Financial Collateral Directive (FCD)

Financial collateral are assets provided by a borrower to a lender to minimise the risk of financial loss to the lender in the event of the borrower defaulting on its financial obligations to the lender.

The FCD covers both title transfer and security interest collateral arrangements and covers financial collateral comprising cash, financial instruments and (since 2009) credit claims.

A title transfer collateral arrangement is one where the collateral provider transfers full ownership of the collateral to the collateral taker for the purpose of securing or otherwise covering the performance of the financial obligations. For an arrangement to be a security financial collateral arrangement, the collateral must be provided by way of security to the collateral taker such that it is delivered, transferred, held, registered or otherwise designated to be in the possession or under the control of the collateral taker, or a person acting on the collateral taker’s behalf.  The terms possession and control are not well defined in the FCD and have caused problems of legal interpretation within certain jurisdictions including the UK.

The FCD removes any formal acts required for the creation, validity, perfection or enforceability of a financial collateral arrangement and includes collateral techniques for collateral substitution and withdrawal of excess collateral without affecting the validity of the arrangements;  it provides for appropriation of collateral on enforcement of a security financial collateral arrangement; and to disapply insolvency law that would interfere with the enforcement of security or application of close-out netting upon insolvency. It also provides that collateral securities held by book entry should be governed by the law in which the relevant account is maintained.

The FCD protections only apply when the parties to a financial collateral arrangement are public authorities, central banks, financial institutions, CCPs, settlement agents and clearing houses, or where these entities are party to a transaction with a non-natural person. Not all jurisdictions implemented this entity scope uniformly. The UK extended the scope to cover transactions between two non-natural persons whilst in Belgium and Luxembourg the scope included natural persons.

Financial collateral arrangements are of key importance in a broad range of securities financing transactions including securities lending, repos, OTC derivatives, and prime brokerage arrangements. The FCD provides protections to parties to title transfer and security financial collateral arrangements that cover recognition of close-out netting provisions, protection from insolvency challenges and removal of national law formalities. In order to mitigate legal and credit risk, participants need certainty as the operation and legal consequences under security and close-out netting provisions in their transaction documentation. Legal opinions that support the enforceability of the arrangements in insolvency are also of key importance in managing participants’ capital requirements.

ISLA provides a range of legal services to support securities lending market activity. Since the early 90’s  it has provided a market standard form of master securities lending agreement, currently the   2010 Global Master Securities Lending Agreements (GMSLA) with various addendums and country annexes, which is the most widely used securities lending agreement in the international market. It also offers a subscription service for access to legal opinions in over 65 jurisdictions globally  covering the enforceability of the GMSLA netting provisions in over 65 jurisdictions globally. These opinions are commissioned by ISLA on annual basis and the service provides a substantial savings in legal costs to subscribers as well as benefit from the process and opinion review. More recently in 2018 ISLA developed a pledge collateral version of the existing GMSLA and provides ISLA members with an alternative to the title transfer collateral framework as well as supporting legal opinions.

ISLA works closely with external legal counsel to review and update legal provisions of the GMSLA, including very recently  in 2024, the introduction of a Digital Assets Annex to the GMSLA.

ISLA runs a Legal Working Group comprising of a Legal Steering Group (LSG) and an LSG Opinions subgroup. The LSG looks more broadly at the implications of political, regulatory and technological change on our market structure, and how those changes may require alterations to the GMSLA whilst the LSG Opinions Subgroup reviews the existing opinions gathering services, including review of the jurisdictions and counterparty types covered. There is also an LSG Documentation subgroup which  reviews and provides guidance to ISLA on the contractual enhancements or supplements that can be made to industry standard documentation to reflect and support the current securities lending landscape.