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

→ Nikola Babić

→ Tanja Šumar

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.