Luxembourg financial collateral law – towards reinforced certainty
Reproduced with permission from Agefi Luxembourg. This article was first published in Agefi Luxembourg - Février 2022 - Luxembourg.
The Luxembourg law of 5 August 2005, as amended, transposing directive 2002/47/EC of 6 June 2002 on financial collateral arrangements (Financial Collateral Law) is a cornerstone of the Luxembourg legal financial framework and one of the reasons for Luxembourg’s attractivity as a jurisdiction for cross-border financing transactions.
As part of the implementation of Regulation (EU) 2021/23 of 16 December 2020 on a framework for the recovery and resolution of central counterparties (CCR Regulation) into Luxembourg law, draft law no. 7933 was filed on 20 December 2021 with the Luxembourg Chamber of Deputies (Draft Law). The Draft Law also aims to codify practices into the Financial Collateral Law that were already used by most of the legal practitioners but were not expressly provided by the Financial Collateral Law, while also correcting inconsistencies and clerical errors from the current version of the law and updating the list of optional enforcement methods. The Draft Law is still in its infancy, since the advisory opinions (in particular, that of the Conseil d'Etat) required as a part of the legislative process have not yet been obtained, so additional changes are still possible.
The first of the “codifying” changes is the express recognition of the possibility of enforcing financial collateral arrangements following the occurrence of any event agreed between the parties (so not only a default of payment). The alternative enforcement triggers include breaches of a contractual obligation or of a financial covenant, even if such breaches do not lead to an acceleration of the secured obligations. This possibility had received recognition in case law and was considered by most legal practitioners as being implied by the current provisions of the Financial Collateral Law. The Draft Law also specifies that in case of an enforcement without acceleration, the proceeds will be used for the discharge of the secured obligations, unless otherwise agreed between parties. Overall, the express recognition of contractually defined enforcement triggers should encourage their use by pledgees which had a more cautious approach.
The Draft Law would also confirm the full applicability of the Financial Collateral Law to security over insurance contracts. This was already accepted in practice as regards the pecuniary rights of the policy holders and beneficiaries, but there remained some uncertainty in respect of other rights which were only related to the right to receive payment under insurance policies. Given the increased importance of the insurance sector in Luxembourg, this clarification can only be beneficial. However, a similar clarification would have also been useful in case of security over undrawn commitments of investors into Luxembourg funds, where a similar approach of “rights connected to the pledged claims” has been developed by the legal practitioners.
Among the changes regarding the (optional) enforcement methods, the Draft Law aims to update the provisions relating to sales via exchanges and public sales. The current reference to sale on “a stock market” would be replaced by “trading platform” on which the assets made subject to security are listed, thus also covering Luxembourg or foreign multilateral trading facilities (MTF) and organised trading facilities (OTF). The Draft Law introduces detailed rules for enforcement by public sale, which can be conducted by either a public notary or a bailiff (and no longer only through the Luxembourg Stock Exchange) and expressly addresses the suspensive effect of any prior approvals from public authorities that may apply to certain types of entities, such as licensed entities. The Draft Law also provides two alternative valuation methods in case of appropriation of shares or units issued by a collective investment undertaking: the beneficiaries of pledges would be allowed to either request the redemption of the pledged shares/units at the value provided for in the issuing documentation or appropriate them at their most recent net asset value.
Overall, these changes will be of limited effect, since both in the current version and in the Draft Law, all of the enforcement options provided by the Financial Collateral Law are optional for the parties, who are therefore free to use other contractually agreed enforcement methods. The main benefit of using one of the new enforcement methods expressly provided by the Draft Law would be to avoid the inherent uncertainty as to validity and enforceability which affects the existing market practices based on the interpretation of the general provisions of the version currently in force of the Financial Collateral Law.
The amendments to the Financial Collateral would also include the addition of payment institutions and e-money institutions to the list of accepted assignees for assignments by way of security taking the form of a fiducie, in an effort to encourage the use of this legal instrument which has had limited success since its introduction.
The changes to be brought by the Draft Law are understandably limited, both because its main purpose is to implement the CCR Regulation and because the success of the Financial Collateral Law is attributable in part to its stability throughout time. While the approach of “codifying” existing market practices contributes to increasing legal security, it not systematic nor consistent. There are other wide-spread market practices which are not officially sanctioned by the Draft Law and therefore the question as to the criteria used for choosing the practices worthy of an official recognition will inevitably arise.
More generally, the Draft Law is a part of a wider recent effort to increase the advantages of Luxembourg law in a post-Brexit landscape that has been based so far, on one hand, on clarification of existing legal concepts (such as the amendment in March 2021 of the Luxembourg on commercial companies of 10 August 1915, as amended relating to financial assistance for sociétés à responsabilité limitée) and, on the other hand, the adoption of new legal concepts based on successful existing ones (such as the law on professional payment guarantee in July 2020, which is largely inspired by the Financial Collateral Law). This effort should result in Luxembourg’s increased competitiveness as a jurisdiction for international financings. But additional changes remain necessary, in particular for facilitating the use of Luxembourg law as governing of main financing agreements, such as loan agreements (compounding of interest, full recognition of agents and trustees, etc) and not only as the governing law of secondary finance documents such as security interests and guarantees.