Select Committee on European Scrutiny Tenth Report




COM(01) 168

Draft Directive on financial collateral arrangements.
Legal base: Article 95 EC; co-decision; QMV
Document originated: 27 March 2001
Forwarded to the Council: 28 March 2001
Deposited in Parliament: 17 April 2001
Department: HM Treasury
Basis of consideration: EM of 5 May and Minister's letter of 5 December 2001
Previous Committee Report: None
To be discussed in Council: 13 December 2001
Committee's assessment: Legally and politically important
Committee's decision: Cleared


  2.1  The EU Financial Services Action Plan (FSAP) was published in May 1999. According to the European Commission the Action Plan "details the work that has to be accomplished to reap the full benefits of the euro and to ensure the continued stability and competitiveness of EU financial markets." Our predecessors reported on the Action Plan on 23 June 1999[1] and recommended it for debate. It was debated in European Standing Committee B on 25 November 1999, along with documents relating to taxation. Subsequently, our predecessors considered successive progress reports, most recently on 13 December 2000.[2]

  2.2  The FSAP also includes elements aimed at improving the workings of capital markets, including transactions between financial institutions and those involving companies raising capital, accessing liquidity and managing financial risks.

The document

  2.3  The purpose of the document is to enable financial collateral, which includes cash and certain financial instruments (principally securities), to be used more effectively across the EU by clarifying the legal framework relating to the use of collateral. The Directive is intended to cover arrangements in which possession or control of the financial collateral passes to the collateral taker. This would include situations in which businesses deposit money with a bank as collateral against a loan from that bank. The proposal is not likely to lead to any substantial change in arrangements for taking security under current UK law.

  2.4  Financial collateral arrangements are important in a transaction because they provide security to both a creditor and debtor. From the creditor's point of view, certainty of payment is increased through the ability to retain or realise value from collateral. For the debtor, transaction costs, for example in the form of risk premiums, are reduced accordingly. At present, the financial collateral arrangements in the EU are a problem since each Member State has its own rules applying to collateral transactions. These different rules can cause difficulties with regard to bankruptcy legislation and other requirements, making it necessary for market participants to build up vast amounts of information on how to handle collateral within the EU. This Directive proposes a simplified framework in order to create legal certainty.[3]

  2.5  In her Explanatory Memorandum of 5 May 2001 the then Economic Secretary to the Treasury (Miss Melanie Johnson) said that the document covered two sorts of arrangements:

  • Title transfer. Ownership of the collateral is transferred to the collateral taker, who only transfers equivalent collateral back to the collateral provider when it has satisfied or performed the obligations that the collateral arrangement was intended to protect. If the collateral provider defaults, then the value of the equivalent collateral that the collateral taker was due to return is set off against that of the collateral provider's obligations, with an amount equal to any surplus being paid to the collateral provider.

  • A security arrangement, often referred to as a pledge. Although the collateral taker obtains possession or control of the collateral, it does not become the owner of it. If the collateral provider defaults, then the collateral taker is entitled to sell or realise the collateral, apply the proceeds against the amounts owed, and return the excess proceeds (if any) to the collateral provider.

  2.6  The two different arrangements have different implications for tax and accounting purposes. Title transfer is the preferred arrangement in the UK and much of Europe. However, the Directive allows the parties a choice as to which arrangement is locally more familiar or more appropriate to their circumstances. The Directive is limited to transactions involving public bodies,[4] financial institutions under prudential supervision and businesses above a certain size limit.

  2.7  According to the Commission:

"This proposal contains two specific measures which will increase liquidity in the collateral market: First is the proposal for a clear statutory regime regarding agreements permitting the collateral taker to re-use the collateral for their own purposes under pledge structures. Re-use of collateral is already known in a number of Member States as 're-hypothecation' or 're-pledging'. Secondly, the proposed Directive would allow for collateral substitution, whereby the collateral provider can withdraw particular securities and replace them with other securities of equivalent value if the collateral agreement so provides. Greater liquidity will lead to more efficient price determination and the resulting reduction in market volatility will enable both large and small investors to buy or sell securities more easily and at a fairer price."

  2.8  On 6 December 2001, the Economic Secretary to the Treasury (Ruth Kelly) wrote informing us that a Presidency text of the Directive is due to go to ECOFIN on 13 December for a general orientation discussion. The Minister says:

"Once the European Parliament has considered the proposed Directive, the Presidency's aim is then to move to political agreement. The European Parliament is due to consider the proposed Directive in plenary in December. From its Committee debate, it appears that the amendments proposed are likely to be broadly supportive of the Presidency text."

The Government's view

  2.9  The Government strongly supports the aims of the Directive and is keen to see the Directive adopted as quickly as possible and to ensure that it meets the objective of reducing the cost of capital in the EU. The Minister told our predecessors that "the UK will aim to support quicker passage into EU law by the end of 2002, subject to an appropriate outcome."

  2.10  Overall, the Government is looking to support the Presidency text and hopes that it will meet with approval at ECOFIN. However, the Minister mentions a number of secondary reservations, such as the removal of the need in the UK to obtain a court order to establish definitively the value of the collateral when it is realised by a sale. The Minister says:

"The Presidency text would mean we would have to remove this requirement in respect of financial collateral covered by the Directive. This seems to us unnecessary and inconvenient: such a provision has not been sought by business. We would prefer its removal."

  2.11  The Minister says that she would also like to see general non-financial companies included within the Directive's scope. However, as the Minister points out many Member States continue to have reservations about this. The Minister says:

"The Presidency has therefore brokered a compromise whereby a collateral arrangement including a general non-financial company (of any size) can come within the Directive's scope, but only if the other party to the arrangement is a public authority or financial institution. (Arrangements between two organisations each of which is either a public authority or financial institution would also be included in the scope.) In the light of the Action Plan aim, this is less than ideal but even this compromise appears to be as much as most other Member States will accept."


  2.12  The document, which is highly technical, is broadly welcomed by industry. The Government also welcomes it. The Belgian Presidency is likely to present to ECOFIN on 13 December a modified proposal that clarifies the text and reflects some amendments proposed by the European Parliament for a general orientation discussion.

  2.13  We are content to clear the document.

1   (20175) 8329/00; see HC 34-xxiii (1998-99), paragraph 1.  Back

2  (21818) - ; see HC 28-i (2000-01), paragraph 18. Back

3 Back

4   The Debt Management Office and the Bank of England are the UK public bodies to whom the Directive is most likely to be relevant. Back

previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2001
Prepared 17 December 2001