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Property Interests in Intermediated Securities

This project looks at issues affecting the ownership and transfer of intermediated securities, that is to say, securities that are held not directly by investors but indirectly through a chain of one or more intermediaries.

'Intermediated' holdings have become the norm in publicly traded securities.  Global custodians and securities brokers hold and trade huge volumes of securities on behalf of their customers.  At the same time, the computerised recording of the transfer and ownership of securities has largely replaced paper share and stock certificates.  In England, as in many countries around the world, the law has sometimes lagged behind these developments.

International Harmonisation: The Role of UNIDROIT

The legal issues raised by intermediated securities have international ramifications. Change is being led by the International Institute for the Unification of Private Law, commonly known as "UNIDROIT".  This is an independent intergovernmental organisation of 61 member states, based in Rome.

UNIDROIT is currently drafting a Convention on Intermediated Securities to harmonise law in this area.  It is likely that the European Union will adopt the Convention once it is finalised at the end of 2008.

The Law Commission has therefore focused its attention on analysing the draft UNIDROIT Convention, and providing advice to the UK Government on the issues it raises.

Our Advice to HM Treasury on the UNIDROIT Convention

We have attempted to provide commentaries and advice to the Treasury on the various drafts of the Convention, as they proceed through successive drafting sessions.

Our Further Updated Advice, published in May 2008, reports on developments at the fourth plenary session and considers issues to be resolved at or before the full Diplomatic Conference in September 2008.  We have also prepared a draft of the Convention (as it stood following the May 2007 meeting), showing our suggested amendments.

This follows our Updated Advice, which was published just before the fourth plenary session in May 2007.

Our first Interim Advice, published in October 2006, advised the Treasury prior to the third plenary session in November 2006.

Developments Discussed in the Further Updated Advice

The Further Updated Advice largely follows the text of our Updated Advice published last year.  Those who are familiar with last year's document may wish to concentrate on the following changes, and look at the paragraphs of the Further Updated Advice, listed below.

OUTSTANDING ISSUES

Following the May 2007 meeting, three issues remained outstanding and were referred to working groups to resolve.

1) Interaction with Insolvency Law

The question of how the Convention interacts with insolvency law remains open. Some delegations, including the UK delegation, consider that the Convention should not prevail over national insolvency law unless it expressly states that it has this effect. Some other delegations, most notably the US, consider that the Convention should, as a general rule, override national insolvency laws to the extent that they conflict unless the Convention states otherwise.

See paras 4.130 to 4.138.

2) Innocent Purchaser Test

All delegations recognise the importance of protecting innocent purchasers of intermediated securities from adverse claims. However, some civil law countries feel that the current test based on 'knowledge' is too far removed from their existing legal principles. The working group will consider ways to address this concern. The Law Commission considers the existence of a common test of 'innocent purchaser' to be one of the most valuable features of the Convention and supports a solution that harmonises the law in this area as far as possible.

See paras 4.102 to 4.106.

3) Definition of Securities Settlement System and Precedence of CSD Rules

The third working group will consider two related issues. The first attempts to reconcile the definition of "securities settlement system" with the definition of a "system" in the Settlement Finality Directive: see paras 4.36 to 4.37.

The second issue is whether the rules of a Central Securities Depository should take precedence over the Convention, in the same way as the rules of a securities settlement system take precedence. As the rules of the UK securities settlement system (the CREST rules) are effectively the rules of the CSD this does not appear to be a significant matter for the UK: see para 4.22.

CHANGES MADE IN MAY 2007

We also report the changes made at the Fourth Plenary session.  These include amendments relating to:

1. Splitting an intermediary's functions (paras 4.29 to 4.30).

2. The definition of "control" (para 4.77).

3. The priority granted to competing security interests (paras 4.78 to 4.84).

4. A declaration mechanism relating to upper tier attachment (paras 4.139 to 4.142);.

5. A clarification of the means by which an intermediary may hold sufficient securities (para 4.146 to 4.150).

Background reading

In July 2004, the Financial Markets Legal Committee issued a report on the need for legislation relating to directly held securities.

In 2006, the European Commission's Legal Certainty Group published an advice in which it sets the principles that it proposes should be adopted in new legislation to govern the legal effect of intermediated securities.

Seminar papers

In 2006 the Law Commission held a series of seminars on this topic.

The first seminar - to discuss general policy issues and the needs of market participants - was held on 22 March 2006. See Seminar paper 1.

The second seminar, held on 23 June 2006, considered:

• the scope and enforceability of account holders' rights;
• the protection of account holders' securities from claims of an insolvent intermediary's creditors;
• the application of the 'no look through' principle in relation to claims against intermediaries as well as the related issue of upper tier attachment; and
• the treatment of shortfalls.

See Seminar paper 2.

The third seminar, held on 27 July 2006, considered:

• the formalities of transfer;
• the moment at which securities are deemed to have been transferred;
• the finality of transfer; and
• the defences available to a transferee against adverse claims.

See Seminar paper 3.

For more information, or to submit your views, contact the commercial and common law team. Further information is available from the team page.

NOTE - We are happy to provide information about our projects. However, we cannot give legal advice or deal with individual cases. Nor do we help with student assignments.

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