On 20 December 2021, a draft law No. 7933 (the "Draft Law") was lodged with the Luxembourg Chamber of Deputies. While the main aim of the Draft Law is to implement Regulation (EU) 2021/23 of 16 December 2020 on a framework for the recovery and resolution of central counterparties (the "CCP Recovery and Resolution Regulation"), the Draft Law also takes the opportunity to bring a number of changes to the Luxembourg law of 5 August 2005 on financial collateral arrangements, as amended (the "Financial Collateral Law"), which transposes Directive 2002/47/EC of 6 June 2002 on financial collateral arrangements (the "Financial Collateral Directive") into Luxembourg law. This publication will focus on such proposed changes to the Financial Collateral Law.
The Financial Collateral Law is extensively used in both cross-border and domestic financing transactions and governs pledges and title transfers for security purposes over financial instruments (including equity and debt securities) and claims and repurchase agreements over any kind of assets. The Financial Collateral Law is widely recognised as offering a robust and flexible framework to parties. The Draft Law aims to further strengthen the Financial Collateral Law.
Inclusion of a reference to the CCP Recovery and Resolution Regulation in the Financial Collateral Law
The Draft Law proposes to introduce a reference to the CCP Recovery and Resolution Regulation in article 2-1 of the Financial Collateral Law. As a result, such article would provide that the provisions of the Financial Collateral Law shall apply without prejudice to Part I of the Luxembourg law of 18 December 2015 on the failure of credit institutions and certain investment firms, as amended, and Part IV of the Luxembourg law of 5 April 1993 on the financial sector, as amended and to the laws and regulations of other EU Member States which transpose Directive 2014/59/EU establishing a framework for the recovery and resolution of credit institutions and investment firms and the CCP Recovery and Resolution Regulation (including any restrictions imposed by such legal instruments on the enforcement or the effect of a financial collateral arrangement or a close-out netting or set-off provision). This proposed amendment reflects a corresponding amendment to be made from 12 August 2022 by the CCP Recovery and Resolution Regulation to the Financial Collateral Directive.
Clarification about enforcement events of pledges
The Draft Law proposes to make two helpful clarifications relating to enforcement events of pledges.
First, it proposes to further clarify that any event agreed between the parties to a pledge agreement can serve as an enforcement event. Although this was already provided for in substance in the Financial Collateral Law, the Draft Law specifies that an enforcement event is a default or any other event 'whatsoever' (in French: 'quelconque') agreed between parties. Such addition confirms that the agreed enforcement events entitling the collateral taker to enforce a pledge can be events other than payment defaults, such as, according to the commentary accompanying the Draft Law, violations of financial covenants or other events or circumstances relating to the general framework or to certain specific aspects of a transaction. In the past, there had been discussions about which events could be agreed as enforcement events of a pledge governed by the Financial Collateral Law. The Luxembourg Court of Appeals has for instance confirmed in a court decision of 22 January 2020 that the mere violation of a financial covenant could in itself constitute an agreed enforcement event of a pledge.
Second, the Draft Law proposes to introduce in the Financial Collateral Law a new paragraph that provides that where the obligations secured by a pledge are not yet due and payable at the time the pledge is enforced, the proceeds of enforcement shall, unless otherwise agreed, be applied in discharge of the obligations the pledge secures.
Where parties agree that a pledge can be enforced on the basis of an enforcement event that may occur prior to a time at which the underlying secured obligations have become due and payable, there have been interrogations in the past on how enforcement proceeds should be treated, more particularly on whether they should be applied immediately in discharge of the underlying secured obligations or could be held as continuing security. The Draft Law helpfully clarifies that the proceeds shall be applied in discharge of the underlying secured obligations unless otherwise agreed between parties, thus offering flexibility to the parties to agree on the application of proceeds.
Amendments to the enforcement methods of pledges
The Draft Law proposes to modernise article 11 of the Financial Collateral Law dealing with enforcement methods of pledges.
First, the Draft Law proposes to specify in article 11 that pledged assets that are admitted to trading on a trading venue could be sold on such trading venue at their market price. A trading venue is, according to the draft law, a regulated market, a multilateral trading facility or an organised trading facility.
Second, the Draft Law proposes to better distinguish between (i) an appropriation of financial instruments admitted to trading on a trading venue (which appropriation could, unless the parties have otherwise agreed, be made at the market price of such financial instruments), and (ii) an appropriation of units or shares in a collective investment undertaking, which could, unless the parties have otherwise agreed, either be made at their market price, provided that such units or shares are admitted to trading on a trading venue, or at the price of the last published net asset value by, or for that, collective investment undertaking, provided that the last publication of the net asset value is not older than one year.
Third, the Draft Law introduces two new paragraphs to article 11 of the Financial Collateral Law which deal with the enforcement of pledges over units or shares in a collective investment undertaking and claims resulting from insurance contracts (including life insurance and capitalisation policies).
The new paragraphs would provide that (i) with respect to units or shares in a collective investment undertaking, the collateral taker can enforce the pledge by requesting the redemption of the pledged units or shares of such collective investment undertaking at their redemption price in accordance with the constitutional documents of that collective investment undertaking, and (ii) with respect to a pledge over claims arising from insurance contracts, the collateral taker may enforce such pledge by exercising all the rights arising under the pledged insurance contract, including, in the case of a life insurance contract or capitalisation transaction, the right to surrender, or demand payment from the insurance company of any sums due under, such insurance contract.
The new paragraph on the enforcement of pledges over claims arising under insurance contracts should also have the benefit of putting to rest doubts that had been raised by certain legal authors about the applicability of the Financial Collateral Law to pledges over insurance contracts. It should however be noted in this respect that a pledge over a Luxembourg life insurance contract would still need to comply with articles 116 and 117 of the Luxembourg law of 27 July 1997 on the insurance contract, which is not being amended by the Draft Law. Such articles provide, amongst other things, that a life insurance contract may only be pledged by an endorsement signed by the policyholder, the collateral taker and the insurer and, where the benefit of a life insurance contract has already been accepted, with the consent of the beneficiary.
Fourth, the Draft Law proposes to fundamentally change the public auction enforcement method for pledges, which was rarely, if at all, used. Currently, the Financial Collateral Law foresees that a public auction would, unless otherwise agreed, be made at, and by, the Luxembourg Stock Exchange. Such an enforcement method has been rendered obsolete by the fact that the Luxembourg Stock Exchange no longer benefits from a governmental concession, but is now one of many regulated professionals of the financial sector and it has therefore become inappropriate to delegate such a mission to the Luxembourg Stock Exchange.
The Draft Law proposes to provide in the Financial Collateral Law for a new public auction procedure which would apply unless parties agree otherwise. The public auction would be carried out by a Luxembourg notary or bailiff and the Draft Law regulates such procedure in detail, including by factoring into such procedure potential authorisations that may be required to be obtained from Luxembourg or foreign public authorities in the event of an enforcement of a pledge over the shares in a regulated entity.
Although an amendment of the current procedure is helpful and was somehow inevitable, it remains to be seen whether in practice parties would often use this new public auction enforcement procedure which would likely be longer and more costly than an enforcement by way of appropriation or sale.
Other notable amendments
The Draft Law also aims to:
specify that the safeguarding of asset rules introduced into the Financial Collateral Law by the Luxembourg law transposing, and implementing, Directive 2014/65/EU on markets in financial instruments ("MiFID II")) and thereto relating regulations also apply to repurchase agreements governed by the Financial Collateral Law. Such rules prohibit credit institutions, when providing investment services or performing investment activities (within the meaning of MiFID II) and investment firms from concluding a title transfer for security purposes with a retail client within the meaning of MiFID II. They also oblige such credit institutions and investment firms to analyse and document the appropriateness of title transfers entered into with professional clients and eligible counterparties within the meaning of MiFID II and highlight risks relating thereto to such persons;
clarify that sequestration measures (séquestre) do not prejudice financial collateral arrangements and set-off (including their enforcement); and
correct certain clerical mistakes contained in the Financial Collateral Law.
The Draft Law should now normally be examined within the designated commission(s) of the Luxembourg Chamber of Deputies, be subject to review by the State Council and the applicable professional bodies and eventually be put to a vote. Such process can result in amendments being made to the Draft Law and, as a result, if voted, the binding law that may result from the Draft Law may differ from the Draft Law examined in this publication.
We will continue to monitor any significant new developments and keep you informed.