CHAPTER V – SPECIAL PROVISIONS WITH RESPECT TO COLLATERAL TRANSACTIONS

3. In this Chapter:

(a) “collateral agreement” means a security collateral agreement or a title transfer collateral agreement;

(b) “security collateral agreement” means an agreement between a collateral provider and a collateral taker providing (in whatever terms) for the grant of an interest other than full ownership in intermediated securi-ties for the purpose of securing the performance of relevant obligations;

(c) “title transfer collateral agreement” means an agreement, including an agreement providing for the sale and repurchase of securities, between a collateral provider and a collateral taker providing (in whatever terms) for the transfer of full ownership of intermediated securities by the collateral provider to the collateral taker for the purpose of securing or otherwise covering the performance of relevant obligations;

(d) “relevant obligations” means any existing, future or contingent obligations of a collateral provider or a third person;

(e) “collateral securities” means intermediated securities delivered under a collateral agreement;

(f) “collateral taker” means a person to whom an interest in intermediated securities is granted under a collateral agreement;

(g) “collateral provider” means an account holder by whom an interest in intermediated securities is granted under a collateral agreement;

(h) “enforcement event” means, in relation to a collateral agreement, an event of default or other event on the occurrence of which, under the terms of that collateral agreement or by the operation of law, the collateral taker is entitled to realise the collateral securities or a close-out netting provision may be operated;

(i) “equivalent collateral” means securities of the same description as collateral securities;

(j) “close-out netting provision” means a provision of a collateral agreement, or of a set of connected agreements of which a collateral agreement forms part, under which, on the occurrence of an enforcement event, either or both of the following shall occur, or may at the election of the collateral taker occur, whether through the operation of netting or set-off or otherwise:

(i) the respective obligations of the parties are accelerated so as to be immediately due and expressed as an obligation to pay an amount representing their estimated current value or are terminated and replaced by an obligation to pay such an amount;

(ii) an account is taken of what is due from each party to the other in respect of such obligations, and a net sum equal to the balance of the account is payable by the party from whom the larger amount is due to the other party.

UNIDROIT 2009 – CONF. 11/2 – Doc. 5 – Article 31 141.

Commentary

I. Introduction

31-1. Chapter V provides a special set of rules with respect to collateral transactions. Most rules in this Chapter are modelled on the European Financial Collateral Directive (European Directive 2002/47/EC of 6 June 2002 on financial collateral arrangements), but they are not identical to the Directive. Article 31(1) sets out the scope of Chapter V. Article 31(2) shows the position that rules in Chapter V set minimum harmonisation standards, in the sense that Contracting States may provide additional rules of protecting the collateral taker. Article 31(2) does not permit Contracting States to limit the protection of the collateral taker provided by Chapter V. Article 31(3) contains a number of definitions that are relevant in Chapter V. Finally, Contracting States are given the opportunity to make declarations for opting-out of entire Chapter V or part of it in accordance with Articles 38 and 36(2).

II. History

Article 31(1)

31-2. An initial version of Article 31(1) was originally part of the provision on enforcement. See Study LXXVIII – Doc. 13, p. 12; Study LXXVIII – Doc. 18, p. 11; Study LXXVIII – Doc. 24, Appendix 1, p. 16.

31-3. During the second meeting of the CGE, it was put at the beginning of the provision that also contains the definitions. See Study LXXVIII – Doc. 42, Appendix 1, p. 16. It was explicitly intended to apply to both title transfer and security collateral agreements. See Study LXXVIII – Doc. 43, section 189.

31-4. Nonetheless, during the third session of the CGE, the collateral chapter was stated to apply in the case of collateral agreements under which a collateral provider “grants a security interest” in intermediated securities […]. See Study LXXVIII – Doc. 57, Appendix 1, p. 17.

31-5. The text of the provision was not changed during the fourth session of CGE. It was, however, remarked that the text of the provision should put beyond doubt that it also relates to title transfer collateral agreements (see Study LXXVIII – Doc. 95, section 210).

31-6. As a consequence, the reference to a “security interest” added during the third meeting of the CGE was replaced during the first session of the diplomatic Conference by a reference to an

“interest”, so as to clearly reflect the intention to cover both security and title transfer collateral agreements.

Article 31(2)

31-7. Article 31(2) was introduced during the first session of the diplomatic Conference.

Article 31(3)

31-8. Definitions of “relevant collateral agreement” (now: “collateral agreement”), “collateral provider”, “collateral taker”, “collateral securities” and “secured obligations” (now: “relevant obligations”) were already present in the very first draft of the chapter on collateral transactions presented by the Study Group. Originally, they formed part of the provision on enforcement. See Study LXXVIII – Doc. 13, p. 12.

31-9. In a later draft, the Study Group added a special definitional provision mentioning these terms, the content of which was, nonetheless, still explained in the provision on enforcement.

Moreover, the Study Group added a definition of “enforcement event”. See Study LXXVIII – Doc. 18, p. 11 and the explanatory note in Study LXXVIII – Doc. 19, p. 34. This approach was maintained during the first session of the CGE (see Study LXXVIII – Doc. 24, Appendix 1, p. 16).

31-10. During the second session of the CGE, however, the definitions were concentrated in one single provision. Whereas the definitions of “enforcement event”, “collateral securities” and

“secured obligation” were maintained, those of “collateral agreement”, “collateral provider” and

“collateral taker” were temporarily suppressed, only to appear again at the CGE’s third session. For the changes made during the second session of the CGE, see Study LXXVIII – Doc. 42, Appendix 1, p. 16.

31-11. The text emerging from the third session of the CGE shows the list of definitions as it is present in the current text of the Convention. The definitions of “collateral agreement”, “collateral provider” and “collateral taker” reappeared, and new definitions of “security collateral agreement”,

“title transfer collateral agreement”, “equivalent collateral” and “close-out netting provision” were introduced. See Study LXXVIII – Doc. 57, Appendix 1, p. 17-18. See also Study LXXVIII – Doc. 58, sections 113, 114 and 184.

31-12. At the fourth session of the CGE, the only change to the definitions was the addition of contingent obligations to the definition of “relevant obligations”, besides existing and future obligations. See Study LXXVIII – Doc. 94, Appendix 1, p. 15 and Study LXXVIII – Doc. 95, section 207.

31-13. During the first session of the diplomatic Conference a minor substantive change was made only to the definition of “enforcement event”, reflecting that such an event could take place not only under the terms of a collateral agreement, but also by the operation of law.

III. Analysis

Article 31(1)

31-14. Article 31(1) sets out the scope of Chapter V on collateral transactions. Chapter V applies to “collateral agreements”, and “collateral agreement” includes both security and title transfer collateral agreements (Article 31(3)(a)-(c)).

31-15. Article 31(1) makes it clear that Chapter V only applies to an interest granted in respect of intermediated securities (defined in Article 1(b)), and not any other assets (unless specified explicitly, as in Articles 34 and 36).

31-16. Article 31(1) also makes it clear that the collateral can secure “the performance of any existing, future or contingent obligation”. These obligations are defined as the “relevant obligations” in Article 31(3)(d).

31-17. The relevant obligations may be owed by either the “collateral provider or a third person”.

This means that Chapter V not only applies to the bi-lateral situation where collateral is given to secure the debt owed by the collateral provider, but also covers the situation where collateral is given to secure the debt owed by a third person.

UNIDROIT 2009 – CONF. 11/2 – Doc. 5 – Article 31 143.

Article 31(2)

31-18. Article 31(2) is a second provision concerning the scope of Chapter V. It is intended to express the minimum harmonisation approach in this chapter. This approach means that by adopting Chapter V, a Contracting State accepts to implement the rules set out in the chapter (subject to opt-out possibilities), but may go further and introduce additional mechanisms of protecting the collateral taker.

EXAMPLE 31-1: State X has the so-called “zero hour rule” stating that the court decision to begin an insolvency proceeding has a retroactive effect back to the beginning of the day when the decision is issued. In line with Articles 36 and 37, State X, by implementing the Convention, excludes the applicability of the zero hour rule in respect of the conclusion of a collateral agreement, the delivery of collateral, top-up collateral or substitute collateral. In addition, however, State X may introduce a rule stating that such events are enforceable even if they are carried out on the day of but after the court decision concerning the commencement of the insolvency proceeding, provided that the collateral taker was not aware of such decision. Such an additional rule is allowed under the Convention's minimum harmonisation approach.

31-19. The idea of minimum harmonisation approach is used in many provisions of the Convention. Article 18 concerning acquisition by an innocent person is another example of this approach. It must be noted that under Article 31(2) Contracting States may provide additional rules of protecting the collateral taker, but Article 31(2) does not permit Contracting States to limit the protection of the collateral taker provided by Chapter V.

Article 31(3)

31-20. Article 31(3) contains a number of definitions specific to Chapter V.

“collateral agreement”, “security collateral agreement” and “title transfer collateral agreement”

31-21. The definitions of “collateral agreement”, “security collateral agreement” and “title transfer collateral agreement” make clear that two types of collateral agreements fall within the scope of Chapter V: security collateral agreements which envisage the grant of an interest in collateral other than transfer of full ownership, such as a right of pledge, and title transfer collateral agreements in which full ownership is transferred to the collateral taker.

31-22. An example of a collateral agreement falling within the scope of these definitions is a repurchase (or commonly known as “repo”) agreement, which involves the sale of securities from seller A to buyer B and a later transfer of equivalent securities for value from B to A. Another example is a securities lending agreement under which borrower A borrows securities from lender B, promising to return those (or equivalent) securities at a later date. (The lender typically obtains a fee or other form of return for lending the securities.) To secure borrower A’s obligation to return the borrowed securities, borrower A provides collateral to lender B. Although this collateral would typically be in the form of cash, in which case this Convention would not apply to such collateral, if the collateral were posted in securities, the agreement governing the provision of such collateral would be covered. This would be true whether or not the agreement provided for a transfer of title to such securities collateral.

“relevant obligations”

31-23. The definition of “relevant obligations” indicates that collateral may be given to secure existing, future or contingent obligations of the collateral provider or a third person. As was stated above, mentioning both the collateral provider and a third person means that collateral given to secure the debt of a third party is covered by Chapter V. A broad terminology including “existing”,

“future” and “contingent” obligations has been chosen in order to cover differences in terminology in different jurisdictions. For instance, in some jurisdictions future obligations comprise contingent obligations, whereas in other jurisdictions they may be in different categories.

31-24. An example of a contingent obligation is the obligation of a party in connection with a standby guarantee or a letter of credit, where, when the agreement is entered into for collateral, no one knows whether in the future the support device will be called upon. In this case, the obligation to reimburse the party under such standby guarantee or letter of credit arrangement is contingent.

31-25. Under Article 38, a Contracting State can declare that Chapter V does not apply to certain types of relevant obligations.

“collateral securities”

31-26. According to the definition of “collateral securities”, only intermediated securities as defined in Article 1(b) fall within the scope of Chapter V. Under Article 38, a Contracting State can narrow the scope of Chapter V by a declaration and specify the type of collateral securities to which Chapter V applies.

“collateral taker” and “collateral provider”

31-27. The definitions of “collateral taker” and “collateral provider” describe the parties to a collateral agreement. These terms may include professional entities such as banks, pension funds and insurance undertakings, but also small- and medium-sized enterprises and natural persons.

Under Article 38, a Contracting State can declare that Chapter V does not apply to certain parties to a collateral agreement.

EXAMPLE 31-2: State X has legislation relating to collateral agreements, which does not extend to transactions involving natural persons under the policy that they need special protection. In such case, State X can make use of the opt-out mechanism set out in Article 38 and, by making a declaration, limit the scope of the definitions of collateral taker and collateral provider.

“enforcement event” and “close-out netting provision”

31-28. The definitions of “enforcement event” and “close-out netting provision” are important for Article 33. The definition of “enforcement event” reflects that enforcement may be triggered by any event agreed upon between the parties or by the operation of law. The occurrence of an enforcement event enables the collateral taker to realise its collateral and allows the operation of a close-out netting provision.

31-29. Close-out netting is an enforcement technique which is commonly found in standard documentation used by market participants in order to structure, e.g., repurchase, securities lending and other collateral arrangements. Whereas the repurchase or securities lending agreement itself may contain a close out netting provision, the parties may also agree on a

UNIDROIT 2009 – CONF. 11/2 – Doc. 5 – Article 32 145.

separate agreement which links different financial products in different agreements to one process of close-out netting.

EXAMPLE 31-3: A typical master repurchase agreement and a typical master securities lending agreement, which are standard agreements to structure repurchase and securities lending arrangements, each contains close-out netting provisions. If two banks have concluded both repurchase and securities lending transactions, they can terminate their relationship under the close-out netting provisions of those agreements separately.

However, they may wish these transactions to be all subject to one single close-out netting process. They can reach this goal, for example, by separately concluding a cross-product master agreement, a standard agreement which has been designed for that purpose.

EXAMPLE 31-4: Two banks conclude repurchase and securities lending transactions and wish these agreements to be subject to a single close-out netting process. They can reach this goal by concluding a multi-product agreement covering both repurchase and securities lending transactions and including a close out netting mechanism for all of these transactions.

31-30. While the agreement pursuant to which collateral provided in certain securities lending transactions could be covered by this provision, it does not govern the treatment of the securities being loaned under a securities lending transaction. As noted above, a collateral agreement associated with a securities lending transaction would only be covered by this provision if the subject collateral is itself securities.

31-31. The definition of close-out netting has been phrased in a broad manner, so as to cover different national legal approaches, for example, set-off, novation or other doctrines.

“equivalent collateral”

31-32. The definition of “equivalent collateral” is, in particular, relevant to determine the collateral taker’s obligations in the case of close-out netting (see Article 33(2)) and where the “right of use”

under a security collateral agreement is exercised (see Article 34).

Article 32

Recognition of title transfer collateral agreements

The law of a Contracting State shall permit a title transfer collateral agreement to take effect in accordance with its terms.

Commentary

I. Introduction

32-1. Article 32 eliminates the risk of so-called re-characterisation, i.e., the risk that an agreement to transfer the full title of collateral is subsequently characterised as a security collateral agreement. Article 32 makes it clear that such re-characterisation is not allowed and that a title transfer collateral agreement takes effect in accordance with its terms.

II. History

32-2. The provision regarding the recognition of title transfer agreements was added during the third session of the CGE. Originally, it also contained a second paragraph relating to the enforce-ment of title transfer collateral agreeenforce-ments by way of close-out netting. See Study LXXVIII – Doc.

57, Appendix 1, p. 18 and Study LXXVIII – Doc. 58, sections 123-127 and 185. The recognition of title transfer collateral arrangements goes back to comments by the International Swaps and Derivatives Association (ISDA). See, notably, Study LXXVIII – Doc. 47, but also earlier submissions by ISDA, such as Study LXXVIII – Doc. 16, section 1 and Study LXXVIII – Doc. 20, p. 8-11.

32-3. No substantive changes were made to the provision at the fourth session of the CGE. See Study LXXVIII – Doc. 94, Appendix 1, p. 16.

32-4. During the first session of the diplomatic Conference, the paragraph relating to the enforcement of title transfer collateral agreements was integrated into current Article 33 on enforcement.

III. Analysis

32-5. The purpose of Article 32 is to eliminate the risk of what is usually referred to as “re-characterisation”, i.e., of a challenge arising from failure to comply with current, generally conservative, legal provisions concerning security interests. This legal risk presents an obstacle to the development of repurchase, or “repo”, transactions (see the description in section 31-22 above) and other forms of collateral transactions based on title transfer.

32-6. Article 32 is intended to eliminate this re-characterisation risk. This means that Article 32 requires a Contracting State to permit the "transfer of full ownership" to be effective under a title transfer collateral agreement. It follows that the Contracting State must give effect to the full ownership of a collateral taker under a title transfer collateral agreement, but nothing more.

32-7. The provision must be read in conjunction with Article 33(2), which confirms that both the secured obligations and the obligation of the collateral taker to return equivalent collateral under the terms of a title transfer collateral agreement may be subject to a close-out netting provision.

This aspect is essential because the enforcement of a title transfer collateral agreement usually entails the implementation of a close-out netting provision.

Article 33 Enforcement

Dans le document Draft Official Commentary on the draft Convention on Substantive Rules regarding Intermediated Securities (Page 146-152)