Harmonising European Securities Laws, Contributed by Kris Rogers, Lawrence Graham LLP
Securities, such as equity securities and debt securities, are usually held in book-entry form rather than traditional paper certificates. Securities in book-entry form are transferred through accounts kept by account providers (or a number of account providers) who act on behalf of an ultimate beneficial owner. The European Commission calls this the “holding chain,” and estimates that throughout Europe, depending on the Member States and form of securities, between 85 and 100 percent of securities are now held in book-entry rather than paper form.
From a domestic point of view, the Commission believes that most Member States’ legislation concerning book-entry securities works well, although it is aware that legal frameworks differ considerably from one Member State to another.
Matters become complicated when the “holding chain” crosses international borders. This is because laws of different Member States end up applying to the same underlying securities. Legal uncertainty arises, for example, when different laws identify different “owners” of the same underlying security. The Commission believes that, on a cross-border basis, holding and selling securities:
- Is legally uncertain because quite often it is not clear what an investor owns;
- Is ineffective; and
- Does not provide ultimate beneficial owners with the right and/or time to exercise rights attached to those securities (e.g., the right to vote at a shareholder meeting or the right to participate in a rights issue or open offer) without major difficulties.
In order to address these concerns, the Commission is preparing a draft directive on legal certainty of securities holdings and transactions (to be known as the Securities Law Directive), which is expected to be adopted by the Commission later this year. It is the Commission’s intention that the Securities Law Directive addresses, amongst other things:
- The holding and disposing of securities held in securities accounts;
- How investors can exercise their rights flowing from securities through a chain of intermediaries (in cross-border situations in particular); and
- The regulation of any activity of safekeeping and administration of securities under an appropriate supervisory regime (e.g., MiFID1).
A first public consultation on the Securities Law Directive was held in 2009,2 following which the Commission prepared a first set of draft provisions that were discussed with Member States’ experts between February and June 2010. Following those discussions, the Commission held a second public consultation (Second Consultation) between November 2010 and January 2011,3 the results of which were published in late September 2011.4
The Second Consultation
— The Principles
In the preamble to the Second Consultation, the Commission made it clear that the Securities Law Directive would not harmonise the laws of Member States as to whom an issuer should recognise as the legal owner of securities. Instead, the Securities Law Directive seeks to ensure that:
- All account providers are regulated at EU level;
- Conflict of laws arrangements for securities held in a securities account are brought into line with existing EU measures;
- The substantive law of individual Member States is made compatible; and
- The full exercise of investor rights is guaranteed.
— The Respondents
In response to the Second Consultation, the Commission received 108 responses: 53 from registered organisations (i.e., any organisation engaged in “activities carried out with the objective of influencing the formulation or implementation of policy and decision-making processes of the EU institutions”), 40 from individuals, and 15 from public authorities. The respondents consisted of 35 intermediaries, 30 issuers and professional investors, 13 trade and post-trade infrastructure providers, 15 other professions (e.g., academics, practitioners, international organisations, etc.), and 15 public authorities. No responses were received from individuals acting as retail investors.
Over half of all responses came from France (23), Germany (17), and the UK (18), with five replies from international organisations, two from the U.S., and the remainder from other Member States.
— Account-held Securities
One of the main principles put forward by the Commission is that an account holder should have at least the right to:
- Exercise and receive the rights attached to the securities (if the account holder is the ultimate account holder);
- Effect a disposal; and
- Instruct the account provider to arrange for holding the securities with another account provider or otherwise than with an account provider (as far as permitted under applicable law etc.),
in relation to any securities that it holds.
Of the 83 stakeholders that commented on this issue, 12 lent their support without comment, and a further 43 either indicated their caveated support or provided comments with no indication as to whether they approved or not. A number of respondents noted that there should be a clear distinction between “account holder” (e.g., a nominee) and “ultimate account holder” (i.e., the beneficial owner) because they should clearly not enjoy the same rights, and others thought it should be made clear as to whom an account provider is accountable. Furthermore, some stakeholders argued that the legislation should permit parties to amend the rights of an account holder by contract (e.g., an agent lender may seek to place contractual restrictions on a client’s ability to deal with collateral received under a stock loan in order to ensure that it is available to be returned to a borrower). These are all sensible suggestions that will hopefully find their way into the text of the draft Directive.
Some 28 stakeholders did not think the above principle adequately defined the legal position of account holders. Some of the respondents, for example, felt that the introduction of the term “account-held securities” would create legal uncertainty as it adds an additional concept to the already existing concepts such as “financial instruments,” “transferable securities,” etc. There are many instances in English law where distinct, but similar, concepts are used without creating legal uncertainty, so it is unlikely that this concern will be an issue.
— Insolvency of an Account Provider
The Commission has also suggested that:
- National law should provide that, in the event of insolvency of the account provider, securities held by the account provider for its account holders should not be available for distribution among or realisation for the benefit of creditors of the account provider; and
- The applicable national law in the insolvency of an account provider should provide for a mechanism governing the distribution of any shortage in the event of an insufficient number of securities being held by an insolvent account provider.
In total, 64 respondents provided answers to this question, with the vast majority agreeing with the proposal. In fact, many stakeholders rightly stressed that the above two suggestions were among the most important aspects of the Securities Law Directive.
Most respondents noted that, as is the case in the UK, securities held by an insolvent account provider for its account holders would not be available for distribution among creditors of the account provider under existing national law. A number did, however, acknowledge that more certainty would be helpful. Some sensibly suggested that securities held by an account holder on its own account should always be segregated from that of its clients. Whether or not this is a practical measure to put in place going forward is another matter.
There were differing views as to whether a mechanism governing distributions of the shortfall in the event of an insufficient number of securities being held by an insolvent account provider was welcome. Swedish intermediaries felt that more far-reaching efforts to harmonise the legal framework for the client securities in insolvency situations would be desirable, whereas others, especially French authorities and intermediaries, proposed to harmonise the loss-sharing methods but to leave the regulation of the loss-sharing itself to Member States, while others (Germany, and European intermediaries associations) supported the proposal as drafted.
— Rights Flowing From the Securities
The Commission proposed that information received by an account holder that is not the ultimate account holder should be passed on to the ultimate account holder without undue delay as far as that information: (1) is necessary in order to exercise a right attached to the securities (e.g., voting at a forthcoming general meeting); and (2) is directed to all legal holders of the securities.
The majority of respondents acknowledged that there were significant problems regarding the cross-border exercise of rights attached to securities and, with a few caveats, largely supported the introduction of the envisaged legislation.
A number of UK-based respondents asked for an “opt-in solution” akin to the information rights that can be granted under the UK Companies Act 2006. A number of other respondents asked for the obligation to pass on information to be restricted if, for example, there is not enough time to permit the ultimate account holder to actually exercise its rights. Whether or not such a suggestion, which presumably would be a discretion exercisable by the intermediary account holder, would work in practice is questionable.
Most of the respondents felt that more guidance was necessary on what constituted “information,” and hopefully a more detailed description will find its way into the text of the Securities Law Directive. For example, some stakeholders asked whether “information” included voting instructions and/or third party information (e.g., information in relation to a third party takeover offer if acceptance of the offer did not involve a vote of shareholders of the issuer). It was also suggested that the obligation to forward information should not extend to publicly available information (e.g., interim accounts). If the Securities Law Directive were to contain a more detailed description of what constitutes “information,” it would be sensible if it covered all rights relating to the securities (whether they emanate from the underlying issuer or a third party).
— Conflict of Laws
The Commission also proposed that matters relating to, inter alia, the legal nature of account-held securities, the requirements relating to acquisitions and disposals of account-held securities, and whether a disposal of account-held securities extends to any entitlement of that security (e.g., to dividends or other distributions) should be governed by the law of the country where the relevant securities account is maintained. This is known by the Commission as PRIMA (Place of Relevant Intermediary Approach).
Some 77 respondents answered this question, the majority of which were in favour of PRIMA, although some queried whether it was possible to identify the relevant account with sufficient certainty.
— Regulation of Account Providers
The Securities Law Directive also anticipates that account providers will be specifically authorised, and the Second Consultation asked whether their authorisation and supervision should be set out in MiFID.
Of the 60 respondents who answered, 27 agreed that only institutions that have been authorised by the appropriate supervisory authority (e.g., in the UK, the Financial Services Authority) should be permitted to maintain securities accounts for their clients.
A further 29 respondents agreed that it was desirable to have regulatory supervision, but some wanted to see specific groups of account providers excluded from regulation (e.g., issuers and/or central securities depositories), while others queried if MiFID was the appropriate instrument.
Anyone who has had experience of cross-border “holding chains” by, for example, trying to exercise voting rights in a foreign issuer will recognise the need for the introduction of the Securities Law Directive. The proposals made represent a very good starting point, and hopefully the Commission will take on board many of the sensible suggestions raised in the Second Consultation when the final legislation is published later in the year.
© 2012 Lawrence Graham LLP
Kris Rogers is an associate in the corporate department of Lawrence Graham LLP in London. He specialises in capital raisings (with particular emphasis on the investment fund sector), restructuring, and M&A. Telephone: +44 (0) 20 7759 6629; E-mail: firstname.lastname@example.org.
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