Why is collateral needed and how is it used?

Financial collateral is an asset provided by a borrower to a lender. It minimises the risk of financial loss to the lender if the borrower fails to meet their obligations.

Collateral is used throughout the EU to support all kinds of financial transactions, from derivatives to general bank lending. Since the financial crisis, collateral has become increasingly important, because of a market need for more secured funding.

Financial collateral directive

The financial collateral directive has created a harmonised EU legal framework for the receipt and enforcement of financial collateral. The directive facilitates the cross-border use of financial collateral by

  • abolishing many formal requirements such as the need to register the collateral
  • improving enforcement rules (e.g. if the borrower defaults on their obligation to the lender, the lender can immediately realise the collateral, in or outside insolvency proceedings)
  • enhancing legal certainty as to which law applies to book-entry securities collateral in cross-border situations

The directive plays a key role in ensuring that EU post-trade systems function properly. It contributes to the integration and cost-efficiency of European financial markets. Harmonised collateral rules reduce credit losses and encourage cross-border business and competitiveness.

The EU's collateral rules were amended in 2009 to bring them in line with regulatory and market developments.