Meaning
Legislation governing the use of financial instruments as security facilitates the rapid liquidation of assets in wholesale financial markets. The financial collateral directive provides a harmonized legal framework for the creation and enforcement of security interests. It applies specifically to cash, financial instruments, and credit claims.
This regulation removes the need for formal notarization or registration that otherwise delays financial transactions.
Statutory Protection
Market participants benefit from reduced legal uncertainty when dealing with cross-border collateral arrangements. The financial collateral directive protects these arrangements from certain insolvency laws that might otherwise freeze assets. This includes the right of the collateral taker to use the assets for their own purposes (known as re-use or re-hypothecation).
Such provisions are necessary for the functioning of the repo and securities lending markets.
Appropriation Right
Creditors can realize the value of the security without a court order if the borrower defaults. The financial collateral directive allows for the appropriation of the assets by the lender at a fair market value. This mechanism bypasses the traditional requirement for a public auction or judicial intervention.
It ensures that liquidity is returned to the market as quickly as possible. The contract must specify the method for valuing the assets at the time of appropriation to ensure fairness. This speed of execution is a major feature of modern financial agreements.
Immediate action prevents the spread of systemic risk during periods of market stress.
Market Liquidity
Standardized rules for collateral use increase the willingness of banks to provide credit to one another. The financial collateral directive reduces the capital requirements for lenders by improving the quality of their security. This leads to lower borrowing costs for all market participants.
