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Intermediated Securities: Who Owns Your Shares? a Scoping Paper

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Intermediated Securities: Who Owns Your Shares? a Scoping Paper 6~~mission Reforming the law Intermediated securities: who owns your shares? A Scoping Paper 11 November 2020 © Crown copyright 2020 This publication is licensed under the terms of the Open Government Licence v3.0 except where otherwise stated. To view this licence, visit nationalarchives.gov.uk/doc/open-government-licence/version/3. Where we have identified any third party copyright information you will need to obtain permission from the copyright holders concerned. This publication is available at www.lawcom.gov.uk. Any enquiries regarding this publication should be sent to [email protected]. The Law Commission The Law Commission was set up by the Law Commissions Act 1965 for the purpose of promoting the reform of the law. The Law Commissioners are: The Right Honourable Lord Justice Green, Chairman Professor Sarah Green Professor Nicholas Hopkins Professor Penney Lewis Nicholas Paines QC The Chief Executive of the Law Commission is Phil Golding. The Law Commission is located at 1st Floor, Tower, 52 Queen Anne's Gate, London SW1H 9AG. The terms of this scoping paper were agreed on 30 September 2020. The text of this scoping paper is available on the Law Commission's website at http://www.lawcom.gov.uk. i Contents Page GLOSSARY VII LIST OF ABBREVIATIONS XIV REFERENCES TO LAW COMMISSION PUBLICATIONS XVI CHAPTER 1: INTRODUCTION 1 Background to this paper 1 Terms of reference and consultation 3 Intermediated securities: at a glance 4 The Law Commission’s view on intermediation 8 A range of possible solutions 8 Costs and benefits of reform 10 The structure of this paper 10 Devolution and Scots law 11 Cross-border issues 12 Acknowledgements and thanks 13 The team working on this paper 13 CHAPTER 2: WHAT ARE INTERMEDIATED SECURITIES? 15 A note on the relevant sources of law 15 Investment securities: nature, form and registration 16 Investors 19 Holding securities 28 An intermediated securities chain 29 CHAPTER 3: VOTING 40 Ultimate investors and voting 40 Voting on resolutions 41 How can an ultimate investor exercise an ability to vote? 42 Consultees’ views on voting 50 Possible solutions to enhance the ability of ultimate investors to vote 54 iii A new obligation to facilitate voting 54 Extending the application of the SRD II, Chapter Ia 58 Section 793 of the CA 2006 63 Confirmation of voting 66 CHAPTER 4: SCHEMES OF ARRANGEMENT 69 The statutory process 69 Schemes of arrangement and intermediated securities 70 New Part 26A of the CA 2006 73 Consultees’ views 75 A possible solution: removing the headcount test 76 CHAPTER 5: THE “NO LOOK THROUGH” PRINCIPLE 83 The effect of the no look through principle 83 Recent cases 85 Consultees’ views 89 Possible solutions 94 CHAPTER 6: INSOLVENCY OF AN INTERMEDIARY 101 The insolvency of an intermediary 101 Consultees’ views 113 Possible solutions to insolvency issues 116 CHAPTER 7: THE GOOD FAITH PURCHASER PRINCIPLE, FORMALITIES AND OTHER ISSUES RAISED BY CONSULTEES 126 Good faith purchaser principle 126 Formalities 136 Taking security over intermediated securities 140 Insolvency and “control” 146 CHAPTER 8: OPPORTUNITIES PRESENTED BY DEMATERIALISATION 148 The move towards dematerialisation 149 The proposed industry model of dematerialisation 150 Dematerialisation and a “name on register” system 155 Dematerialisation and the option to hold securities directly 162 CHAPTER 9: NON-LEGISLATIVE SYSTEMIC APPROACHES 165 The potential for an industry-led response 165 iv Principles of best practice 166 Terms and conditions 169 Considerations specific to retail investors 171 Technology 175 CHAPTER 10: SUMMARY OF POTENTIAL AREAS FOR FURTHER WORK 182 List of possible solutions for further work 182 Assessing the impact of possible solutions 185 APPENDIX 1: ADVISORY PANEL 192 APPENDIX 2: ACKNOWLEDGEMENTS 193 APPENDIX 3: TERMS OF REFERENCE 198 APPENDIX 4: A SUMMARY OF DISTRIBUTED LEDGER TECHNOLOGY 199 Overview 199 Benefits of DLT compared to centralised ledgers 200 Permissionless and permissioned DLT systems 201 v Glossary Term Definition Bearer note A document that embodies a debt security. Ownership of the security is evidenced by physical possession of the bearer note rather than by an entry on a register. Bitcoin A type of digital currency which is supported by blockchain. Blockchain A method of recording data on a distributed ledger. Data on the ledger is grouped into timestamped “blocks” which are mathematically linked or “chained” to the preceding block on the ledger. Bonds A type of debt security (see also “debt securities”). Central securities depository An organisation that operates an electronic system for the recording and settlement of uncertificated securities. Certificated register See “register of members”. Charge A type of security interest that can be taken over an asset. The owner of the asset creates a proprietary interest in relation to that asset in favour of the person who takes the benefit of the charge. Corporate governance The policies and processes by which a company is directed and controlled. CREST The central securities depository in the United Kingdom. CREST personal member An individual who has a CREST account in their own name. vii Term Definition Custody The process by which a financial institution holds securities on behalf of a client and assumes responsibility for their safekeeping and administration. Debt securities Investment securities which embody an obligation on the issuing company to repay a debt to the holder of the security. Deed poll A formal document, executed by one party, which provides rights to another party and creates a binding obligation on the party who has issued it. Dematerialisation The issue of securities by companies without paper certificates to evidence title or the transformation of existing paper, certificated securities into electronic form. A dematerialised security is represented by an entry in an electronic register. Distributed Ledger Technology A method of recording and sharing data across a network in a decentralised and transparent way. A DLT system comprises a digital database (a “ledger”) which is shared (that is, “distributed”) among a network of computers (known as “nodes”). Each node holds an identical copy of the ledger on its system, which is updated instantaneously as new data is added. Nodes approve of additions to the ledger through the consensus mechanism. Equity securities Investment securities which give the legal owner of the security (the “shareholder”) a stake in the company. Good faith purchaser principle The principle that a person who acquires securities which are not negotiable may do so free of any equitable claim, right or interest of a third party if they are a good faith purchaser of the legal title to the securities without notice. viii Term Definition Headcount test The requirement under section 899 of the Companies Act 2006 that a scheme of arrangement must be approved by a majority in number of the creditors or members (or class of creditors or members) who vote on the compromise or arrangement. Immediate intermediary The intermediary with whom the ultimate investor has a contractual relationship. Immobilisation The process by which a security is located in a particular CSD, to enable subsequent transfers of interests in that security by book entry. Institutional investor An organisation which purchases investment securities, either for itself or to hold for other investors. Examples of institutional investors include pension funds and insurance companies. Intermediary An individual or, more commonly, an organisation which holds an interest in investment securities on trust for another, who may be another intermediary or the ultimate investor. Intermediated securities Interests in investment securities which are held by participants through a chain of intermediaries. Investment manager An individual or organisation to whom the responsibility for the day-to-day management of an investor’s assets is delegated. The investment manager will act on the basis of instructions given to them in the investment mandate. Also known as “asset manager” or “fund manager”. Investment mandate The agreement between an investment manager and their client outlining how the assets of the investor are to be managed. Investment platform An online tool or service that facilitates the purchase and sale of securities. Investment securities Instruments issued by a company in order to raise money. See “equity securities” and “debt securities”. ix Term Definition ISA Individual savings account, set up under the Individual Savings Account Regulations 1998, SI 1998 No 1870. Issuer record See “register of members”. Issuing company The company which issues the investment securities. Lien A right to retain possession of a thing until a claim or debt has been satisfied (in the context of financial collateral arrangements, a lien is a security interest). Majority in number requirement See “headcount test”. Majority in value requirement The requirement under section 899 of the Companies Act 2006 that a scheme of arrangement must be approved by a majority of creditors or members (or class of creditors or members) representing 75% in value of the creditors or members (or class of creditors or members) who vote on the compromise or arrangement. Negotiability Negotiability converts an instrument from mere evidence of ownership into an instrument that is legally deemed to constitute the securities. Title to the negotiable instrument is transferred by physical delivery (or, in some cases, by endorsement and delivery) of the paper certificate or document of title, provided that the transferor has the necessary intention to transfer. “No look through” principle The principle that an ultimate investor may only make a contractual or trusts law claim against their immediate intermediary and not against the issuing company or intermediaries higher in the chain. Node A participant on a DLT system. Nominee account See “omnibus account”. x Term Definition Open-ended investment company See “unit trust”. An open-ended investment company operates in a similar way to a unit trust but using a corporate structure. Operator record See “register of members”.
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