Party Autonomy in International Property Law - Peace Palace Library

11. Financial Collateral Arrangements and Party Autonomy
poration specializing in telecommunications services and the issuer of a
large number of bonds. Alpha Bank has hedged this exposure by entering
into a credit default swap with Rock Solid Bank, also based in the Netherlands.
Under this credit default swap, in the case of a default of Issuer,
Alpha Bank will receive payments from Rock Solid Bank in order to
make good its loss. The maximum exposure of Rock Solid Bank under
this arrangement is EUR 20,000,000, i.e. the total amount due from Issuer
to Alpha Bank. The parties have agreed that Rock Solid Bank is to
provide financial collateral to Alpha Bank in order to limit this exposure.
At a certain point in time this means that collateral with a value of EUR
2,000,000 needs to be provided. 18 How could this be effected? There are
at least four options:
(i) Rock Solid Bank could post 19 cash collateral with Alpha Bank
through a title transfer arrangement;
(ii) Rock Solid Bank could charge or pledge 20 a cash balance that it holds
with either Alpha Bank or a third party; 21
18
The value of the collateral to be provided depends on the contract between
the protection seller and the protection buyer and is often arrived at through
the use of complicated mathematical models of credit risk. Moreover, since the
collateral itself may consist of debt securities and since these types of securities
are constantly subject to changes in value, there may be various moments during
the lifetime of the credit default swap where additional collateral needs to
be provided or where collateral that has previously been provided may have to
be returned to the collateral provider. I will leave all these complications to a
side and just assume that there is a need to provide collateral in the amount
(i.e. with a market value) of EUR 2,000,000.
19
‘Posting’ collateral is the industry jargon for collateral arrangements that involve
an outright transfer of collateral.
20
The term ‘pledge’ is used here as understood under Dutch law: the standard
form security interest over an asset (generally) entitling the holder to sell the
asset or (if it is a claim) collect it from the debtor and keep the proceeds. In
an English law context, the term may have a more restrictive meaning (see
Hudson 2009, § 45-25) and the standard form security interest would be a
charge. In the remainder of this chapter, I only use the term pledge because
my reference point is Dutch law security interests.
21
Since the credit crunch, market practice has been that a third party custodian
is no longer acceptable in light of such custodian’s additional insolvency
risk. An exception is Euroclear Bank, the Brussels (Belgium) based financial
services company that specializes in the settlement of securities transactions
as well as the safekeeping and asset servicing of these securities.
Reinout M. Wibier
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