3. Reuse of financial collateral

3.1. Repledge

The starting point is that the collateral-taker to a collateral agreement, unless explicitly excluded, has an independent right to repledge. A distinction can generally be made between an agreed right of use and an independent right to repledge <1>.

--------------------------------

<1> Prop. 2002/03:107. P. 45.

Ch. 10, § 6 of the Commercial Code (1736:1232) provides an independent right for collateral-takers to repledge collateral, i.e. it regulates the cases that are not covered by an agreement. As this provision, which dates back to 1736, is very old, certain parts of it are deemed to be obsolete. Its contents are also uncertain <1>. The most important condition, which is not obsolete, is that a repledge cannot take place for a larger debt than the original debt or on conditions different from the original agreement between the initial collateral-provider A (the pledgor) and collateral-taker B (the pledgee). However, as this rule can be modified by agreement, the parties can agree on a more extensive right of use <2>. It is also required that the owner of the collateral is notified about the repledge although this condition is not considered to have constitutive implications. Hence, failure to notify the owner does not affect the validity of the repledge as such <3>.

--------------------------------

<1> Ibid. P. 43.

<2> Prop. 2004/05:30. P. 41 - 54; avseende egendom (6 ed., Norstedts Juridik AB, 1996). P. 300.

<3> Prop. 2004/05:30. P. 41 - 54; Ds 2003:38. P. 82; ; Walin G. Pantratt ( ed., Norstedts Juridik AB, 1998). P. 52.

Where the collateral consists of financial instruments, the Trade with Financial Instruments (1991:980) Act applies. Under Ch. 3, § 1 of the Act, institutions under the supervision of the Swedish Financial Services Authority (Finansinspektionen) shall specify clearly in a special agreement the conditions under which they have the right to dispose of their clients' financial instruments. The type of disposal shall be carefully specified and can, for example, include a right to sell or pledge the financial instruments to a third party. The same applies if the institution takes part or facilitates such an arrangement between other parties. It should be noted that it can be questioned whether this paragraph covers repledge or whether it only covers the case where a custodian uses its client's assets (depositum irregulare) <1>.

--------------------------------

<1> Cf.: Prop. 2004/05:30. P. 124 - 125.

Chapter 3, § 3 of the Trade with Financial Instruments Act provides an explicit right to repledge or transfer the pledge right, either together with the underlying debt or in some other way. If a company under the supervision of the Financial Services Authority has received financial instruments as security, the company is permitted to pledge or transfer the pledge right only together with the underlying obligation that it secures. A repledge or transfer detached from the underlying obligation requires the same type of special agreement as set out under Ch. 3, § 1 of the Act. A repledge or a transfer cannot take place for a larger amount or on more stringent conditions than under the original agreement between A and B.

The rules under Ch. 3 of the Trade with Financial Instruments Act were preceded by the Act on a Right to Use Others' Securities (1979:750), which in its turn replaced the Act with Certain Provisions with a Right to Use Others' Securities (1919:242). The 1919 Act was implemented as a result of an increasing trend in repledging financial collateral and disposing of securities held in custody or kept by commission agents in the 1910s, which itself developed from an expanding trade in securities. During this time a practice developed whereby brokers repledged their customers' securities against a revolving line of credit, a method which can have the effect of repledging collateral on more stringent conditions than under the original agreements between the brokers and their customers as each financial instrument is repledged against the broker's total credit. Brokers also repledged collateral for a larger debt following an increase in the price of the collateral. Even though Ch. 10, § 6 of the Commercial Code, which was applicable at this time, forbids a repledge on more stringent conditions, since it is amendable through agreement, the practice was to include a provision in the standard agreement between brokers and their customers approving of such a repledge. Repledge of securities also took place against all of the broker's obligations, which in effect was a repledge on more stringent conditions. Since the clauses in the agreements on repledge often were difficult to fully comprehend the situation was considered unacceptable <1>. It was also common to assume a right to use financial collateral on more stringent conditions even though explicit permission was absent and, as a result, a special Act regulating the right to use securities was considered necessary <2>. Paragraph 2 of the implemented provisions contained a requirement that the securities should be carefully described to ensure that they could be distinguished from other securities.

--------------------------------

<1> Cf.: NJA, II, 1919. P. 702 ff.

<2> Ibid. P. 702 - 704.

In the discussions which preceded the 1979 Act, abolition of the 1919 Act was considered as it posed difficulties for brokers in obtaining finance <1>. The protection for investors was, however, deemed to compensate for this inconvenience. The biggest difference between the 1919 and the 1979 Acts was that in the 1979 Act a broker under the supervision of the Financial Services Authority no longer had to specify the securities that the use concerned. The specification of each security involved practical constraints and was also burdensome for brokers <2>. In 1991, the 1979 Act was replaced by the current provisions in the Trade with Financial Instruments Act described above.

--------------------------------

<1> Prop. 1978/79:9. P. 158; SOU 1976:54. P. 118 f.

<2> Prop. 1978/79:9. P. 158 f.; SOU 1976:54. P. 118 f. and 180; Myrdal S. . Om av pant och (Norstedts Juridik AB, Stockholm, 2005). P. 67.

The rules under Ch. 3 of the Trade with Financial Instruments Act have been said to be primarily of a regulatory law nature, and thus, do not govern private law matters. In keeping with the regulatory law nature of these rules, the Financial Services Authority may order an institution that does not comply with them to cease trading subject to a fine <1>.

--------------------------------

<1> Ch. 6, § 2 Trade with Financial Instruments Act; Prop. 2004/05:30. P. 48; Ds 2003:38. P. 72 - 73.

As with the rule in Ch. 10, § 6 of the Commercial Code, the contents of the rules under Ch. 3 of the Trade with Financial Instruments Act are unclear. Since the rules are of a regulatory character, it is also unclear whether an agreement that is contrary to the rules will be invalid or result in other legal consequences. An agreement that conflicts with these rules may be modified under § 36 of the Contract Act (1915:218) <1>.

--------------------------------

<1> Prop. 2004/05:30. P. 48; see also: Myrdal S. . P. 445 - 447.

The Financial Services Authority may provide additional regulations in respect of terms and conditions for agreements covered by Ch. 3, § 1 and 3 of the Trade with Financial Instruments Act <1>.

--------------------------------

<1> Ordinance (2007:375) on Trade in Financial Instruments.

Euroclear Sweden has also included a few provisions on repledge in its terms and conditions. Euroclear Sweden's terms and conditions are binding through accession to the VPC-system. Under these regulations a repledge shall be marked on the pledge account with a designated number referring to the collateral-taker C (the repledgee) and B's (the pledgee and repledgor) pledge number <1>. When a nominee is repledging nominee-registered securities, the pledge is registered on a special nominee-account to which the collateral is transferred. When the repledging nominee is also the account operator, the registration of the repledge may not be carried out by the same operator. Instead, the repledge needs to be registered by another account keeping institution to which the collateral is transferred. The repledging nominee is, however, registered as the holder of the repledged collateral <2>.

--------------------------------

<1> Euroclear Sweden General Terms: Account Keeping and Clearing (2009-02-07). P. 51.

<2> Ibidem.

It is clear from the above that unless there is an exclusion clause to that effect in the pledge agreement, B has A right to repledge the collateral. This right can be said to spring from B's rights as a pledgee <1>.

--------------------------------

<1> Cf.: Prop. 2004/05:30. P. 43 - 44.

If B repledges the collateral on more stringent conditions or for a larger debt than under the agreement with A, the repledge agreement is invalid - at least in relation to the extent that the amount exceeds the original amount or in relation to those clauses that go beyond the provisions under the original agreement <1>. As part of the prohibition on repledging collateral on more stringent conditions, C cannot realise the collateral before B has been able to do so or use the collateral on conditions other than those under the agreement between A and B <2>. A bona fide purchaser can, however, acquire the collateral free from adverse claims, i.e. free from A's property rights. The same applies to collateral arrangements; A bona fide collateral-taker can acquire a security interest in the collateral <3>.

--------------------------------

<1> Ch. 10, § 6 Commercial Code.

<2> M. Hellden & Millqvist G. (Norstedts Juridik AB, , 2001). P. 197; Walin G. . P. 327 f.

<3> Cf.: Prop. 2004/05:30. P. 54.

There is no explicit rule as to B's duty to return the collateral to A; rather, it is a matter of course. Since B has not cancelled the contract with A, the collateral still needs to be returned <1>. B's obligation to return the collateral derives from A's ownership rights in the collateral; as the owner of the collateral A has a right to separate the asset on the bankruptcy of B <2>.

--------------------------------

<1> Walin G., . P. 310.

<2> Cf.: Ch. 4, § 17 - 19 Code of Execution (1981:774) and Ch. 3, § 3 Bankruptcy Act (1987:672).

Generally, the pledge right is limited by the duty of care in respect of the collateral so it can be returned to A <1>. C is furthermore considered to have an independent duty of care in relation to B. The liability of B and C in relation to A is deemed to be joint and several <2>.

--------------------------------

<1> Ch. 10, § 3 - 4 Commercial Code; Ds 2003:38, Finansiella . P. 69; G. Lennander, Panthavares skyldigheter vid pantavtal om egendom (Stockholm, 1977). P. 63 ff.; Walin G. . P. 296 ff.

<2> G. Lennander, Panthavares skyldigheter. P. 177; Walin G. . P. 309.

As to perfection, the same requirements which apply to a normal pledge are deemed to apply to a repledge of collateral, ie the collateral-provider must be cut-off from controlling the collateral <1>.

--------------------------------

<1> . P. 240, 299. For a different opinion on perfection of repledge, see: Myrdal S. , who argues that notification to A would best achieve the purpose of cutting B off from controlling the collateral, as such notification would limit A's incentive to pay its debt to B.

One of the main questions that have been discussed is whether Ch. 10, § 6 of the Commercial Code and the rules under Ch. 3, § 3 of the Trade with Financial Instruments Act refer to repledge of the collateral or to B's pledgee-right <1>. Should these provisions only cover repledge of the pledgee-right, C's right has been deemed to not constitute an independent right <2>. Myrdal, who wrote his doctoral thesis on "Repledge: On Pledging Collateral and Pledgee-rights", concludes that if the object of the repledge is B's pledgee-rights, B cannot repledge the collateral on more stringent conditions than under the agreement with A, as B cannot repledge anything but its own rights. Moreover, in this case, ie a repledge on more stringent conditions, it would be impossible for C to make a good faith purchase of the pledgee-rights <3>. Even though Myrdal finds it more natural that a repledge would concern B's pledgee-rights, based on statements made in case law and in the preparatory works that repledge can take place on more stringent conditions and that a good faith purchase can be made, he draws the conclusion that the object of a repledge is most probably the collateral <4>.

--------------------------------

<1> Prop. 2004/05:30. P. 43, 46; Myrdal S. .

<2> Ds 2003:38. P. 69.

<3> Myrdal S. , Ch. 11.3 and p. 507 ff.

<4> Ibid. P. 507 ff.

In my opinion this whole discussion is an unfortunate result of the separation of the pledgee-rights from the collateral. A repledge concerns the collateral-taker's repledgee-rights while, at the same time, the object of the pledgee-right is the collateral <1>. One simply cannot talk about a right to repledge without having something to repledge. Should the collateral be destroyed it would be difficult to argue that B's pledgee-rights remain since the object of the pledge and the ownership rights are extinguished <2>. As a result, unless agreed otherwise, a repledge on more stringent conditions than under the original pledge agreement between A and B cannot take place unless C acts in good faith. Moreover, since the object of the repledgee-rights is the collateral, a bona fide purchase can take place even though the object of the repledge is the repledgee-rights.

--------------------------------

<1> Cf.: Lennander G. Panthavares skyldigheter. P. 156; Millqvist G. Recension: Staffan Myrdal, . Om av pant och , Norstedts Juridik, Stockholm, 2005, 594 s., JT, 2005-06. P. 460.

<2> It could, of course, be argued that the pledge right remains through the right of surrogation to the insurance compensation, cf. Ch. 9 Insurance Agreements Act (2005:104); the Act (2005:105) on Security Rights in Insurance Compensation. Even though the collateral-taker has a right of separation in the compensation, the right is principally derived from the insurance contract covering the interests of third parties rather than through surrogation, cf.: . P. 166.

Another question which has been discussed and which is also unclear is whether A can pay off the underlying debt to B if A knows that the collateral has been repledged to C. If this is possible it undermines C's security right as A then ultimately has the right to redeem the collateral without paying C's claim against B <1>. A closely related question is whether the repledge disappears once the original debt has been paid off.

--------------------------------

<1> Cf.: Prop. 2004/05:30. P. 126; Myrdal S. . P. 253 ff.

It is also questionable whether a joint repledge, ie a repledge of assets belonging to several parties for a larger amount than the smallest for which the collateral was originally pledged is a repledge on more stringent conditions. For instance, where A and A1 has each pledged collateral worth 50,000 to B for a loan of 90,000, respectively 80,000, and B repledges the same collateral to C for a loan of 110,000, it is possible that this transaction would constitute a repledge for a larger debt, i.e. on more stringent conditions. This is because A or A1 would have to pay the whole debt of 110,000 if either one of them wanted to redeem the collateral from C <1>.

--------------------------------

<1> Myrdal S. . P. 458 - 459.

Another concern is that the rules on repledge are ill suited to the development of the securities markets and the securities holding and settlement systems. Problems may occur as i) securities in the VPC-system are held on a fungible basis (cf. Sect. 2), ii) securities belonging to different entitlement holders' often are mixed on nominee accounts (cf. Sect. II) and iii) the collateral often is specified in relation to a certain value only (see further, Sect. 4.3). Problems may also occur as the value of the collateral, the requirement for collateral under the collateral agreement, the extended credit and the related derivatives positions fluctuate from to time to time. If, for instance, B's claim against A was to be reduced and C's claim was not reduced to the same extent, this might involve a repledge on more onerous terms <1>.

--------------------------------

<1> Cf.: Myrdal S. . P. 462 ff.