Banking, Finance & CM

The Montenegrin Financial Collaterals Act: Carving Out a New System for Banks and Financial Institutions

The Montenegrin Parliament enacted the Financial Collaterals Act (FCA) in July 2012, as part of the EU integration process. The FCA was drafted using the EU Directive 2002/47/EC of 6 June 2002 on Financial Collateral arrangements (Directive) as its basis. Its greatest contribution is providing a high-quality legal basis for establishing and realising collateral more easily – which also contributes to the stability of the financial system in Montenegro.

Financial collateral agreement as a key element of the FCA

The FCA sets forth a frame­work for estab­lish­ing finan­cial col­lat­er­al through a finan­cial col­lat­er­al agree­ment (Agree­ment). The Agree­ment is the key instru­ment for trans­fer­ring own­er­ship rights or estab­lish­ing pledges over finan­cial instru­ments or cred­it claims. As with the Direc­tive, the speci­fici­ty of the FCA is pre­cise­ly the fact that it applies only to indi­vid­ual enti­ties in the finan­cial sys­tem, such as cen­tral banks, states, inter­na­tion­al devel­op­ment banks and all oth­er finan­cial insti­tu­tions sub­ject to super­vi­sion, act­ing as both col­lat­er­al provider and col­lat­er­al tak­er.

Special feature of the financial collateral – precedence in insolvency

The FCA con­tains some spe­cial fea­tures. It takes prece­dence over the Bank­rupt­cy Act. And its rules on net­ting and real­i­sa­tion of col­lat­er­al and the creditor’s right to use the col­lat­er­alised asset are impor­tant.

How­ev­er, the FCA’s most promi­nent fea­ture by far is weaved into its rules reg­u­lat­ing insol­ven­cy (or bank­rupt­cy) of the col­lat­er­al provider. Specif­i­cal­ly, the insol­ven­cy of the col­lat­er­al provider will not influ­ence the finan­cial col­lat­er­al arrange­ment, as it would under oth­er, more gen­er­al bank­rupt­cy-relat­ed reg­u­la­tions. The gen­er­al rule of the FCA is that the finan­cial col­lat­er­al agree­ment and the rights stem­ming from it remain valid even after the ini­ti­a­tion and dur­ing the insol­ven­cy pro­ceed­ings.

Fur­ther­more, the FCA does not fore­see a stan­dard pro­ce­dure of set­tle­ment through bank­rupt­cy or for class­es of cred­i­tors and their pri­or­i­ty in set­tle­ment. To the con­trary, the FCA allows the col­lat­er­al tak­er to inde­pen­dent­ly enforce its finan­cial col­lat­er­al even after the insol­ven­cy pro­ceed­ings have been ini­ti­at­ed. In oth­er words, the FCA allows the col­lat­er­al tak­er to cir­cum­vent the insol­ven­cy pro­ceed­ings and realise its col­lat­er­al with­out being depend­ing on deci­sions ren­dered in such pro­ceed­ings. More­over, even if the finan­cial col­lat­er­al was pro­vid­ed to the col­lat­er­al tak­er after adop­tion of the deci­sion ini­ti­at­ing insol­ven­cy, such col­lat­er­al will sur­vive if the col­lat­er­al tak­er was not aware and was not required to be aware of the ini­ti­a­tion of insol­ven­cy against the col­lat­er­al provider.

What to do with the financial collateral?

The finan­cial col­lat­er­al can be enforced as soon as (and for as long as) the col­lat­er­al provider defaults on the under­ly­ing, col­lat­er­alised oblig­a­tion. In such case, the col­lat­er­al tak­er has the right (i) (as usu­al) to sell the pledged finan­cial instru­ment and use the pro­ceeds to set­tle its claims against the col­lat­er­al provider, (ii) to retain the pledged finan­cial instru­ment in its pos­ses­sion and even (iii) to exe­cute the close-out net­ting to ter­mi­nate the finan­cial col­lat­er­al ear­ly.

Using the financial collateral

The FCA gives the col­lat­er­al tak­er the right to use the rel­e­vant col­lat­er­al and to dis­pose of it as if the col­lat­er­al tak­er were the own­er of the col­lat­er­alised asset. This right of use ends only if the col­lat­er­al provider set­tles its debts or if the col­lat­er­al is enforced or net­ted pur­suant to the Agree­ment. But the col­lat­er­al tak­er still does not gain the right of use over cred­it claims as col­lat­er­alised assets.

Cutting the procedure short

The FCA pro­vides anoth­er con­ve­nient pos­si­bil­i­ty for the par­tic­i­pat­ing par­ties. If a net­ting clause was intro­duced in the Agree­ment, it would make it pos­si­ble for all oblig­a­tions of the par­ties to be (i) accel­er­at­ed to become imme­di­ate­ly due and expressed as an oblig­a­tion to pay an amount rep­re­sent­ing their val­ue or (b) ter­mi­nat­ed and replaced by an oblig­a­tion to pay such an amount, or for an account to be tak­en of what is due from each par­ty to the oth­er, and a bal­ance of such account to be payable by the par­ty owing the larg­er of those amounts.
As men­tioned, the insol­ven­cy of the col­lat­er­al provider will not influ­ence the effect of the net­ting clause; the close-out net­ting will be pos­si­ble even if the col­lat­er­al provider is under­go­ing bank­rupt­cy.

Conclusion

The FCA has turned col­lat­er­al­i­sa­tion into one of the pri­ma­ry risk mit­i­ga­tion mech­a­nisms enabling a bet­ter finan­cial envi­ron­ment to devel­op in Mon­tene­gro. In that sense, one of the FCA’s most impor­tant points – its prece­dence over oth­er rules reg­u­lat­ing insol­ven­cy – may prove to be the deci­sive step to an improved, mod­ern finan­cial mar­ket in Mon­tene­gro.

The FCA gives the collateral taker the right to use the relevant collateral and to dispose of it as if the collateral taker were the owner of the collateralised asset.