to provide, upon request by third parties, the necessary information allowing for the identification of the collateral taker.
No longer protection for close-out netting with consumers
As far as close-out netting is concerned, the original provisions of the Belgian Financial Collateral Law introduced in 2004 went far beyond what was required by the EU Directive 2002/47/CE (the “Financial Collateral Directive”) as it provided protection for netting and related close-out provisions irrespective of the type of agreement (i.e., also all types of agreement that do not constitute collateral agreements) or the type of parties concerned. However, in a 2008 ruling, the Belgian Constitutional Court held that these provisions were in breach of the constitution in so far as they included netting with physical persons that did not have an independent commercial activity.
Although this ruling was rightly severely criticised, the new legislation will expressly exclude from its application any netting and related close-out provisions where at least one of the parties is a physical person that is not an independent merchant (handelaars/commerçants) at the time the set-off provision is to be used, except when all of the following conditions are met: (i) such person previously was an independent merchant, (ii) the contractual set-off provisions were entered into during the period it was an independent merchant, and (iii) at least one of the debts to be set-off arose at the time it was still an independent merchant.
Limitations on the close-out netting in the event of a judicial reorganisation
The Financial Collateral Directive requires that close-out netting provisions can be invoked in an effective way in the event of insolvency or reorganisation of certain types of entities active in the financial markets and certain types of public sector entities. In 2004 the Belgian Financial Collateral Law extended such protection to all types of persons and entities, with only very limited exceptions.
Whereas this broad scope of application was widely applauded for giving all types of creditors access to an important instrument that could allow them to manage insolvency risk, a concern was expressed as to how flexible close-out netting rights might adversely impact private companies that applied for a judicial reorganisation (gerechtelijke reorganiatie/réorganisation judiciaire), i.e., proceedings that allow companies to be granted protection against their creditors in order for those companies to reorganise their business.
The amendments to the Financial Collateral Law will introduce a rule stating that close-out netting cannot be implemented when any counterparty which is neither in the public sector or is a financial institution as defined by the amendments applies for a judicial reorganisation. In the event that judicial reorganisation has been granted to a counterparty which is in the public sector or is a financial institution, only other public or financial institutions will be allowed to continue to rely on such provisions.
This suspension of the close-out netting has, however, several exceptions. Firstly, it is only a suspension which lasts for the duration of the judicial reorganisation procedure. Secondly, it does not apply when the counterparty has actually defaulted on a payment obligation. Thirdly, the netting provisions can still be relied on where netting only serves to settle payments without any early close-out of the positions or contracts involved. Fourthly, this does not affect netting, even close-out netting, which are required for the enforcement of collateral that has been provided in the form of financial instruments or by way of title transfer. Finally, and this is a very important safe harbour, the suspension will not apply to netting provisions entered into in relation to derivatives and other financial transactions specified by Royal Decree.
A Royal Decree for this purpose has been published along with the amending legislation4. The “protected transactions” will include (i) derivatives, transactions (such as sale, resale and lending) in respect of securities and other types of instruments and spot transactions, (ii) lending in relation to the settlement of financial instruments, and (iii) guarantees, sureties, and letters of credit in respect of any of the above. For the avoidance of doubt, any claim arisen from the settlement, transfer order or clearing of any of those 3 categories of transactions are also included. For the first two of these categories the protection is, however, conditional upon meeting one of two further conditions. The first condition requires that the transaction be documented on the basis of one of the listed international master agreements, an equivalent Belgian market agreement, or is done under the rules of a regulated market, an MTF, a settlement system, central counterparty or a system as defined under the Belgian finality legislation. The second condition is that the transaction must be of a kind that qualifies for trading on a regulated market or MTF or for settlement through a clearinghouse, central counterparty or a system.
Limitations on close-out netting in the event that emergency measures are applied to banks, insurers or clearing and settlement institutions
In 2010 additional rules and measures were introduced in Belgian law to allow supervisory authorities to deal more effectively with credit institutions, insurance companies and clearing and settlement institutions experiencing severe financial or management distress (“Emergency Measures”). When an Emergency Measure is taken towards such an institution, close-out netting will not be permitted against it by any counterparty which is neither in the public sector or a financial institution as defined by the amendments. The exceptions described above in respect of the suspension for cases of judicial reorganisation will also apply, except for the first exception.
Suspension of the right to enforce cash collateral or collateral in the form of credit claims
In the circumstances described above where the right to close-out netting is suspended, such suspension will equally apply to a collateral taker’s enforcement of its rights to cash or credit claims that have been pledged. The same exceptions will apply, including where the collateral has been provided in relation to derivatives and other financial transactions as identified by the Royal Decree referred to above.
Clarifications for cash collateral and the use of certain financial instruments
Whereas in 2004 the Belgian legislator intended that cash collateral could benefit from the financial collateral legislation without the need for any additional requirements other than those imposed for the valid and effective creation of a pledge or title transfer under general civil law, the actual wording of the original provisions of that legislation (in particular Article 4) left the impression that it was a requirement to deliver the possession of or control over the cash to the collateral taker or its representative. The amending provisions of the new legislation will remove all doubt: no such delivery or control will be required. Thus it will be possible to pledge or assign cash on a bank account without notice to the bank and, irrespective of whether the bank will have been given notice, the fact that the collateral provider is allowed to continue to deal with the cash on the account will not exclude the full application of the Belgian financial collateral legislation.
Finally, the new legislation amends the definition of “financial instruments”, as used for the purposes of this legislation, to clarify that all such instruments need not necessarily to be traded or tradable on financial markets. Thus there will no longer be any doubt that financial instruments which do not or cannot qualify for trading on a financial market (such as shares of a private limited liability company Bvba/Sprl) can be used as collateral, provided that they are at least transferable by nature.