Global Markets Update

On 7 July 2022, the Luxembourg Parliament (Chambre des Députés) voted a new bill no 7933 (the "Bill") amending the Luxembourg law of 5 August 2005 on financial collateral arrangements, as amended (the "Financial Collateral Law" or the "Law"). The Bill reinforces the legal certainty of Luxembourg financial collateral arrangements by introducing a number of welcome clarifications to the Law.

While the Bill primarily intended to align certain provisions of the Luxembourg law with Regulation (EU) 2021/23 of 16 December 2020 on a framework for the recovery and resolution of central counterparties (the "Recovery and Resolution Regulation" or the "Regulation"), the Luxembourg Parliament has also seized this opportunity to update the Financial Collateral Law in line with the current market practice and case law. Most importantly, clarifications have been added to the provisions regulating the enforcement of security interests by way of sale and the application of enforcement proceeds.

Recovery and Resolution Regulation

Article 2-1 of the Financial Collateral Law will now include a reference to the Recovery and Resolution Regulation in order to specify that the Financial Collateral Law applies without prejudice to the provisions of the Regulation as well as the provisions of Part I of the 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, which include some derogations from the Financial Collateral Law in certain circumstances.

Enforcement Trigger – Freedom of choice

In line with the general creditor friendly orientation of the Financial Collateral Law, the Luxembourg courts previously confirmed that security financial collateral arrangements can be enforced upon the occurrence of any contractually agreed enforcement trigger event (in the specific case, a breach of financial covenant), irrespective of whether a payment default occurred or any secured obligations are due and payable. This flexibility in the structuring of an enforcement clearly is a clear stand out feature of the Luxembourg financial collateral regime for creditors compared to other European countries.

The amendments to the Financial Collateral Law set out in the Bill now canonise this jurisprudential position by amending the definition of "Enforcement Event" in the Law to refer explicitly to "any event of default or any event whatsoever" (fr. "une défaillance ou tout autre événement quelconque").

Sale of pledged assets – Modernisation and increased flexibility

In addition to the technical amendments relating to the application of the Recovery and Resolution Regulation, more substantial amendments relating to the enforcement by way of sale of pledged assets have been introduced in the Law. However, it should be noted that parties may always agree on alternative methods of enforcement and the provisions of Financial Collateral Law only apply to the extent the pledgor and the pledgee have not agreed otherwise.

In the past the Financial Collateral Law provided the pledgee with a possibility to enforce pledged assets "by private sale on normal commercial conditions, by sale over a stock exchange or by public auction" and by default, public auction was to be effected through the Luxembourg Stock Exchange. (the "LuxSE") based on a specific license.

The reference to the LuxSE has become outdated as its status has changed and thus a new detailed public auction procedure has been introduced to the Financial Collateral Law. Public auctions of pledged assets will be led by a notary or bailiff following a detailed procedure set out in the Law. Interestingly, the Law provides that assets can be acquired in a public auction through any payment method, including set-off against the obligations secured under the relevant security arrangement.

Separately, in respect of the private sale of financial instruments admitted to trading, the reference to "stock exchange" is now updated to clarify that sale of assets can happen on a platform on which pledged assets are admitted to trading and this does not need to be a regulated market only. Thus, assets admitted to trading on any regulated or un-regulated market can be directly disposed of on the same market, this includes any Luxembourgish, European or third country regulated markets, MTF or OTF.

Collateral over units in investment funds – Extension of enforcement methods

An additional new feature in the Bill is the introduction of provisions regarding the value at which units in an undertaking for collective investments subject to a security financial collateral arrangement can be appropriated.

Indeed the Bill specifies that such units may be appropriated either (a) (for units admitted to trading on an exchange) at the market price of the relevant units or (b) at their latest net asset value (which cannot be older than a year).

According to a new sub-paragraph (f) of the article 11(1) of the Financial Collateral Law, the pledgee may also request the redemption of the pledged units or shares at a price determined in accordance with the constitutional document of the relevant undertaking for collective investments.

This addition to the Financial Collateral Law follows an evolution in market practice where a similar approach on appropriation of fund units had become increasingly common.

Insurance contracts – Precisions on enforcement methods

An additional sub-paragraph (g) covering insurance contracts has been included in article 11(1) of the Financial Collateral Law, thereby also indirectly confirming that insurance contracts constitute financial collateral within the scope of the Financial Collateral Law (some legal scholars had debated this previously). The Financial Collateral Law now offers a new, specific enforcement method for this type of claims by providing that a pledge over such insurance contracts can be enforced by requesting the repurchase of the contract or demanding the payment of all sums due under the insurance contract in satisfaction of the secured obligations.

Application of proceeds – Clarifications

As mentioned above, one of the advantages of the Luxembourg financial collateral regime is that is allows security interests to be enforced even if there is no payment default or acceleration of the underlying secured obligations.

This however also raised the question how and when enforcement proceeds should be applied against the relevant secured obligations or whether the pledgee should be required to hold these proceeds as continuing security until secured obligations become due and payable.

The Bill now clarifies this question as the amendments introduced to the Financial Collateral Law provide that, unless otherwise agreed by the parties, enforcements will be immediately applied against the secured obligations on enforcement. This clarification again cements a position previously adopted by legal practice into the Financial Collateral Law.

Summary

On 15 July 2022, the requirement for a second vote in the Luxembourg parliament (Chambre des Députés)on the Bill was waived and its publication in the official journal of Luxembourg is expected, after which the amendments discussed will enter into force.

The changes discussed bring about some helpful clarifications to the Financial Collateral Law, without changing its substance and reinforce its strong creditor friendly position.

For more information on enforcement of Luxembourg financial collateral arrangements, please refer to our previous briefing.