Intermediation and Beyond

Louise Gullifer, Jennifer Payne, Louise Gullifer, Jennifer Payne

• Publisher: Hart Publishing
• Year: 2019
• Print ISBN: 9781509919901
• eBook ISBN: 9781509919932
• Edition: 1
• Topic: Law
• Subtopic: Financial Law
• Index: Law

The global shift from the direct holding of securities by investors to the current intermediated holding system raises many important legal issues. These include the impact of the intermediated holding system on the rights of investors, and the enforcement of those rights against intermediaries and issuers. The cross-border nature of many holding patterns adds another layer of complexity to these issues, and reduces legal certainty. Against this, intermediation offers benefits for many investors, including the ability to hold a cross-border portfolio with one intermediary, a reduction in costs and the facilitation of the use of securities in the collateral, repo, and securities lending markets. This book covers a number of legal topics relating to intermediated securities including the history of intermediation, the benefits and problems in the current intermediated holding system, and how future legal and technological developments could help to resolve these problems while retaining the benefits of intermediation. It also examines the possible impact of FinTech on this area, in particular the potential for Blockchain to be used in the issuing, holding and settlement of securities, the extent to which this will solve some of the difficulties that currently exist, and whether the use of Blockchain will create new difficulties that will need to be overcome. This book, which originated in a series of workshops organised by the Commercial Law Centre at Harris Manchester College, Oxford, will appeal to those interested in financial and corporate law, including academics, practitioners, policy makers and students.

1

Introduction

LOUISE GULLIFER AND JENNIFER PAYNE

I.The Genesis of the ‘Intermediation and Beyond’ Project and Book

This book is the result of a project called ‘Intermediation and Beyond’, which involved a series of workshops which took place in Harris Manchester College, Oxford in 2016–18. The original inspiration for the project came from discussions in the context of teaching the subject of ‘intermediated securities’ to a graduate seminar group taking the course ‘Legal Concepts in Financial Law’ at Oxford. The debate focused on how various English law consequences in relation to securities differed (or potentially differed) when those securities were held through intermediaries compared to where they were held directly. Thus, for example, the enforcement of debt securities was not as straightforward, nor was suing the issuer for breach of contract,¹ nor was voting on a cancellation of a resolution to delist a company.² Workarounds had to be found in various common situations, such as where a company sought a bondholder scheme of arrangement.³ Those of us teaching the seminar⁴ decided to convene a group of experts to examine whether these were real problems, and what solutions could be suggested.

However, two things became immediately obvious in the first workshop. One was that this was a much bigger issue than originally envisaged: it spanned all types of securities (debt and equity), it raised questions which were not confined to English law, and the potential solutions were not limited to UK legislative changes but could include wider measures and, potentially, structural change as to the whole operation of the system including innovative use of technology. The second was that, by very good fortune, the workshops comprised a group of experts, domestic and international, who, by dint of their wide experience and expertise, were not only ideally suited to thinking about these issues but were enthusiastic about doing so. They also spanned many aspects of the legal profession: barristers, solicitors, inhouse lawyers and academics. Thus, it was decided to continue the series of workshops and to further the debate by encompassing the results of the group’s deliberations in this book. The book, therefore, is more than just a series of essays on related subjects. The arguments made have been honed by extended discussion between experts, and include ideas which have emerged as a result of that discussion.

The discussions also resulted in deeper thinking and analysis of the distinctions arising within the intermediated system than has previously been the case. For example, propositions asserted about the holding of securities and consequential problems were tested to see how much they applied to different types of securities: equity, and different types of debt; short-term debt securities, corporate bonds, government bonds. The question of what amounts to the bottom of the ‘chain’ was also thrashed out and the analysis set out below was developed.⁵ The discourse about the holding of securities through the intermediated chain has often been conducted on a quite general level, and it is not always clear that what appear to be opposing discussions are actually talking about the same thing.⁶ In the group’s discussions an attempt was made to follow consistent terminology and to make sure that the debate was addressing the same issue, applying to the same type of securities, the same type of holder and so on. This same approach has been adopted for this book.

Another, related, impetus for this book is that it is the second in a series. The editors of this book organised a conference in 2009 in Oxford, entitled ‘Interests in Securities’, focusing on what was then the draft UNIDROIT Convention on Substantive Rules for Intermediated Securities (which was adopted as the Geneva Securities Convention (GSC) later that year). The papers and comments presented in that conference became a book Intermediated Securities: Legal Problems and Practical Issues, published in 2010.⁷ That conference, and the book, focused on explaining the intermediated securities holding system, reflecting on the conceptual underpinnings of the system in various countries, consideration of important issues such as conflict of laws and the right to vote, and discussion of the draft Convention and how it could be implemented in various countries.

Much has happened since that conference and that book. First, a significant, though not enormous, number of cases in the UK and elsewhere have considered issues directly related to the intermediated holding system, many of which arose out of the global financial crisis.⁸ These cases have highlighted some of the consequences of intermediation which might not have been immediately obvious, and, at least in the UK, have confirmed much of the conceptual analysis which had been discussed in the 2010 book.

Second, while the GSC itself has so far failed to gain traction with states (only Bangladesh has ratified it), and is not yet in force,⁹ its influence has been substantial. It had a strong influence on the EU project considering whether there should be substantive harmonisation of securities law which ran from 2009 to 2011,¹⁰ which unfortunately has not resulted in any actual legal reform. It has also instigated a global debate as to the optimal rules for an intermediated system and the desirability and practicality of substantive harmonisation. Some of this took place in the context of the preparation of a legislative guide to the GSC, which was adopted in 2017,¹¹ as well as the publication of edited volumes written by international groups of authors,¹² the preparation of Model Provisions on Secured Transactions for Intermediated Securities¹³ and other conferences and articles. The alternative approach to full substantive harmonisation is harmonisation of conflict of laws rules.

Third, the Hague Securities Convention¹⁴ (HSC) on choice of law came into force in 2017 after being ratified by a third state, the US, in 2016. The other two ratifying states are Mauritius and Switzerland.¹⁵ In the light of this development, the EU launched a consultation in 2017 on ‘Conflict of Laws Rules for Third Party Effects of Transactions in Securities and Claims’,¹⁶ which has led to a proposal on the choice of law in relation to the proprietary aspects of assignments of claims,¹⁷ but not in relation to the holding of securities.¹⁸

Fourth, there have been very considerable technological developments since 2010. The most significant has been the emergence of distributed ledger technology (DLT) and blockchain, which can provide a way of permanently recording transactions, transfers and other information. This has raised the possibility of a totally new way of holding securities, which itself generates questions about the legal basis on which this could occur.¹⁹

The upshot of all these developments is that, irrespective of the particular imperative towards the current book, it is time for a new book considering the holding of intermediated securities with particular reference to English law. This focus differentiates this book from others considering harmonisation or global initiatives more generally. Specific, piecemeal, legal reforms are suggested which would deal with some of the issues raised without wider legal or structural change. But the book goes wider and deeper than this. First, it attempts to engage with what appears to be an almost intractable problem, namely, how to cope with a tiered approach to holding securities when different tiers could be in different countries with very different legal approaches to the proprietary and other rights of holders.²⁰ Second, it asks whether the current system is fit for purpose, and, if not, what changes could be made to reform or replace it. Moreover, it engages with the technological developments which will occur whether we like it or not, considers the possible practical consequences of these and then opens the debate as to the desirable legal consequences.

The book focuses on four main topics:

(i)the enforcement of debt securities held through intermediaries, including the ‘no look through’ principle and the difficulties this poses in terms of investor rights;

(ii)voting and governance issues where equity securities are held through an intermediary;

(iii)conflict of law issues, which are heightened by the increasing growth and internationalisation of securities trading and finance; and

(iv)the future of securities holding and settlement and, in particular, whether and how the system should be reformed.

Each topic was the subject of a specific workshop, where the issues were discussed, together with potential solutions. The way in which the book deals with these issues, and its structure, will be discussed at the end of this introduction. First, the introduction sets the scene, by describing generically the different types of securities and the pattern of holding of intermediated securities. Second, despite the many variations in practice as well as in law, between jurisdictions, and between types of securities, an attempt has been made to use a consistent terminology throughout the book so that like can be compared with like. The introduction explains and describes this terminology.

II.Introduction to Intermediated Holdings

A.Different Types of Securities

While there are many ways to classify securities, the most obvious distinction is between debt and equity securities. Equity securities, often called shares, are issued by companies and represent a participation right in the enterprise.²¹ Wherever shares are issued, investors in those shares can be in any country. One of the ways in which most shareholders are protected against erosion in the value of their shares is by having some control over how the company is run, which comes from the right to vote in certain situations. The ability to exercise voting rights is therefore particularly critical in relation to equity securities.²²

Debt securities come in a number of forms. First, companies can issue bonds or notes directly onto the markets in order to finance their operation.²³ These corporate debt securities can be long term or very short term (for example, commercial paper). Second, debt securities can be issued, typically by a special purpose vehicle, as a result of securitisation. Third, debt securities can be issued by governments. While holders of debt securities usually have some rights to vote, typically in order to instruct a trustee or agent to take some sort of action in relation to enforcement, but also on other issues, such as changes to the terms of the securities,²⁴ the ability to exercise such rights is perhaps less critical than with equity securities, at least to corporate governance outside financial distress of the issuer. However, the ability to act in situations of financial distress is important to holders of debt securities, whether this be by v...

Table of contents

• Cover
• Title Page
• Preface
• Summary Contents
• Detailed Contents
• Table of Cases
• Table of Legislation (National)
• Table of Legislation (EU)
• Table of Treaties and Other International Instruments
• List of Contributors
• List of Abbreviations
• 1. Introduction
• 2. Historical Introduction: The Growth of Intermediation and Development of Legal Analysis of Intermediated Securities
• 3. The Legal Nature of Intermediated Securities: An Insurmountable Obstacle to Legal Certainty?
• 4. Why are Securities Held in Intermediated Form?
• 5. Intermediated Securities: The Long Haul to a Modern, Comprehensive Legal Structure
• 6. Are Warranties in an Immobilised Bearer Note Enforceable?
• 7. Enforcing Debt Securities
• 8. Two Consequences of the Intermediated Holding of Debt Securities: Examining Discharge of Debt and Set-off
• 9. Intermediation and Bondholder Schemes of Arrangement
• 10. Investment Chains and Corporate Governance
• 11. Stewardship and Collateral: The Advantages and Disadvantages of the No Look Through System
• 12. Intermediated Securities from the Perspective of Investors: Problems, Quick Fixes and Long-term Solutions
• 13. European Harmonisation of Intermediated Securities Law: Dispossession and Segregation in Regulatory and Private Law
• 14. Conflict of Laws and Relational Rights
• 15. Intermediated Securities Holding Systems Revisited: A View Through the Prism of Transparency
• 16. Intermediated Securities and Distributed Ledger Technology
• 17. Conclusion
• Index
• Copyright Page