Financial collateral arrangements – improving legal clarity

KEY POINTS

Counterparties covered

The Directive applies to financial collateral arrangements between specific categories of counterparties to ensure legal certainty across the EU:

• central banks;
• public authorities;
• certain supervised financial institutions;
• central counterparties, settlement agents and clearing houses;
• persons other than natural persons (including unincorporated firms and partnerships), provided that the other party to the financial collateral arrangement is one of the aforementioned entities and the EU Member State has not opted out of the exercise of this option.

Types of collateral

The Directive defines the assets that may be used as financial collateral:

• eligible collateral consists of cash, financial instruments (such as shares and bonds) and credit claims;
• Member States may restrict the use of certain instruments, for example shares issued by the collateral provider or its affiliated companies.

Forms of collateral arrangements

The Directive recognises two types of arrangements that secure obligations by collateral:

• title transfer financial collateral arrangements, where full ownership of the collateral passes to the collateral taker;
• security financial collateral arrangements, where collateral is provided as security but ownership remains with the collateral provider.

Formal requirements

The Directive minimises national formalities so financial collateral arrangements are effective and enforceable without excessive administrative burdens. However, the Directive requires financial collateral arrangements to be evidenced in writing or a legally equivalent form.

Right of use under security financial collateral arrangements

Under a security financial collateral arrangement, the collateral taker may use financial collateral as if it were the owner, under agreed conditions:

• if collateral is used, the taker must return equivalent assets when the obligation ends;
• the directive allows substitution of collateral, ensuring flexibility while maintaining protection for both parties.

Enforcement of collateral

The Directive lays down rules for the enforcement of collateral in the case of an enforcement event, such as the default of the collateral giver or taker:

• collateral may be enforced by sale, appropriation or setting off the value against relevant financial obligations (depending on the kind of collateral);
• enforcement must follow agreed contractual terms and must not require prior court approval;
• the value of appropriated collateral must be determined in a commercially reasonable way and has to be agreed on in the security financial collateral arrangement.

Close-out netting²

The Directive requires recognition of close-out netting even in insolvency proceedings. Close-out netting converts, on the occurrence of an enforcement event, mutual claims into a single balance payable between the parties, whether through the operation of netting, set-off or otherwise. This ensures that financial stability is preserved by limiting contagion from defaults.

Protection from insolvency law

The Directive shields financial collateral arrangements from certain national insolvency rules:

• financial collateral arrangements cannot be declared invalid solely because they were concluded shortly before insolvency proceedings;
• additional financial collateral is protected from being challenged on the sole basis that it was provided shortly before insolvency proceedings, if the provision of additional financial collateral is required to take account of changes in the value of the financial collateral provided originally or in the amount of the relevant financial obligation;
• collateral takers may enforce their rights despite the reorganisation or winding-up of the provider even if the financial collateral has been provided on the day of – but after the moment of the commencement of – winding-up proceedings or reorganisation measures, if they can prove that they were not aware, nor should have been aware, of the commencement of such proceedings or measures.

Conflict of laws

The Directive provides that collateral in the form of book-entry securities is governed – for specific matters – by the law of the country in which the relevant account, on which the securities are held, is maintained.

Interaction with other EU laws

The Directive was amended by Directive 2009/44/EC, Directive 2014/59/EU (see summary) and Regulation (EU) 2021/23 (see summary), aligning it with the EU framework for financial markets and resolution of failing institutions. Directive (EU) 2025/1 further amends Directive 2002/47/EC to clarify that, when insurance and reinsurance undertakings are placed under EU resolution procedures, the usual rights to use, enforce or offset collateral may be restricted. This aligns the directive with existing EU resolution regimes for banks and central counterparties and ensures consistent treatment across the financial sector.