On 14 August 2015, an amendment to the Bulgarian law implementing the EU Financial Collateral Directive and extending its personal scope to "any person" entered into force. The amendment was primarily meant to allow the Bulgarian Bank Deposits Guarantee Fund to serve as an eligible counterparty to repo transactions. However, the new law might have a wider impact, as it allows some SPVs set-up for particular bonds or derivatives transactions that previously did not fall in the personal scope of the law to now serve as eligible counterparties to financial collateral arrangements.
1 Personal Scope of the EU Financial Collateral Directive
The EU Financial Collateral Directive 2002/47/EC (Directive) has a restricted personal scope of application.
Firstly, eligible counterparties to a financial collateral arrangement under the Directive may be certain public authorities, quasi-sovereign entities, and financial institutions as listed in art 1, para 2 points (a) to (d) of the Directive (Eligible Institutions).
Secondly, if one of the counterparties is an Eligible Institution, the other counterparty may be "a person other than a natural person, including unincorporated firms and partnerships" - see to this effect art 1, para 2 point (e) of the Directive.
Member States, however, are permitted to exclude (either entirely or partially) that second group of counterparties - i.e. legal persons where the other counterparty is an Eligible Institution - when transposing the Directive into their jurisdictions. In other words, they are permitted to opt-out of the Directive on that particular matter.
2 Personal Scope of Financial Collateral Arrangements in Bulgaria until 14 August 2015
Initially, Bulgaria availed partially of the possibility to opt-out of art 1, para 2 point (e) of the Directive. In particular, the Bulgarian Financial Collateral Agreements Act (FCA) that was in force until 14 August 2015 featured as eligible counterparties: (i) Eligible Institutions; and (ii) merchants1 excluding "sole merchants"2, as well as3 partnerships (дружества) that are not legal persons, provided that the other party to the financial collateral agreement is an Eligible Institution. In other words, the reference in the Directive to "a person other than a natural person" was transposed in Bulgaria through a reference to a narrower group, i.e. "merchants excluding sole merchants ".
This narrow scope proved to be problematic for certain financial markets players who sought to benefit from the regime under the FCA, the most important of which being the Bulgarian Bank Deposits Guarantee Fund. It was actually via a rule in the final provisions of the Bank Deposits Guarantee Act that the FCA's personal scope was extended4, to embrace inter alia the Fund.
3 Obstacles for the Bank Deposits Guarantee Fund to be an Eligible Counterparty under the FCA until 14 August 2015
Being restricted by statute to invest only in certain bank deposits and governmental bonds (GBs), the Bulgarian Bank Deposits Guarantee Fund (Fund) obviously regards repo transactions over GBs (which form a large portion of the Fund's assets) as a means to provide itself with liquidity in case of need.
Thus, the Fund's Annual Report for 20135 (2013 Report) contains a statement that the Fund took steps in 2013 to enter into master agreements for repo transactions with Bulgarian banks6. According to the 2013 Report, such agreements would be useful for the Fund by ensuring an alternative route to liquidity in emergency scenarios and would minimise the negative impact on the GBs market if it were to be necessary for the Fund to sell its portfolio of GBs in emergency scenarios7.
Arguably, however, until 14 August 2015, there would seem to have been legal obstacles for the Fund to enter into any repo transactions.
First, there is a general prohibition in Bulgaria - under the Bulgarian Obligations and Contracts Act - whereby any sale with a repurchase clause is declared void. There is an exception from that prohibition under the Commerce Act, whereby such sales with repurchase clauses are valid, but it is applicable only when the parties are merchants. It is debatable whether the Fund may be classified as a merchant under Bulgarian law8, so it was uncertain whether it could avail of the exception under the Commerce Act.
On another hand, the FCA regulates title transfer agreements (including expressly repo transactions), but its personal scope, as explained above, used to be similarly restricted to "merchants", so under the FCA it was equally uncertain whether the Fund could qualify as an eligible counterparty to repo transactions.
4 Amendments to the FCA and Other Statutory Instruments to Provide Capacity for the Fund to Enter into Repo Transactions
In order to make the Fund eligible to enter into repos, two substantial amendments in two different statutory instruments have been made by the Bulgarian Parliament.
The first amendment is to the FCA, in which the former reference to "a merchant" (denoting the last of those groups of eligible counterparties specified under the FCA) has been substituted by "any person"9. As the Fund is expressly classified as "a legal person" by a statutory rule, it may now fall within that last group of eligible parties under the FCA. One should note that in order for the Fund to be eligible under the FCA, its counterparty to the respective financial collateral arrangement must be an Eligible Institution.
Secondly there is an express new rule in the law regulating the Fund's activities permitting it to enter into "financial transactions to reduce risks or provide liquidity". The new rule clarifying the matter seems justified since the Fund, unlike some other legal persons under Bulgarian law, has a limited capacity by definition. Therefore, only amending the FCA might have been viewed as insufficient to provide the Fund with the capacity to enter into repo transactions. That second amendment seems to be sufficiently broad to reinforce the Fund's capacity to enter not only in repos, but also in certain derivatives that have similar economic effects, eg total return swaps.
5 Other Potential Financial Markets Players that would be Eligible under the FCA, Following the Recent FCA Amendment
Apart from the Fund, a second group of potential financial market players stands to benefit from the extended personal scope of the FCA and is worth mentioning. This group includes certain offshore special purpose vehicles (SPVs) set up for particular financial transactions for which the involved parties may wish to receive financial collateral – eg as a security for their potential exposure under derivatives with Bulgarian counterparties. Such provision of financial collateral may be of vital importance to ensuring enforceability of the close-out netting arrangements in the respective derivative agreement. That is so, because Bulgaria does not have general netting-friendly legislation, thus forcing interested parties to seek other methods to make their close-out netting arrangements effective. It is therefore customary in Bulgaria to request provision of financial collateral (linked to the derivative transaction), thus bringing into play the netting mechanism under the FCA. That netting mechanism may be negotiated as being applicable to any mutual obligations of the counterparties, including their obligations under the derivative with respect to which a financial collateral arrangement has been entered into. Thus, the mutual obligations under a derivative may be effectively netted in case of a termination event under the respective derivatives agreement.
Why is this group of SPVs important? When structuring derivatives or bonds products for their clients, banks sometimes prefer instead of entering into the transactions themselves, to set up SPVs (often in a foreign jurisdiction) to serve as counterparties to the particular transaction10. Previously there was a degree of uncertainty as to whether some offshore SPVs could be classified as merchants for the purposes of the FCA (and thus serve as eligible counterparties to financial collateral arrangements). The SPVs' status as merchants for the purposes of the FCA must be determined under their national law. However, in our practice we have experienced that some foreign law counsels are reluctant to provide a capacity opinion that certain SPVs are merchants under their national law - eg on account of the fact that they did not perform merchant's activity in a commercial manner, but rather were set up for the purposes of a single transaction. That uncertainty proved to be an obstacle to potential derivatives transactions with Bulgarian counterparties.
However, as a result of the extension of the personal scope of the FCA, banks may now structure financial transactions for their Bulgarian clients by using offshore SPVs that have the status of "legal persons" under their national law. Determining this status must be less controversial than classifying SPV's as "merchants", which had been required before the amendment to the FCA. Provided the counterparty to the transaction is an Eligible Institution (eg an insurance undertaking, pension fund or another bank for example), such SPVs may validly enter into financial collateral arrangements (and receive financial collateral). And if the respective financial collateral arrangement is well drafted, and is linked in an appropriate manner with the respective derivative, that approach may suffice to ensure enforceability of the close-out netting under the derivative.
Footnotes
1. The term "merchant" (търговец) under Bulgarian law covers: (a) legal entities incorporated pursuant to the Bulgarian Commerce Act (such as limited liability companies, joint-stock companies, general partnerships, limited partnerships, partnerships limited by shares), (b) any other natural or legal person that carries out in a commercial manner (по занятие) a broad spectrum of transactions listed under the Commerce Act (such as purchasing goods or securities with the purpose of re-selling them, selling goods manufactured by those persons, commercial agency, transportation, insurance, banking, warehousing and other services), as well (c) any other person who, although not carrying out the transactions listed in the statute, has created an enterprise the scale and subject matter of which requires its affairs to be organized in a professional commercial manner.
2. "Sole merchants" are natural persons registered as merchants under the Commerce Act, i.e. without setting up a separate company.
3. "As well as" (както и) is a verbatim translation of the conjunction used in the Bulgarian law. This conjunction may raise doubts in the particular case as to (i) whether the "partnerships" (referred to after the usage of "as well as") belong to the excluded pool along with the sole merchants, or (ii) whether they are the second eligible group next to the "merchants". We believe that the second alternative is to be preferred, as Bulgarian law must be construed in accordance with the Directive, in which such partnerships are expressly included in its personal scope.
4. It is a customary statutory practice in Bulgaria to amend certain statutory acts by inserting new provisions to that effect at the end (i.e. final provisions) of another statutory act where the latter act is linked in terms of its subject matter to the former one.
5. Available in Bulgarian language on the webpage of the Fund at the following link: http://dif.bg/wp-content/uploads/2014/05/FGVB_Godishen_otchet_2013.pdf
6. See page 23 of the 2013 Report.
7. Ibid.
8. The Fund is not set up as a company under the Commerce Act (which could have been one possibility to bring it within the range of merchants under the Commerce Act), but has been set-up under a special piece of legislation whereby it is declared to be a "legal person". Furthermore, due to its limited capacity, it is debatable whether the Fund performs commercial activity in a commercial manner (which could have been another possibility to bring it within the range of merchants under the Commerce Act).
9. That new reference to "any person" under the FCA may arguably capture not only legal persons, but some natural persons as well. However a detailed analysis on whether FCA may be applicable to individuals is outside the scope of this article.
10. Banks do so for various legitimate reasons – eg tax optimisation and risk-mitigation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
