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Domestic and International Initiatives Concerning Conflict of
Law Issues Relating to Securities
Consultation
Document
CONTENTS
This consultation
paper introduces and seeks views on two related initiatives
to resolve some of the conflict of law issues that can arise
in the context of securities.
2.
Part I of this paper concerns a draft multilateral Convention
to determine the law applying to the proprietary aspects of
dealing in securities held through intermediaries. The
proposed Convention is being drawn up under the auspices of
the Hague Conference on Private International Law, which began
work on the subject last year. The intention is that the
Convention should be finalised early next year with a view to
its being adopted at a Plenary Session of the Hague Conference
in the summer of 2002.
3.
Part II concerns a proposal to amend the Financial Markets and
Insolvency (Settlement Finality) Regulations 1999. The
purpose of the amendment is to apply a common choice of law
rule in respect of securities provided as collateral.
The Amendment Regulations would extend the UK’s implementation
of the 1998 EU Settlement Finality Directive (Directive 98/26/EC).
4.
Comments on the draft Convention and draft Regulations generally
or on any particular aspects would be welcomed. Responses
should be submitted by 17 October to :
Andrew Wren
Financial Stability and Markets Team
HM Treasury
Allington Towers
19 Allington Street
London SW1E 5EB
Tel : 020-7270 4478
Fax : 020-7451 7524
e-mail : andrew.wren@hm-treasury.gov.uk
5. Further copies
of this Consultation paper may be obtained from Sue Cook on
020-7270 4345 or by e-mail at sue.cook@hm-treasury.gov.uk.
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PART I: PROPOSED HAGUE CONVENTION ON
THE LAW APPLICABLE TO SECURITIES HELD THROUGH INDIRECT HOLDING
SYSTEMS
Background
6.
The purpose of this initiative is to establish an international
standard choice of law rule for the proprietary aspects of dealing
in immobilised securities. These securities are those
where one or usually more intermediaries (investment bank, securities
settlement system, custodian, etc) are placed between the investor
and the issuer of the securities. This indirect method
of holding securities now accounts for the vast majority of
securities around the world. The investor’s interest in
respect of the underlying securities is recorded on the books
of an intermediary, which in turn has its interest recorded
with another intermediary and so on up the chain until some
intermediary either
i) is recorded
as the registered owner on the books of the issuer or the
issuer’s official recordholder; or
ii) holds the certificates
or other documents of title representing the securities.
Transfers of interests
in securities often occur through book entries without any form
of delivery.
7.
The traditional rule which applies to determine the law applying
to proprietary interests is the “lex situs”. This rule
provides that interests in property are to be governed by the
law of the place where the property is situated. This
rule is difficult, if not impossible, to apply in the context
of indirectly held securities. This is because the problems
which arise from seeking to attribute a location to a security
are stretched to the limit in the context of indirectly held
securities because of the complex nature of the rights that
are created. The existence of multiple levels of intermediaries
(often in different jurisdictions) then mean that it is impossible
to ascertain with certainty the location of an indirectly held
security. To take a very simple example, a UK investor
could own an interest in the securities of a US-incorporated
company via a bank in Switzerland which in turn has an account
with a Belgian-based securities depository (in practice more
intermediaries would be involved). In these circumstances
the question arises as to which jurisdiction’s law will govern
the proprietary aspects of dealings in the indirectly held securities.
This is particularly important if there is a dispute as to the
ownership of the securities.
8.
There is therefore a clear benefit in having a standardised
method of determining which jurisdiction’s law is the applicable
one in order to prevent uncertainty and avoid conflict of laws.
The proposed Hague Convention is designed to provide this.
Place of Relevant Intermediary Approach
9.
The solution adopted in the proposed Convention is to use the
place of the relevant intermediary approach (PRIMA) to determine
which jurisdiction’s laws are the applicable ones. PRIMA
provides that the applicable law is that of the jurisdiction
of the intermediary with whom the investor has an account in
respect of the immobilised securities. The Convention
will set out in detail the rules which will apply to determine
the location of the intermediary in each case.
10.
The principal attributes of PRIMA are as follows
- it dictates that
questions of creation, perfection (steps necessary to preserve
rights against third parties) or completion, priorities and
realisation of interests in respect of securities, be governed
by the law of the place of the immediate intermediary on whose
books the relevant interest is recorded;
- it situates all
of an investor’s interest with respect to a portfolio of securities
with a particular intermediary in one single jurisdiction,
even where the issuers and certificates evidencing such underlying
securities are situated in many different countries;
- it applies irrespective
of whether a transfer is made by way of sale or by way of
a collateral transaction, and in the case of a collateral
transaction, irrespective of whether the transaction takes
the form of a pledge or of a transfer of title;
- it applies irrespective
of the particular legal status of the investor, intermediary
and any collateral provider or collateral taker;
- it applies irrespective
of the jurisdiction in which any collateral provider, collateral
taker or any intermediary up or downstream is formed or located.
11.
PRIMA is the approach adopted in the Settlement Finality Directive
(and the UK’s implementing legislation – the Financial
Markets and Insolvency (Settlement Finality) Regulations 1999)
and the proposed EU Directive on Collateral. However,
the scope of each of these Directives is slightly different
from the proposed Convention. As has been explained, the
Convention would apply to all dealings in indirectly held securities,
whether for the purposes of collateral or otherwise and whether
in the context of a settlement system or otherwise. It
would not apply to direct holdings in securities. The
PRIMA approach has already been adopted in a number of national
jurisdictions and is being considered by several others.
As such, besides its inherent advantages in providing certainty
and predictability in this field, it also looks to be increasingly
the standard approach and is one the UK supports.
The Draft Convention
12.
The latest (annotated) text of the draft Convention is at Annex
A (further papers are also be available on the Hague Conference’s
website www.hcch.net). It should be noted that a number
of issues remain to be resolved and further negotiations are
likely to result in some modifications to the text. The
ongoing negotiations are currently focusing upon the rules for
determining the location of the intermediary in question and
thus it is in this area that most changes are anticipated.
i)
Articles 1 to 3 - Scope
13.
It is proposed that the Convention will apply to all immobilised
securities held cross-border ie not just to securities given
as collateral in a transaction. (The term “securities”
is defined broadly “any stock, share, bond or other financial
asset or instrument, or any interest therein …”). The
Convention will apply in all cases involving a choice between
the laws of different States. As is standard in such Conventions,
there will be a provision disapplying its effect where all the
relevant elements of a situation are in one State.
14.
The UK agrees with the broad approach it is proposed should
be adopted in the Convention.
ii) Articles
4 and 5 – Place of Relevant Intermediary
15.
Article 4 sets out the rule that the law governing dealings
in securities is that of the place of the relevant intermediary.
It also specifies the matters which the law of the place of
the relevant intermediary will determine.
16.
Article 5 then focuses on how to determine which is the place
of the relevant intermediary. It offers two approaches
for doing so: the account approach; and the branch/office approach
The account approach links the location of the relevant intermediary
to the place of the account to which the securities are credited.
Three options are put forward as to how to localise the securities
account. Under the branch/office approach the parties to the
transaction would be allowed to specify the location of the
place of the relevant intermediary by agreement, provided that
certain nexus requirements were satisfied (ie the parties could
not specify that the governing law should be that of a State
which had no connection with the parties or securities involved).
iv) Articles 6
to 19 – Miscellaneous Provisions
17.
The suggested Article 6 provides that insolvency proceedings
shall not affect the validity of a proprietary right constituted
and perfected in accordance with the law of PRIMA, but that
this principle does not affect rules of insolvency law relating
to the avoidance of transactions as a preference, transfers
in fraud of creditors or rules of insolvency procedure.
It has not yet been decided whether the ranking of categories
of claims should be included in this list of rules.
18.
Article 7 would provide that the Convention would apply even
if the choice of law points to the law of a country which is
not a signatory to the Convention. This has the advantage
that in States which decide to become a party to the proposed
Convention the desired certainty and predictability would be
obtained instantly without waiting for other countries to join.
19.
Article 8 would provide that “renvoi” should be excluded ie
that the law of the relevant intermediary should not be construed
as including that a jurisdiction’s own private international
conflict of law rules, only its substantive rules. The
reason for the exclusion of renvoi is that, if the designation
of the applicable law were to include the PRIMA jurisdiction’s
private international law rules, an element of uncertainty would
therefore be reintroduced as to which was the applicable law,
thereby frustrating the purpose of the Convention. For
example, if renvoi were included and the PRIMA jurisdiction’s
private international law rules point to the law of a State
which is not a party to the proposed Convention and which has
adopted a different approach to the question at stake, the parties
to the transaction would lose all the benefits of certainty
and predictability that the proposed Convention is designed
to provide.
20.
Article 9 would provide that the provisions of any law determined
by the Convention could only be disregarded by the court which
had jurisdiction when their application was “manifestly contrary”
to public policy. This means that a court would be able
to apply its own laws to extent that these are to be regarded
as an expression of fundamental values which are so important
that, as a matter of policy, they should be applied even though
the issues are otherwise to be governed by the foreign law.
Article 10 would provide that the Convention would not apply
in respect to conflicts of law between two different territorial
units within the same State. Article 11 concerns uniform
interpretation.
21.
The remaining Articles will deal with procedural issues concerning
review, amendment, adoption, etc. of the Convention.
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Consultation
22.
Views are invited from recipients on
1)
whether any of the provisions of the proposed Convention would
cause difficulties in their current form and, if so, the objectives
which any amendments should seek to attain;
2)
whether there are any issues currently not included in the proposed
Convention which should be covered;
3)
whether any of the provisions of the Convention should be elaborated
and, if so, the objectives which any elaborations should seek
to attain.
Cost Benefit Analysis
23. The Convention
will not impose any additional regulatory burdens on business
and should not therefore lead to any additional costs.
Indeed, since the Convention should result in greater certainty
and predictability as to which jurisdictions’ law will apply
concerning securities held through indirect holding systems,
the costs of undertaking due diligence and of resolving disputes
as to title to securities held cross-border should be reduced.
However, it is not possible to quantify these benefits.
PART II: DRAFT FINANCIAL MARKETS AND INSOLVENCY
(SETTLEMENT FINALITY) (AMENDMENT) REGULATIONS
Purpose
24.
The purpose of these proposed Amendment Regulations is to provide
a clear statement in UK law regarding the law which will govern
proprietary interests in securities given as collateral, where
the entitlement is recorded in a register, account or centralised
deposit system. This is intended to facilitate the resolution
of disputes regarding ownership of such securities by providing
for a common standard (ie PRIMA) as to the ‘choice of law’ in
these circumstances. The draft Amendment Regulations are
at Annex B.
25.
The Amendment Regulations would extend the implementation of
the provisions of the EU Settlement Finality Directive in the
UK. This Directive has been implemented by the Financial
Markets and Insolvency (Settlement Finality) Regulations 1999.
These already provide for a PRIMA ‘choice of law’ rule
concerning securities held as collateral. However, this only
applies in respect of collateral provided to central banks in
connection with their functions; or to participants in certain
designated clearing systems (intended to cover the International
Central Securities Depositories and national payments and securities
systems In EU Member States) in connection with their participation
in that system. This is a fairly narrow scope and we consider
that extending this choice of law rule more widely would bring
benefits in terms of clarity and simplicity, reduction of systemic
risk and improved market efficiency and ensuring that UK law
is clearly in line with what is increasingly becoming the global
standard in this field.
26.
Our original intention had been to extend the PRIMA rule to
all securities held indirectly cross-border, regardless of whether
they had been provided as collateral or not. However, this would
have had an unintended and unwelcome effect on the UK bond issuance
market. The proposed Amendment Regulations avoid this problem
by limiting their scope to securities given as collateral.
Costs and Benefits
27.
As with the proposed Hague Convention, the Amendment Regulations
would impose no regulatory burden or additional cost on business.
Indeed by providing extra certainty as to which law governs
proprietary interests in cross-border securities given
as collateral, there should be definite benefits for financial
market participants. However, again, it is not possible to quantify
these.
Consultation
28.
Views are invited from respondents on the draft Regulations.
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