The Hague and UNIDROIT Conventions

Anayansy Rojas Chan

The Hague Conference on Private International Law

◦ Convention on the law applicable to certain rights with respect to securities held with an intermediary. (2006)

International Institute for the unification of Private Law. UNIDROIT

◦ The UNIDROIT convention on substantive rules applicable to intermediated securities. (2009)

Conventions

The Hague Conference on Private Law and UNIDROIT.

Intergovernmental organizations that develop multilateral legal instruments that respond to contemporary needs of private law.

Progressive unification of the rules of private international law.

Nature of Institutions

Fundamental changes over the last decades of the holding system and representation of securities:

1. Dematerialization of security title Book-entry or Global Certificate.

2. International Expansion of the indirect holding system or multilevel.

Sets off the direct link between issuer and investor. Substituted by dealer. (Intermediated securities)

Environment

Investors maintain investments with dealer A), (banks or brokerage firms).

Dealer A) mantains their accounts with another dealer B).

Dealer B)- mantains their accounts with a global custodian or international central securities depository.

◦ Each level is located in a different jurisdiction.

Indirect Holding System

Issuer - Deposits issue

ICSD

Dealer / Participant

Custodian / participant

Clients

Dealer

Dealer

Clients

Dealer

Characteristics of Indirect Holding There is no identifiable legal relationship

between the investor and the issuing agent.

It presents a plurality of legally independent relationships that arise at every stage of the holding.

It is common that the dealers hold the securities in fungible omnibus accounts. In the higher level the end investor is not identifiable.

What type of rights does the investor have?

Is it a proportional right on a fungible mass of securities held with the dealer with whom it was contracted?

What right does they have if the dealer holds the securities through another dealer?

Legal Challenges

The right of the end investor, is it of property or obligation?

The roman civil jurisdictions and common law, present different legal treatment. Not always compatible.

◦ Acquisition of property of securities. ◦ Insolvency or bankruptcy of the dealer.◦ Constitution of collateral.◦ Extending the concept of security.

Legal Challenges

Convention Objectives Unify the legal treatment in the described

changes.

◦ THE HAGUE- purpose to determine certainty on the law that applies to the constitution and perfection of the collateral in cross-border transactions.

◦ UNIDROIT- aspects of substantive rules of the intermediated securities.

The Hague Convention

On the law applicable to certain rights in respect of securities held with an

intermediary.

PURPOSE

To determine the law applicable to a loan with collateral on an international portfolio of securities and shares.

Securities are held by the borrower through:◦ Different levels of participants: dealers,

custodians and central depositories.◦ Domiciled in different jurisdictions.

Conflict of Laws

Traditionally, property rights involved, are defined in accordance to the legal system of each country, no contract applies.

◦ Principle Lex Rei Sitae o Lex Situs (Law where the security is located)

The issuers of the securities of the portfolio are scattered around the world.

To Consider:

It is called the Looking Through approach

A traditional analysis considers the range of securities that form the portfolio granted in guarantee and will analyze the conflict of laws, in accordance with each group of securities.

Traditional Treatment

1. For securities incorporated in physical form, the local law of the physical location of the title applies.

2. Securities represented by electronic book-entry. To find the security look for the issuer registration because it is where the security is immobilized.

◦ Involves searching through the different levels and registrations of the dealers until reaching the issuer.

◦ Once registration is located, the Lex Rei Sitae applies.

How does it apply?

1. In a multi-jurisdictional portfolio of securities, if the operator wants to ensure the real jurisdictional extent of the transaction they must comply with the legal requirements demanded by the registration law of the issuer.

2. There is uncertainty in countries on the applicable law:

◦ Law of the place of the issuer.◦ Law of the place of the registration of the issuer.◦ Law of the place of the securities deposit.

Disadvantages of the Approach

It proposes a legal solution based on the dealer´s registrations of the intermediary.

◦ PRIMA (Place of the relevant intermediary approach)

Principle seeks to reflect the reality of the indirect holding system of securities.

The Hague Proposal

Basic Principle:

When the securities are held through an intermediary dealer, the law that applies to the rights derived from electronic book-entries is the one established in the agreement between the investor and the dealer intermediary.

Lex contractus appliesLaw designated by the account holder and the dealer intermediary in the contract of the securities account. (Art. 4)

PRIMA

The Convention establishes certain rules to determine the applicable law when it has not been established in the contract.

◦ The law of the country where the office of the financial entity with which the contract was perfected is located.

◦ Otherwise the law of the country where the dealer intermediary is constituted or operates.

Reality Test

Signed by: Switzerland (ratified) USA (not ratified) Mauritius (ratified)

What is the impact of this Convention from the perspective of the central securities depository?

Conclusions

UNIDROIT Convention On substantive rules applicable to intermediated

securities.

1. Modernization and creation of uniform rules on substantive aspects of the law applicable to the holding and transfer of cross-border securities.

2. Search of compatibility when applied to different legal holding systems.

◦ Functional approach: use of neutral language and formulation of rules based on facts and effects, not on legal concepts.

Purposes of the Convention

Chapter I-Definitions, sphere of application and interpretation.

Chapter II- Rights of the account holder. Chapter III-Transfer of intermediated securities. Chapter IV-Integrity of the intermediated

holding system. Chapter V-Special provisions in relation to

collateral transactions. Chapters VI y VII- Transitional and final

provisions.

UNIDROIT Convention

Intermediated securities

Securities account and

Dealer Intermediary

These three concepts establish the main sphere of application of the Convention.

Main Concepts of the Convention

It is the main focus of the Convention.

Intermediated security holding presents a change in the concept of legal and real ownership of the investor: ◦ The representation of the rights comes from the

book-entries administered in a decentralized form by dealers intermediaries in one or more levels of intermediation.

Intermediated Securities

What right does the participant have of a in an intermediated structure?

Apply traditional right of security title: ◦ Investor may lose the securities in case of

insolvency of the dealer in control of them.

◦ The applicable law considers that the end investor does not hold the physical security, the investor does not appear in the registrations of the issuer.

Intermediation Risk Management

Article 1.b)-

Intermediated securities: means securities credited to a securities

account or rights or interests in securities resulting from their book-entry to a securities account

SECURITIES RIGHTS or INTERESTS

Intermediated Security Concept

c)- securities account: refers to an account maintained by an dealer intermediary to which securities may be credited or debited;

◦ This definition may apply to:1. Account of an intermediary on behalf of a non-

intermediary. 2. Account of an intermediary on behalf of another

intermediary.3. Account of a centralized deposit central securities

depository on behalf of an intermediary.

Securities Account

d)- intermediary: means a person (including a central securities depository) who in the course of a business or other regular activity maintains securities accounts for others or on behalf of others and on their own and is acting in said capacity;

◦ The application of the Convention requires that at least one intermediary is involved.

Intermediary

Who are considered intermediaries?

◦ Providers of securities accounts. Brokerage firms, central banks and similar that keep accounts

for their clients.

◦ Custodians.

◦ Central Securities Depositories. Only in relation to their participants who are clients, not with

issuers. Issuer and Depository are not linked through a securities

account for credits and debits.

Intermediary

1. Subject to paragraph 3, no attachment of intermediated securities of an account holder shall be made against, or so as to affect:

a)- a securities account of any person other than that account holder;

b)-the issuer of any securities credited to a securities account of that account holder; or

c)- a person other than the account holder and the relevant dealer.

2. (…) “Attachment of intermediated securities of an account holder” means any judicial, administrative or other act or process to freeze, restrict or impound intermediated securities of that account holder in order to enforce or satisfy a judgment, award or other judicial, arbitral, administrative or other decision or in order to ensure the availability of such intermediated securities to enforce or satisfy any future judgment, award or decision (…)

Prohibition of upper-tier attachment .- Art. 22

CSD

Intermediary B Bank

Holder Y account A with intermediary B

Bank loan collateral with the securities account A

Securities A deposited in CSD, omnibus fungible account

Attachment account A in B

CSD attachment freezes all securities registrations A of B

1. The encumbrance should not be allowed in circumstances that impair the ability of the intermediary to perform his their functions.

2. The encumbrance in higher level is not compatible with the capacity of a securities account holder of a lower level to trust in his their position as it appears in the account.

Prohibition Foundation

1. The encumbrance or attachment of securities operates in the precise location of the intermediation chain.

2. It builds on the assumption that there are three parts involved:

◦ Debtor◦ Creditor ◦ Recipient of the obligation (intermediary)

General Rule

Bank CGlobal Custodian

Bank B

Client X with securities account bank B

Bank B fungible securities account of all its clients Bank C

Creditor of X tries to encumber the account of Bank B in C.

Other topics on substantive rules1. Protection of an innocent person. 2. Integrity of the system.3. Protection of the holder of the account in

case of insolvency of the relevant dealer. 4. Transmission of securities. Final and

irrevocable.5. Granting collaterals.

The holder of a securities account requires needs to trust that his their holding represented in account is effective against:

◦ The dealer intermediary◦ Third parties

Includes insolvency or bankruptcy.

Applicable to any level of in the chain of intermediated securities.

Conclusion