Financial Collateral: Drafting Secured Obligations Clauses
The secured obligations clause defines which obligations a financial collateral pledge actually secures. It is the operative boundary between the credit exposure and the collateral. Imprecision in that clause — whether through ambiguous drafting, accidental narrowing, or inconsistency with the facility documents — creates enforcement risk that may be difficult, and sometimes impossible, to cure once enforcement pressure arises.
The statutory framework
Under Article 1(10) of the Luxembourg Law of 5 August 2005 on financial collateral arrangements (the “Financial Collateral Law”), “relevant financial obligations” means obligations secured by a financial collateral arrangement that give a right to cash settlement and/or delivery of financial instruments, or to assets underlying those financial instruments.
The definition is deliberately broad. Relevant financial obligations may include: present or future obligations; actual, contingent or prospective obligations; obligations owed by a person other than the collateral provider; and obligations of a specified class or kind arising from time to time. The law states expressly that present, future, actual, contingent or prospective obligations need not be specifically described in the financial collateral arrangement.
This statutory breadth is a feature, not a drafting shortcut. It allows parties to structure revolving facilities, uncommitted lines, hedging arrangements, fee obligations, indemnities and multi-party credit structures within a single collateral framework — provided the documents are internally consistent.
Practical discipline
The permissive scope of Article 1(10) does not remove the obligation to draft coherently. In practice, the secured obligations clause must be tested against the full transaction document stack: the facility agreement, side letters, hedging documents, accession mechanics, security-agent wording, amendment history, and custody or account-control arrangements.
The practical test is straightforward: the pledge, facility agreement, parties, collateral description and enforcement mechanics must all describe the same secured exposure. Where the pledge is intended to secure principal, interest, default interest, fees, indemnities, break costs, refinancing liabilities, increased commitments or third-party obligations, each category should be addressed expressly or through a clearly defined perimeter — not through vague omnibus language that may not withstand scrutiny at enforcement.
The risk in Luxembourg practice is not broad drafting as such — Article 1(10) permits a wide secured-obligations perimeter. The risk is uncontrolled breadth or internal inconsistency: a pledge that captures obligations the facility agreement does not support, or a collateral description that does not map to the account or asset structure that credit risk actually relies on.
Why Luxembourg
Luxembourg’s Financial Collateral Law is designed for cross-border financial assets, fund interests, custody accounts and professional market participants. For fund finance, Lombard lending, subscription finance and structured credit, the law’s permissive treatment of the secured obligations perimeter is a structural advantage — but only where the drafting is disciplined enough to use it correctly.
