Interest and Intermediated Securities: Difference between pages

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by ''[[Tobias Tröger]]''
by ''[[Simon Schwarz]]''


== 1. Scope and purpose ==
== 1. Subject matter and purpose ==


Interest is the typical remuneration for providing the scarce resource of capital (money or fungible goods). Forgoing current liquidity incurs opportunity costs that can be offset by an adequate rate of interest on the capital provided. Hence, interest rates are calculated with regard to maturity and default risk but are generally independent of any proceeds the debtor may generate from the funds he received. From the perspective of the law, primarily two issues are of general significance. On the one hand, jurisdictions are concerned with the prerequisites and limits of valid interest agreements between private parties. On the other hand, the unauthorized arrogation of capital calls for adequate sanctions like an ''ex lege'' duty to pay interest.
The safekeeping and administration of securities or [[Financial Instruments|financial instruments]] by custodian banks has developed into an area to be distinguished from the rules of general [[Deposit|deposit]], ie the business of custody of investments or global custody. In the broader sense the law of global custody deals with the legal characterization and regulation of those operational infrastructures which have emerged on modern financial markets to allow for a smooth processing and settlement of securities transactions as well as an effective administration of the underlying assets (see 2. below). Systematically, the law of intermediated securities thus forms part of [[Banking Law|banking law]] as well as of securities [[Capital Markets Law|capital markets law]] and aims in particular at [[Investor Protection|investor protection]].


The vital economic significance of the allocation of debt capital for both investment and consumption purposes has induced all market-oriented European legal systems to generally honour private parties’ agreements on interest rates. Only widely drawn limits that rest upon either a need to protect the debtor or more general common welfare considerations are imposed upon private agents’ freedom. However, this finding of largely unrestricted private autonomy is nothing but the current state of a highly varied historical development. In [[Roman Law|Roman law]] economic individualism was largely unfettered and thus agreements on interest rates were valid without any restrictions on the merits. However, the Law of the Twelve Tables introduced the ''fenus unciarium'' for the ''nexum'', which established a stable interest rate for loans. Charging higher interest rates was considered usury. If such usurious interest rates were stipulated in an agreement, the debtor was not only entitled to reclaim the overpaid amount but could also bring the ''actio poenalis'' aiming at the ''quadruplum'', ie at the quadruplicate of the excess payment. To the extent that the ''nexum'' was replaced by the informal ''mutuum ''over the course of time, the mentioned limitation on interest rates was obliterated. However, this development was rectified to some degree when the ''centesimae usurae'' (12 percent p.a.) was implemented for the ''mutuum'' as well at the end of the Republic.
== 2. Modern financial market infrastructure ==


As a result of Christian influence, the [[Corpus Juris Civilis|''Corpus Juris Civilis'']] imposed reduced limits on interest rates for the general public and less rigid restrictions in certain areas of business (maritime loans) or for certain agents (merchants, fabricants) to reflect both the specific risks of certain transactions and the superior experience of the parties involved. The increasing power of the Christian Church led to the strict prohibition of interest rates in [[Canon Law|canon law]] gaining importance in secular statutes as well. However, as early as in the late Middle Ages, the prohibition was undermined by special arrangements in the trade practices of the time (eg in the form of a ‘purchase of annuities’, an arrangement under which capital was provided against the promise to pay annuities and which could not be terminated by the consignee). It can be observed that the comparably strict prohibition of interest stipulations under [[Islamic Law|Islamic law]] was bypassed by similar arrangements. It has nevertheless survived as applicable law in some jurisdictions. In contrast, the rigid prohibitions of Christian origin were gradually repealed by territorial statutes that emanated first from the upper Italian cities and knew only prescriptions of maximum interest rates. Due to the influence of political liberalism and classical economics, particularly the writings of Adam Smith and Jeremy Bentham (''Defence of Usury'', 1789), strict limits on interest rates have been incrementally substituted for more flexible usury provisions in Europe since the middle of the 19th century. While even the latter rules and standards are frequently regarded as undesirably curtailing mutually beneficial lending activities, (behavioural) economists have recently defended the pertinent provisions against the proponents of unfettered lending. Their rationale for usury law rests on the grounds that it prevents limited rational would-be borrowers with poor credit standing from accumulating excessive debt simply because (risk-adequate) high-interest loans are unavailable to them.
=== a) Immobilization of securities  ===


With regard to the protection of debtors, interest on interest (anatocism) demands particular attention. The properties of the interest-function involve total interest due rising exponentially if interest that accrued in the past is subject to future interest calculation. Historically, this accumulating effect of compound interest was regarded as a rationale for regulation. The main purpose of these interventions was to protect debtors from snowballing burdens of interest or at least to make the perils originating from compound interest agreements transparent. In this spirit, classical Roman law had already prohibited the stipulation of interest on interest outright in order to make sure that interest would accrue only in a linear rather than in an exponential manner. However, the experience under [[Roman Law|Roman law]] in particular also illustrates that parties who see economic reason in compound interest agreements have ample opportunities to contract around blunt prohibitions, eg by periodically entering into new loan agreements and simply adding the previously accrued interest to the new nominal sum borrowed.
Today, acquisitions and dispositions of securities traded on capital markets ([[Financial Instruments|financial instruments]]) are, from an operational perspective, effected only via credits and debits in securities accounts maintained by custodians. This development was initially based on the so-called immobilization or mediation of securities: any (bearer) security certificate issued within a country is immediately transferred to a central securities depository (CSD) that undertakes the permanent safe custody of the whole issue. If registered securities are immobilized, either the CSD or its nominee is entered into the relevant register instead of the final investor. Hence, the register does not need to be changed to reflect trading (but, if applicable, for the purpose of legitimization vis-à-vis the issuer). Within this ‘mediated’ or ‘indirect holding system’, the certificate or register entry that represents the underlying asset no longer points directly to the investor having the economic interest therein. The CSD does not hold the shares on its own behalf but rather on behalf of its customers, usually a limited number of custodians (participants). The CSD maintains securities accounts on which it breaks down which type of financial instrument it retains in what amount for which participant (first or highest holding tier). The participants, in turn, partly hold these shares as their own stock (proprietary securities) but predominantly on behalf of their own customers (customer securities) as evidenced by entries in the securities accounts operated by the participants as custodians (second holding tier). Further tiers may follow before the final investor is reached. Thus, a safekeeping pyramid comprising a holding chain of any number of custodians is created. Each link in the chain maintaining customer accounts qualifies as an intermediary. Similarly to the modern giro payment system, dispositions are accomplished solely by credits and debits on securities accounts managed by intermediaries on the investors’ instructions; no physical transfer takes place (‘book-entry securities’, Art 2(2)(g) Dir 47/2002 of 6 June 2002 on financial collateral arrangements). Hence, physical certificates have lost their original function almost completely; even the exercise of the rights attached to the securities (eg dividend and interest payments, preemption and voting rights, or other corporate actions) is normally processed through intermediaries (see Dir 36/2007 of 11 July 2007 on the exercise of certain rights of shareholders in listed companies).


Finally, the primary function of interest payments to compensate creditors for temporary forgoing liquid funds is also relevant where defaulting debtors usurp capital that would have been vested in the creditor if performance had occurred in time. Statutory obligations to pay interest as a sanction for the [[Delay in Payment|delay in payment]] can thwart incentives to behave opportunistically.
=== b) Transparent and non-transparent holding structures  ===


== 2. Structures and tendencies of legal development ==
Within the mediated holding system, contractual relationships (account agreements) exist only between the respective neighbours in the custodial chain. Intermediaries usually maintain fungible or omnibus accounts, ie they pool the securities of one customer and credit them to the customer’s account on an unseparated basis even if the latter holds the assets for downstream customers (''dépôt en fongibilité'','' verzameldepot'','' Sammelverwahrung''). Therefore, end-investors are unknown at higher tiers; they may only be identified by looking into the books of their immediate intermediary. This phenomenon is called a non-transparent holding structure (eg Austria, Belgium, Germany, France, Netherlands, Switzerland, Canada, the United States, and optionally in England). However, there are also transparent holding systems in which credits may at all tiers be directly assigned to the respective end-investor (eg'' ''Greece, Nordic countries, Spain, optional in England). To this end, some systems allow even private investors to become members of the CSD, which then manages an unlimited quantity of individual accounts (single-tier holding, eg Greece, optional in England). In other systems the accounts of the CSD participants consist of various sub-accounts showing the final investors (two-tier holding, eg Finland, Spain, optional in Sweden). Hence, in these systems the true shareholder may be identified by one glance into the books of the CSD.


=== a) Contractual interest stipulations ===
=== c) Dematerialization of securities ===


Today, in European jurisdictions the general freedom to stipulate interest obligations in contracts is not in question. However, if the parties do not agree upon specific provisions, it remains to be determined whether the respective private law systems treat any allocation of capital as remuneration by default or rather assume that it is free of charge in the absence of any express stipulation to the contrary. The [[Loan|loan]] as the basic type contract for the allocation of capital does not provide for interest payments as default remuneration for the lender in those jurisdictions that follow the example of Roman law (eg Art 1905 [[Code Civil|''Code civil'']], Art 1755 [[Código Civil|''Código civil'']], Art 7A:1804 [[Burgerlijk Wetboek (BW)|''Burgerlijk Wetboek'' (BW)]]; Art 313(1) OR; for the English common law see ''Page v Newman'' (1829) 9 B & C 378, 381; ''President of India v La Pintada Compania Navegacion'' ''SA'' [1985] AC 104; for a different default rule see in particular Art 1815(1) [[Codice Civile|''Codice civile'']], § 488 (1)2 [[Bürgerliches Gesetzbuch (BGB)|''Bürgerliches Gesetzbuch'' (BGB)]]). However, in [[Commercial Law|commercial law]], the opposite often applies, ie interest has to be paid for any allocation of capital by default (eg § 354(2) HGB (UGB); Art 313(2) OR). Moreover, even where specific regulations are lacking, the prevailing case law in line with the typical interests of the parties frequently assumes a tacit agreement on remuneration or a common commercial practice to this end. In these scenarios, statutory interest rates that only serve as a default of ‘last resort’ (eg § 246 BGB, § 352(1) HGB, Art 1284 ''Codice civile'', Art 7A:1805 BW) are usually considered to be tacitly replaced by the customary interest rate.  
The obvious discrepancy between the costs of the producing and safekeeping of paper certificates and the practical significance thereof led to a phenomenon closely related to that of immobilization: the dematerialization of securities, ie the partial or complete abandonment of physical certificates as a means of representation of underlying assets. The first step was the aggregated securitization of identical shares in one or more ‘global’ or ‘jumbo’ certificate (eg Austria, England, Germany, Luxembourg, the Netherlands, Switzerland, Canada, the United States). Often, the entire issue is permanently represented by only a single global certificate. By virtue of a legal fiction this single document represents a number of individual certificates equivalent to the face value of the issue, but the shareholders’ right to ask for individual certificates has been fully excluded in the terms of the issue. Hence, even though ‘true’ certificates theoretically still exist, trades may only be settled electronically through credit/debit transfers instead of any physical delivery. It thus appears more consistent to abandon any paper basis in total and to install an electronic registry system involving ‘dematerialized’ or ‘uncertificated securities’ instead. In the 1980s, France was the first legal system to convert its securities system for all financial instruments of all issuers into a pure book-entry system based on dematerialized securities; an example which is being followed by an increasing number of countries (eg Belgium, Greece, Italy, Spain, Nordic countries, Japan; optionally (and partly established even earlier) in England, Switzerland, Australia, Canada, the United States; limited to government bonds in Austria, Germany).


The harmonized law on [[Consumer Credit (Regulatory Principles)|consumer credit (regulatory principles)]] requires strict transparency of agreements on interest rates. Extensive information (in particular on debit interest, annual percentage rate, etc) has to be provided to the consumer both prior to the conclusion of the contract and in the contractual document itself (Arts 4 ff Consumer Credit Directive (Dir 2008/ 48)).
=== d) Clearing and settlement of securities transactions ===


Substantive limits for contractual stipulations of interest rates exist in all European legal systems, in particular as rules and standards prohibiting usury. The terminology can be deduced from its Latin root ''usura'' (or in Medieval Latin ''usuria'') not only in the Romance languages but also, for example, in English, Swedish (''ocker'') and German (''Wucher''). The comparison of various jurisdictions reveals two different regulatory approaches. In some legal systems, the mere existence of a heavy disproportion between the market value of the allocated capital (ie the customary interest rate) and the agreed interest rate is considered sufficient to trigger the allegation of usury. Other legal systems require additionally that the lending party deliberately took advantage of the other side’s inferior position.  
The subsequent operational processes following the conclusion of a securities trade via a securities exchange ([[Exchanges|exchanges]]) or other [[Markets for Financial Instruments|markets for financial instruments]] (trading) and serving the clearance and performance of the transaction are usually referred to as the post-trade phase or the clearing and settlement (C&S) of the transaction. The term ‘clearing’ generically and comprehensively paraphrases all steps necessary to determine the mutual obligations and to prepare the fulfilment thereof, ie transmission and reconciliation of trade details, bilateral set-off of similar obligations, assessment of collateralization duties, etc. Often, a central counterparty (CCP, Art 2(c) Dir 26/1998 of 19 May 1998 on settlement finality in payment and securities settlement systems) is involved in the process of clearing. If so, each trade between the market participants is split into two identical contracts with the CCP as a respective counterparty (trade A-B becomes trade A-CCP and CCP-B). The CCP thus assumes the credit and settlement risk of the participants which are obliged to provide sufficient [[Financial Collateral|financial collateral]] to mitigate the risks involved (margining). As far as they relate to the same type of security, the various contractual obligations between the participants and the CCP are set-off to a single net delivery obligation (‘peak’) (multilateral netting). Thus, the volume of securities which effectively have to be moved and the associated risks are substantially reduced (by over 90 per cent). The final step consists of the actual delivery of the securities by way of debit/credit transfer, ie the settlement of the trades. At the top tier of the holding chain the CSD performs the necessary book entries (securities settlement system, SSS) while the intermediaries are responsible for the corresponding bookings at the downstream levels. If a CCP is used, only the net peaks will be cleared within the SSS. On lower tiers, however, all trades have to be evidenced by book-entries. That is why, today, it is usually impossible to identify a complete chain of debits and credits connecting seller and buyer in case of transactions on a securities exchange. Within the book-entry securities system the (intermediated) access to a settlement system is a prerequisite for participation in securities markets (essential facility). Therefore, the respective infrastructures are becoming more and more interlinked even in the cross-border context. In addition, there are two specialized institutions in Belgium and Luxembourg serving as settlement hubs for international securities transactions (international central securities depositories, ICSD).


Particularly in the context of consumer credit law, the mere existence of a grave disproportion is usually regarded sufficient to amount to usury, arguably because of the structurally inferior position of the consumer who concedes excessive interest payments. However, regulations are rarely limited to consumer contracts. Special rules for usury exist, for example, in France (Art L-313-5 ''Code monétaire et financier'' and Art L-313-3 ''Code de la consommation''), England (ss 137–140 Consumer Credit Act 1974), Spain (Art 1 ''Ley de la represión de la usura'') and Italy (Art 1815(2) [[Codice Civile|''Codice civile'']]). These regulations partly contain fixed limits on interest rates (France: usury found above an interest rate of 133 percent of the average global annual percentage rate as calculated by financial institutions during the previous quarter for credits of the pertinent type) which nevertheless leave room for a good share of distinction between various types of credits. Moreover, courts construe blanket provisions in civil law statutes (§ 138(1) BGB, § 879(1) ABGB, Art 178 f Greek Civil Code, Art 36 Nordic contract statutes) in a way that the mere existence of a disproportion amounts to usury (eg the leading case of the German Federal Supreme Court, BGH 24 March 1988, BGHZ 104, 102, 105: overall interest rate of more than 200 percent of the average interest rate is considered usurious and therefore against public policy).  
== 3. National regulatory structures ==


An additional exploitation of the inferior party’s vulnerable position is generally required if the usurious transaction is to be appraised under laws and doctrines that potentially apply not only to the stipulation of disproportionate interest rates but to other disfavoured practices as well. This is true, for example, with regard to the equitable doctrines ([[Equity|equity]]) of [[Undue Influence|undue influence]] and unconscionable bargain, but also in the law of the Netherlands (Art 3:44(4) BW).
The situation of assets of different proprietors being lodged with a depositary which transfers them to a third party not separating and allocating them to the original depositors (fungible custody) usually gives rise to a ''depositum irregulare'', ie the proprietors lose their right'' in rem'' in return for a mere contractual claim ([[Deposit|deposit]]). Hence, investors would be exposed to their intermediaries’ insolvency risk and would thus be worse off than under traditional securities law. Therefore, the shielding of the investment from the custodian’s credit and custody risk constitutes a central purpose of the rules relating to intermediated securities. In addition, the traditional securities law with its physical connecting factor for the disposition of equity interests meets its constructive limits on modern capital markets. Conceptual problems are raised, for example, by issues of good faith acquisition ([[Acquisition of Ownership from a Non-Owner|acquisition of ownership from a non-owner]]) or the concept of tracing of assets within the book-entry system. Many issues still remain to be clarified in several national legal systems. From a comparative perspective, two main (but overlapping) approaches may be identified, ie the co-ownership solutions and the trust solutions.


The general consequence of usury in most jurisdictions lies in the reduction of the agreed rate of interest to the average market interest rate. Yet, significant differences in the doctrinal paths that lead to this uniform result exist. While in some legal systems the contract is adapted either through judicial act or statutory provisions, others partly nullify the interest clause or declare it void in its entirety and secure remuneration in line with the market rate via the principles of [[Unjustified Enrichment|unjustified enrichment]] (eg France, England, Italy, Germany and Scandinavia).
=== a) Co-ownership solutions ===


=== b) Interest on interest ===
In Europe, most continental legal systems grant the investor a right ''in rem'' in all securities deposited with the CSD or registered in its name in the form of joint or co-ownership. They thus construe a direct link ''in rem'' between the final investor and the physical certificate or register entry which represents the respective underlying asset. However, investors have no property right to individually identifiable papers or register entries but rather a fractional co-ownership right in all assets of the same type deposited at the CSD (German (1937) and Austrian (1969) ''Depotgesetz''). Other legal systems employ a legal fiction according to which all securities credited to accounts within the intermediated holding system form part of a (virtual) global safe custody deposit irrespective of their actual place of safekeeping (''universalité de titre de même espèce''). The investor receives a ‘non-physical right of co-ownership’ in this virtual deposit (''droit de copropriété'','' de nature incorporelle'', Belgian ''Arrêté Royal n°62'' (1967); similarly, Luxembourg ''Loi du 1.8.2001'' (formerly ''Règlement Grand-Ducal du 17.2.1971''), Dutch ''Wet giraal effectenverkeer'' (1977/2011)). Outside of the account provider’s insolvency, however, the investor may not exercise this right ''in rem'' ''erga omnes'' but only vis-à-vis its own intermediary (Belgium, Luxembourg, Netherlands; the correct interpretation is disputed in Austria, Germany). Even the paper-free French system sticks to a ‘physical’ terminology in describing the investor as being the owner of book-entry securities ‘materialized by account credit’ (''valeurs mobilières ne sont matérialisés que par une inscription au compte de leur propriétaire'', Art R211-1 ''Code monétaire et financier''). Italian law expressly states that the holding of securities through fungible accounts shall be regarded as a ''depositum regulare'' (depositors keep their original right ''in rem'') and that a debit/credit transfer qualifies as physical delivery (''Legge 19.6.1986'','' n. 289''). Finally, transparent systems always grant the investor a direct property right to the shares evidenced on the accounts of the CSD.


In those jurisdictions where an outright prohibition of anatocism is still in force today (eg § 248(1), § 289(1) BGB; Art 314(3) OR; Art 1154 ''Code civil'') it is usually attenuated by substantive and personal exemptions. Particularly in [[Commercial Law|commercial law]], extensive exceptions and opportunities to custom-tailor compound interest arrangements exist (eg § 355(1) HGB, Art 314(3) OR, § 317 ''Código de commercio''). The general theme of the relevant law in action is that an austere prohibition in this context would be regarded as excessive with regard to adequate creditor protection. Hence, the pertinent rules are construed in a rather narrow manner.  
As to the disposition of these rights ''in rem'', some legal systems simply apply the general rules of [[Transfer of Title (Movable Goods)|transfer of title (movable goods)]] whereby the debits and credits are interpreted as the transfer of constructive possession of the underlying certificates (Austria, Germany). Other laws contain an explicit reference to the account bookings as the transfer mode (''virement de compte à compte'', Belgium, France, Italy, Luxembourg, Netherlands). In many legal systems, however, the precise scope of these principles still remains to be clarified. With a view to the principles of good faith acquisition, for example, it is often disputed whether account credits substitute for the transfer of physical possession ([[Acquisition of Ownership from a Non-Owner|acquisition of ownership from a non-owner]]). The prevailing view in Germany and Austria answers this question in the affirmative. Just recently (2009), the French legislature ordered that the general principle ''la possession vaut titre'' of Art 2279 ''Code civil'' shall apply to ‘possession of credits’ as well; the same was done earlier in Belgium. According to Italian law, the same effects should be ascribed to a credit/debit transfer as to the physical circulation of paper securities. Overall, as far as dispositions are concerned, the co-ownership solutions treat the mediated and to a large extent dematerialized book-entry securities more or less analogously to traditional securities law. This view is still based on the idea that, in commercial transactions, the very same asset is transferred (''viz'' the share of co-ownership in the collective safe custody) irrespective of the question whether transferor and transferee can be identified ''ex ante'' or ''ex post'', and whether they are actually linked to each other by a continuous chain of debits and credits.


=== c) Duty to pay interest as a remedy for late payment ===
=== b) Trust solutions ===


Continental European jurisdictions generally prescribe a duty for the debtor of a monetary obligation to pay interest to the creditor by law if he is in [[Delay in Payment|delay of payment]]. Contrary to this, the common law does not acknowledge such obligations and denies, for example, the lender a claim for interest payments for the time after the due date of the loan, even if the debtor is in delay with the redemption (''London'','' Chatham & Dover Ry v South Easter Ry'' [1893] AC 429, ''President of India v La Pintada Compania Navegacion SA'' [1985] AC 104). This general observation remains valid even though the rule has been alleviated in certain cases, particularly where creditors are entitled to claim damages for actual and foreseeable losses of interest yields (''Trans Trust SPRL v Danubian Trading Co'' [1952] QB 297, 306, 307; ''Wadsworth v Lydell'' [1952] 1 WLR 598). Only statutory law provides for true exceptions from the common law rule. The directive on late payment (Dir 2000/35) is of critical importance in this respect. It prescribes a duty to pay interest on monetary obligations from the 30th day after the due date in all commercial transactions (Art 3 Late Payment Directive). The directive goes beyond the traditional state of the law not only in the United Kingdom as it features an obviously penalizing character unknown to many jurisdictions. The (default) level of interest for late payment is determined at a margin of at least seven percentage points above the reference interest rate (base lending rate of the [[European Central Bank]] or national central bank). This margin cannot generally be justified with considerations of a necessary compensation for higher default-risks. It rather serves as a tool to create strong incentives for punctual payments.
According to the trust solutions, the investor has no direct right ''in rem'' to the assets kept by the CSD. Rather, the investor receives a direct property right only to the assets held with its own intermediary. The leading model in this respect is the ‘security entitlement’ under Art 8 of the Uniform Commercial Code (UCC) in its revised version of 1994 (this concept has also been adopted in Canada, Panama, Puerto Rico). A security entitlement is defined as a package of rights of the account holder against its intermediary comprising of, inter alia, the right to dispose of the book-entries and the intermediary’s duty to enable the investor to enjoy the rights attached to the underlying securities. Hence, in principle, a security entitlement qualifies as a (mere) contractual claim. It is, however, vested with important proprietary (''erga omnes'') effects. Namely, all credits granted to the intermediary by its higher tier custodian are shielded from any recourse by the intermediary’s general creditors and serve only to cover the account holders’ claims. Thus, a property right ''sui generis'' between the law of obligations and property law emerges. Despite some ambiguities, the prevailing opinion interprets the unwritten English law as being substantially in line with the concept of security entitlement. The fungible holding of securities through intermediaries is understood to constitute a chain of successive [[Trusts|trusts]], each in favour of the respective downstream account holder. The assets of the (sub-)trust in favour of the final investors consist of the equitable interest ([[Equity|equity]]) enjoyed by the custodians in the assets held by their own intermediaries. The participants of the SSS are the legal owners of the underlying securities which hold their legal title on trust for downstream customers. Further, a similar trust solution is implemented by some continental legal systems for securities stored abroad but credited to domestic securities accounts (eg Austria, Germany; others simply apply their local regime for intermediated securities, eg Belgium, Luxembourg, Netherlands). The Swiss ''Bucheffektengesetz'' of 2008 combines the co-ownership model with the concept of security entitlement and creates an own asset falling between those two solutions (similarly already in Belgium, Luxembourg, the Netherlands).


== 3. Regulatory structures in uniform law and unification projects ==
Dispositions in the trust system are construed analogously to the giro transfer model implemented in payment systems: each credit gives rise to a new asset in the hands of the transferee while the transferor’s asset extinguishes once the account is debited. Thus, there is no ‘passing through’ of the same asset along the holding chain. Therefore, in principle, this model does not give rise to any problems of good faith. In addition, the practice of multilateral netting resulting in the de facto impossibility to trace assets does not cause any conceptual difficulties. However, the trust system theoretically allows more book-entries to be credited to end-investors than shares have originally been issued, which may lead to problems in the context of corporate actions.


The academic projects aimed at a unified European private law generally grant parties the freedom to enter into agreements on interest obligations and set interest rates freely. However, they do not contain any general rule on whether transactions leading to a capital commitment generally carry an implicit remuneration clause or not. Even though gratuity is a conceivable option for such agreements, as is the default rule in many jurisdictions, rules like Art 6:104 PECL (or its substantive equivalents in Art II.-9:104 DCFR, Art 5.1.7 UNIDROIT PICC) that provide for the ‘reasonable’ or ‘normal’ price as the agreed compensation may be understood in light of economic realities in a way that, in the absence of an express agreement, any commitment of capital is instituted at the typical market rate. Yet, it militates against such an interpretation that the decision on the pertinent question should not be made in general contract law but rather be left to the provisions dealing with the specific types of contracts that aim at an allocation of capital (cf the respective rule for ''loan contracts'' in Art IV.F.-1:104 DCFR).
== 4. Regulatory structures of Union law ==


The academic projects do not comprise prohibitions of compound interest agreements. Usury, on the other hand, is captured by provisions that pertain not only to interest agreements. Hence, it is no surprise that a finding of usury requires not only the stipulation of a disproportionate interest rate but also the deliberate exploitation of the other party’s vulnerable position (Art 4:109(1) PECL, Art II.-7:207(1) DCFR, Art 3.10 UNIDROIT PICC).
As to Union law, the Finality Directive (Dir 26/1998) and the Financial Collateral Directive (Dir 47/2002) constitute the basic cornerstones of the European market infrastructure regime ([[Financial Collateral|financial collateral]]). In addition, the Directive on [[Markets for Financial Instruments]] (MiFID) (Dir 39/2004) including implementing directive (Dir 73/2006) contain provisions relating to the safekeeping of the mediated assets (Art 13(7) MiFID, Arts 16 ff Dir 73/2006). Furthermore, the MiFID grants market participants a claim to (cross-border) access to and the choice of C&S systems (Arts 34, 46). As a result a given market is not necessarily linked to a single predefined settlement system. Rather, a trade may be concluded in country A, cleared in country B and finally settled in country C provided that the respective systems are compatible and interlinked. The latter can only be realized by the service providers themselves. For that reason (and to counter concerns of competition law), the C&S industry elaborated a code of conduct ([[Private Rule-Making and Codes of Conduct|private rule-making and codes of conduct]]) with rules on price transparency and system compatibility. Its implementation is supervised by the ‘Monitoring Group of the Code of Conduct on Clearing and Settlement’ (MOG) installed by the [[European Commission]].


Finally, uniform laws (Art 48(2) Geneva Convention on Bills of Exchange, Art 45(1) Geneva Convention on Cheques, Arts 78, 84(1) CISG) as well as the academic projects (Art 9:508 PECL, Art III.-3:708 DCFR, Art 7.4.9 UNIDROIT PICC) contain numerous provisions that prescribe a legal duty to pay interest in the case of delayed payments. It is noteworthy in this context that the relevant statutory interest rates—the CISG does not contain a specification due to insurmountable differences in opinion among participants at the Vienna congress—do not exhibit any penalizing character. The relevant statutory interest rates that determine interest obligations arising in case of delayed payment are set at the common interest rates commercial banks charge short-term borrowers with first-class credit-worthiness (Art 9:508(1) PECL, Art III-3:708(1) DCFR, Art 7.4.9(2) UNIDROIT PICC). As a consequence, for some debtors of bad standing, some leeway for opportunistic arbitrage remains. This holds particularly true if the debtor does not pay his liabilities from deposits—that carry a low interest yield—but from credit lines that were granted only at the price of a high interest-burden.
Issues relating to intermediated securities are increasingly coming into the regulatory focus of the Commission since the existence of a clear legal basis as to the settlement of (cross-border) securities transactions is a basic prerequisite for an efficient [[European Internal Market|European internal market]] for financial services and the effective [[Free Movement of Capital and Payments|free movement of capital and payments]] (comprehensive information is to be found on the website of DG MARKT, Financial Markets Infrastructure). Following two reports by the so-called Giovannini Group, which identified 15 market hurdles (2001) and highlighted possible solutions (2003), the Commission adopted a communication on the way forward on the post-trade sector (COM (2004) 312 final). Consequently, the Commission convened several expert groups, ''viz'' the ‘Clearing and Settlement Advisory and Monitoring Expert Group’ (CESAME) looking into technology, market practices and governance, the ‘Clearing and Settlement Fiscal Compliance Expert Group’ (FISCO) analysing fiscal barriers, and the ‘Legal Certainty Group’ (LCG) preparing the harmonization of private law rules on intermediated securities. In addition, there are numerous working papers and recommendations of several international expert groups, eg the ‘Group of Thirty’ (G30), the ‘European Financial Markets Lawyers Group’ (EFMLG), the ‘European Central Securities Depositories Association’ (ECSDA), the ‘Committee of European Securities Regulators’ (CESR) and the ‘Committee on Payment and Settlement Systems’ (CPSS).
 
In August 2008, the Legal Certainty Group presented its detailed final report including legislative recommendations. Adopting a functional approach, only the legal effects of account credits are determined (''ie'' book-entry securities, rec 4) rather than their conceptual nature (property right or trust). Book-entry securities are validly acquired vis-à-vis third parties (including the intermediary’s creditors but not necessarily the issuer) once credited to a securities account and disposed of by corresponding debit; acquisition in good faith is possible (recs 5–7). The report also contains recommendations regarding the possibility of a reversal of a credit or debit and the legal consequences thereof (recs 6f, 9). Furthermore, proposals concerning the mediated processing of corporate actions are also included (recs 12–14). Finally, issuers shall be able to choose any CSD within the EU to immobilize their issue (rec 15). Overall, the LCG’s recommendations are more detailed and aim at a higher degree of harmonization than UNIDROIT’s project (see 5. below). Based on the LCG report, the Commission is elaborating a securities law directive which is expected to be published in the second half of 2011 subsequent to public consultations which occurred in spring 2009 and December 2010, whereby the second consultation already referred to draft regulatory principles essentially implementing the LCG’s recommendations. The Draft [[Common Frame of Reference (CFR)|Common Frame of Reference]] (DCFR) is somewhat ambiguous as regards book-entry securities: while the provisions on [[Deposit|deposit]] (Art IV.C.-5:101(2)(c)) and on [[Transfer of Title (Movable Goods)|transfer of title (movable goods)]] (Art VII.-1:101(4)(a)) do not extent to securities, the rules on [[Security Rights in Movable Assets|security rights in movable assets]] are explicitly applicable to intermediated holdings (Art IX.-1:201(7), (8)) ([[Financial Collateral|financial collateral]]).
 
== 5. Regulatory structures of uniform law ==
 
A global model on modern securities holdings has been elaborated under the auspices of [[UNIDROIT]], ie the (Draft) Convention on Substantive Rules regarding Intermediated Securities adopted in Geneva in October 2009 (Geneva Securities Convention). The Convention does not aim at full harmonization but uses a functional approach to implement a compromise between legal certainty in cross-border cases and the preservation of national regulatory structures (‘internal soundness’). Inter alia, a securities credit gives rises to an insolvency-protected (Arts 14, 21) claim of the investor to the fruits attached to the underlying securities as well as the right to issue transfer orders (Art 9). Intermediated securities are acquired by credit and disposed of by debit (Art 11; on security interests [[Financial Collateral|financial collateral]]), good faith acquisition ([[Acquisition of Ownership from a Non-Owner|acquisition of ownership from a non-owner]]) being possible (Art 18). However, the Convention leaves the question of the validity of a credit or the possibility of its reversal almost completely up to the applicable national law (Art 16) which undermines the intended legal certainty to a certain extent. The Convention similarly refers to the applicable law in numerous other provisions so that national law will continue to have considerable impact and therefore so will the rules on conflicts of laws.
 
== 6. Private international law ==
 
As to the [[Private International Law (PIL)|private international law (PIL)]] of intermediated securities, both European and uniform law provide for special regimes ([[Financial Collateral|financial collateral]]).


==Literature==
==Literature==
Winfried A Hetger, ''Sittenwidrigkeit von Ratenkrediten und Kreditwucher'' (1989); Eric Posner, ‘Contract Law in the Welfare State: A Defense of Usury Laws, the Unconscionability Doctrine, and Related Limitations on the Freedom to Contract’ (1995) 24 JLS&nbsp;283; Eric Kerridge, ''Usury'','' Interest and the Reformation'' (2002); Jochen Dilcher, ''Die Zins-Wucher-Gesetzgebung in Deutschland im 19.&nbsp;Jahr­hun­dert'' (2002); John M Houkes, ''An Annotated Bibliography on the History of Usury and Interest from the Earliest Times through the Eighteenth Century'' (2004); Diego Quaglioni, Giacomo Todeschini and Gian Maria Varanini&nbsp;(eds), ''Credito e usura fra teologia'','' diritto e amministrazione'' (2005); Cass Sunstein, ‘Boundedly Rational Borrowing: A Consumer’s Guide’ (2006) 73 University of Chicago Law Review 271; Franz Dorn, ‘§§&nbsp;246–248. Zinsen’ in Mathias Schmoeckel, Joachim Rückert and Reinhard Zimmermann&nbsp;(eds), ''Historisch-kritischer Kommentar zum BGB'','' vol&nbsp;II''/''1'' (2007); Sieg Eiselen, ‘Interest on Sums in Arrears’ in John Felemegas&nbsp;(ed), ''An International Approach to the Interpretation of the United Nations Convention on Contracts for the International Sale of Goods (1980) as Uniform Sales Law'' (2007).</div>
Dorothee Einsele, ''Wertpapierrecht als Schuldrecht'' (1995); James Steven Rogers, ‘Policy Perspectives on Revised U.C.C. Article&nbsp;8’ (1996) 43 UCLA Law Review 1431; Joanna Benjamin and Madeleine Yates, ''The Law of Global Custody'' (2nd&nbsp;edn, 2002); Frédéric Nizard, ''Les titres négociables'' (2003); Eva Micheler, ''Wertpapierrecht zwischen Schuldrecht und Sachenrecht'' (2004); Matthias Haentjens, ''Harmonisation of Securities Law'','' Custody and Transfer of Securities in European Private Law'' (2007); Philipp&nbsp;R Wood, ''Set-Off and Netting'','' Derivatives'','' Clearing Systems'' (2nd&nbsp;edn, 2007) paras&nbsp;18-001&nbsp;ff; Luc Thévenoz, ‘Intermediated Securities, Legal Risk, and the International Harmonisation of Commercial Law’ (2008) 13 Stanford Journal of Law, Business & Finance 384; Law Commission, ''The UNIDROIT Convention on Substantive Rules regarding Intermediated Securities'','' Further Updated Advice to HM Treasury'' (May 2008); Legal Certainty Group, ''Second Advice of the Legal Certainty Group'':'' Solutions to Legal Barriers related to Post trading within the EU'' (August 2008); Hideki Kanda, Charles Mooney, Luc Thévenoz and Stéphane Béraud (eds), ''Draft Official Commentary on the draft Convention on Substantive Rules regarding Intermediated Securities'' (2009); Mathias Lehmann, ''Finanzinstrumente ''(2009); Matthias Haentjens, ‘Clearing, Settlement and Legal Infrastructure: Ways Forward’ [2011] Journal of International Banking Law and Regulation 243.</div>
 


[[Category:A–Z]]
[[Category:A–Z]]
[[de:Zins-_und_Zinseszins]]
[[de:Verwahrung_(Wertpapiere)]]

Latest revision as of 18:39, 5 June 2025

by Simon Schwarz

1. Subject matter and purpose

The safekeeping and administration of securities or financial instruments by custodian banks has developed into an area to be distinguished from the rules of general deposit, ie the business of custody of investments or global custody. In the broader sense the law of global custody deals with the legal characterization and regulation of those operational infrastructures which have emerged on modern financial markets to allow for a smooth processing and settlement of securities transactions as well as an effective administration of the underlying assets (see 2. below). Systematically, the law of intermediated securities thus forms part of banking law as well as of securities capital markets law and aims in particular at investor protection.

2. Modern financial market infrastructure

a) Immobilization of securities

Today, acquisitions and dispositions of securities traded on capital markets (financial instruments) are, from an operational perspective, effected only via credits and debits in securities accounts maintained by custodians. This development was initially based on the so-called immobilization or mediation of securities: any (bearer) security certificate issued within a country is immediately transferred to a central securities depository (CSD) that undertakes the permanent safe custody of the whole issue. If registered securities are immobilized, either the CSD or its nominee is entered into the relevant register instead of the final investor. Hence, the register does not need to be changed to reflect trading (but, if applicable, for the purpose of legitimization vis-à-vis the issuer). Within this ‘mediated’ or ‘indirect holding system’, the certificate or register entry that represents the underlying asset no longer points directly to the investor having the economic interest therein. The CSD does not hold the shares on its own behalf but rather on behalf of its customers, usually a limited number of custodians (participants). The CSD maintains securities accounts on which it breaks down which type of financial instrument it retains in what amount for which participant (first or highest holding tier). The participants, in turn, partly hold these shares as their own stock (proprietary securities) but predominantly on behalf of their own customers (customer securities) as evidenced by entries in the securities accounts operated by the participants as custodians (second holding tier). Further tiers may follow before the final investor is reached. Thus, a safekeeping pyramid comprising a holding chain of any number of custodians is created. Each link in the chain maintaining customer accounts qualifies as an intermediary. Similarly to the modern giro payment system, dispositions are accomplished solely by credits and debits on securities accounts managed by intermediaries on the investors’ instructions; no physical transfer takes place (‘book-entry securities’, Art 2(2)(g) Dir 47/2002 of 6 June 2002 on financial collateral arrangements). Hence, physical certificates have lost their original function almost completely; even the exercise of the rights attached to the securities (eg dividend and interest payments, preemption and voting rights, or other corporate actions) is normally processed through intermediaries (see Dir 36/2007 of 11 July 2007 on the exercise of certain rights of shareholders in listed companies).

b) Transparent and non-transparent holding structures

Within the mediated holding system, contractual relationships (account agreements) exist only between the respective neighbours in the custodial chain. Intermediaries usually maintain fungible or omnibus accounts, ie they pool the securities of one customer and credit them to the customer’s account on an unseparated basis even if the latter holds the assets for downstream customers (dépôt en fongibilité, verzameldepot, Sammelverwahrung). Therefore, end-investors are unknown at higher tiers; they may only be identified by looking into the books of their immediate intermediary. This phenomenon is called a non-transparent holding structure (eg Austria, Belgium, Germany, France, Netherlands, Switzerland, Canada, the United States, and optionally in England). However, there are also transparent holding systems in which credits may at all tiers be directly assigned to the respective end-investor (eg Greece, Nordic countries, Spain, optional in England). To this end, some systems allow even private investors to become members of the CSD, which then manages an unlimited quantity of individual accounts (single-tier holding, eg Greece, optional in England). In other systems the accounts of the CSD participants consist of various sub-accounts showing the final investors (two-tier holding, eg Finland, Spain, optional in Sweden). Hence, in these systems the true shareholder may be identified by one glance into the books of the CSD.

c) Dematerialization of securities

The obvious discrepancy between the costs of the producing and safekeeping of paper certificates and the practical significance thereof led to a phenomenon closely related to that of immobilization: the dematerialization of securities, ie the partial or complete abandonment of physical certificates as a means of representation of underlying assets. The first step was the aggregated securitization of identical shares in one or more ‘global’ or ‘jumbo’ certificate (eg Austria, England, Germany, Luxembourg, the Netherlands, Switzerland, Canada, the United States). Often, the entire issue is permanently represented by only a single global certificate. By virtue of a legal fiction this single document represents a number of individual certificates equivalent to the face value of the issue, but the shareholders’ right to ask for individual certificates has been fully excluded in the terms of the issue. Hence, even though ‘true’ certificates theoretically still exist, trades may only be settled electronically through credit/debit transfers instead of any physical delivery. It thus appears more consistent to abandon any paper basis in total and to install an electronic registry system involving ‘dematerialized’ or ‘uncertificated securities’ instead. In the 1980s, France was the first legal system to convert its securities system for all financial instruments of all issuers into a pure book-entry system based on dematerialized securities; an example which is being followed by an increasing number of countries (eg Belgium, Greece, Italy, Spain, Nordic countries, Japan; optionally (and partly established even earlier) in England, Switzerland, Australia, Canada, the United States; limited to government bonds in Austria, Germany).

d) Clearing and settlement of securities transactions

The subsequent operational processes following the conclusion of a securities trade via a securities exchange (exchanges) or other markets for financial instruments (trading) and serving the clearance and performance of the transaction are usually referred to as the post-trade phase or the clearing and settlement (C&S) of the transaction. The term ‘clearing’ generically and comprehensively paraphrases all steps necessary to determine the mutual obligations and to prepare the fulfilment thereof, ie transmission and reconciliation of trade details, bilateral set-off of similar obligations, assessment of collateralization duties, etc. Often, a central counterparty (CCP, Art 2(c) Dir 26/1998 of 19 May 1998 on settlement finality in payment and securities settlement systems) is involved in the process of clearing. If so, each trade between the market participants is split into two identical contracts with the CCP as a respective counterparty (trade A-B becomes trade A-CCP and CCP-B). The CCP thus assumes the credit and settlement risk of the participants which are obliged to provide sufficient financial collateral to mitigate the risks involved (margining). As far as they relate to the same type of security, the various contractual obligations between the participants and the CCP are set-off to a single net delivery obligation (‘peak’) (multilateral netting). Thus, the volume of securities which effectively have to be moved and the associated risks are substantially reduced (by over 90 per cent). The final step consists of the actual delivery of the securities by way of debit/credit transfer, ie the settlement of the trades. At the top tier of the holding chain the CSD performs the necessary book entries (securities settlement system, SSS) while the intermediaries are responsible for the corresponding bookings at the downstream levels. If a CCP is used, only the net peaks will be cleared within the SSS. On lower tiers, however, all trades have to be evidenced by book-entries. That is why, today, it is usually impossible to identify a complete chain of debits and credits connecting seller and buyer in case of transactions on a securities exchange. Within the book-entry securities system the (intermediated) access to a settlement system is a prerequisite for participation in securities markets (essential facility). Therefore, the respective infrastructures are becoming more and more interlinked even in the cross-border context. In addition, there are two specialized institutions in Belgium and Luxembourg serving as settlement hubs for international securities transactions (international central securities depositories, ICSD).

3. National regulatory structures

The situation of assets of different proprietors being lodged with a depositary which transfers them to a third party not separating and allocating them to the original depositors (fungible custody) usually gives rise to a depositum irregulare, ie the proprietors lose their right in rem in return for a mere contractual claim (deposit). Hence, investors would be exposed to their intermediaries’ insolvency risk and would thus be worse off than under traditional securities law. Therefore, the shielding of the investment from the custodian’s credit and custody risk constitutes a central purpose of the rules relating to intermediated securities. In addition, the traditional securities law with its physical connecting factor for the disposition of equity interests meets its constructive limits on modern capital markets. Conceptual problems are raised, for example, by issues of good faith acquisition (acquisition of ownership from a non-owner) or the concept of tracing of assets within the book-entry system. Many issues still remain to be clarified in several national legal systems. From a comparative perspective, two main (but overlapping) approaches may be identified, ie the co-ownership solutions and the trust solutions.

a) Co-ownership solutions

In Europe, most continental legal systems grant the investor a right in rem in all securities deposited with the CSD or registered in its name in the form of joint or co-ownership. They thus construe a direct link in rem between the final investor and the physical certificate or register entry which represents the respective underlying asset. However, investors have no property right to individually identifiable papers or register entries but rather a fractional co-ownership right in all assets of the same type deposited at the CSD (German (1937) and Austrian (1969) Depotgesetz). Other legal systems employ a legal fiction according to which all securities credited to accounts within the intermediated holding system form part of a (virtual) global safe custody deposit irrespective of their actual place of safekeeping (universalité de titre de même espèce). The investor receives a ‘non-physical right of co-ownership’ in this virtual deposit (droit de copropriété, de nature incorporelle, Belgian Arrêté Royal n°62 (1967); similarly, Luxembourg Loi du 1.8.2001 (formerly Règlement Grand-Ducal du 17.2.1971), Dutch Wet giraal effectenverkeer (1977/2011)). Outside of the account provider’s insolvency, however, the investor may not exercise this right in rem erga omnes but only vis-à-vis its own intermediary (Belgium, Luxembourg, Netherlands; the correct interpretation is disputed in Austria, Germany). Even the paper-free French system sticks to a ‘physical’ terminology in describing the investor as being the owner of book-entry securities ‘materialized by account credit’ (valeurs mobilières ne sont matérialisés que par une inscription au compte de leur propriétaire, Art R211-1 Code monétaire et financier). Italian law expressly states that the holding of securities through fungible accounts shall be regarded as a depositum regulare (depositors keep their original right in rem) and that a debit/credit transfer qualifies as physical delivery (Legge 19.6.1986, n. 289). Finally, transparent systems always grant the investor a direct property right to the shares evidenced on the accounts of the CSD.

As to the disposition of these rights in rem, some legal systems simply apply the general rules of transfer of title (movable goods) whereby the debits and credits are interpreted as the transfer of constructive possession of the underlying certificates (Austria, Germany). Other laws contain an explicit reference to the account bookings as the transfer mode (virement de compte à compte, Belgium, France, Italy, Luxembourg, Netherlands). In many legal systems, however, the precise scope of these principles still remains to be clarified. With a view to the principles of good faith acquisition, for example, it is often disputed whether account credits substitute for the transfer of physical possession (acquisition of ownership from a non-owner). The prevailing view in Germany and Austria answers this question in the affirmative. Just recently (2009), the French legislature ordered that the general principle la possession vaut titre of Art 2279 Code civil shall apply to ‘possession of credits’ as well; the same was done earlier in Belgium. According to Italian law, the same effects should be ascribed to a credit/debit transfer as to the physical circulation of paper securities. Overall, as far as dispositions are concerned, the co-ownership solutions treat the mediated and to a large extent dematerialized book-entry securities more or less analogously to traditional securities law. This view is still based on the idea that, in commercial transactions, the very same asset is transferred (viz the share of co-ownership in the collective safe custody) irrespective of the question whether transferor and transferee can be identified ex ante or ex post, and whether they are actually linked to each other by a continuous chain of debits and credits.

b) Trust solutions

According to the trust solutions, the investor has no direct right in rem to the assets kept by the CSD. Rather, the investor receives a direct property right only to the assets held with its own intermediary. The leading model in this respect is the ‘security entitlement’ under Art 8 of the Uniform Commercial Code (UCC) in its revised version of 1994 (this concept has also been adopted in Canada, Panama, Puerto Rico). A security entitlement is defined as a package of rights of the account holder against its intermediary comprising of, inter alia, the right to dispose of the book-entries and the intermediary’s duty to enable the investor to enjoy the rights attached to the underlying securities. Hence, in principle, a security entitlement qualifies as a (mere) contractual claim. It is, however, vested with important proprietary (erga omnes) effects. Namely, all credits granted to the intermediary by its higher tier custodian are shielded from any recourse by the intermediary’s general creditors and serve only to cover the account holders’ claims. Thus, a property right sui generis between the law of obligations and property law emerges. Despite some ambiguities, the prevailing opinion interprets the unwritten English law as being substantially in line with the concept of security entitlement. The fungible holding of securities through intermediaries is understood to constitute a chain of successive trusts, each in favour of the respective downstream account holder. The assets of the (sub-)trust in favour of the final investors consist of the equitable interest (equity) enjoyed by the custodians in the assets held by their own intermediaries. The participants of the SSS are the legal owners of the underlying securities which hold their legal title on trust for downstream customers. Further, a similar trust solution is implemented by some continental legal systems for securities stored abroad but credited to domestic securities accounts (eg Austria, Germany; others simply apply their local regime for intermediated securities, eg Belgium, Luxembourg, Netherlands). The Swiss Bucheffektengesetz of 2008 combines the co-ownership model with the concept of security entitlement and creates an own asset falling between those two solutions (similarly already in Belgium, Luxembourg, the Netherlands).

Dispositions in the trust system are construed analogously to the giro transfer model implemented in payment systems: each credit gives rise to a new asset in the hands of the transferee while the transferor’s asset extinguishes once the account is debited. Thus, there is no ‘passing through’ of the same asset along the holding chain. Therefore, in principle, this model does not give rise to any problems of good faith. In addition, the practice of multilateral netting resulting in the de facto impossibility to trace assets does not cause any conceptual difficulties. However, the trust system theoretically allows more book-entries to be credited to end-investors than shares have originally been issued, which may lead to problems in the context of corporate actions.

4. Regulatory structures of Union law

As to Union law, the Finality Directive (Dir 26/1998) and the Financial Collateral Directive (Dir 47/2002) constitute the basic cornerstones of the European market infrastructure regime (financial collateral). In addition, the Directive on Markets for Financial Instruments (MiFID) (Dir 39/2004) including implementing directive (Dir 73/2006) contain provisions relating to the safekeeping of the mediated assets (Art 13(7) MiFID, Arts 16 ff Dir 73/2006). Furthermore, the MiFID grants market participants a claim to (cross-border) access to and the choice of C&S systems (Arts 34, 46). As a result a given market is not necessarily linked to a single predefined settlement system. Rather, a trade may be concluded in country A, cleared in country B and finally settled in country C provided that the respective systems are compatible and interlinked. The latter can only be realized by the service providers themselves. For that reason (and to counter concerns of competition law), the C&S industry elaborated a code of conduct (private rule-making and codes of conduct) with rules on price transparency and system compatibility. Its implementation is supervised by the ‘Monitoring Group of the Code of Conduct on Clearing and Settlement’ (MOG) installed by the European Commission.

Issues relating to intermediated securities are increasingly coming into the regulatory focus of the Commission since the existence of a clear legal basis as to the settlement of (cross-border) securities transactions is a basic prerequisite for an efficient European internal market for financial services and the effective free movement of capital and payments (comprehensive information is to be found on the website of DG MARKT, Financial Markets Infrastructure). Following two reports by the so-called Giovannini Group, which identified 15 market hurdles (2001) and highlighted possible solutions (2003), the Commission adopted a communication on the way forward on the post-trade sector (COM (2004) 312 final). Consequently, the Commission convened several expert groups, viz the ‘Clearing and Settlement Advisory and Monitoring Expert Group’ (CESAME) looking into technology, market practices and governance, the ‘Clearing and Settlement Fiscal Compliance Expert Group’ (FISCO) analysing fiscal barriers, and the ‘Legal Certainty Group’ (LCG) preparing the harmonization of private law rules on intermediated securities. In addition, there are numerous working papers and recommendations of several international expert groups, eg the ‘Group of Thirty’ (G30), the ‘European Financial Markets Lawyers Group’ (EFMLG), the ‘European Central Securities Depositories Association’ (ECSDA), the ‘Committee of European Securities Regulators’ (CESR) and the ‘Committee on Payment and Settlement Systems’ (CPSS).

In August 2008, the Legal Certainty Group presented its detailed final report including legislative recommendations. Adopting a functional approach, only the legal effects of account credits are determined (ie book-entry securities, rec 4) rather than their conceptual nature (property right or trust). Book-entry securities are validly acquired vis-à-vis third parties (including the intermediary’s creditors but not necessarily the issuer) once credited to a securities account and disposed of by corresponding debit; acquisition in good faith is possible (recs 5–7). The report also contains recommendations regarding the possibility of a reversal of a credit or debit and the legal consequences thereof (recs 6f, 9). Furthermore, proposals concerning the mediated processing of corporate actions are also included (recs 12–14). Finally, issuers shall be able to choose any CSD within the EU to immobilize their issue (rec 15). Overall, the LCG’s recommendations are more detailed and aim at a higher degree of harmonization than UNIDROIT’s project (see 5. below). Based on the LCG report, the Commission is elaborating a securities law directive which is expected to be published in the second half of 2011 subsequent to public consultations which occurred in spring 2009 and December 2010, whereby the second consultation already referred to draft regulatory principles essentially implementing the LCG’s recommendations. The Draft Common Frame of Reference (DCFR) is somewhat ambiguous as regards book-entry securities: while the provisions on deposit (Art IV.C.-5:101(2)(c)) and on transfer of title (movable goods) (Art VII.-1:101(4)(a)) do not extent to securities, the rules on security rights in movable assets are explicitly applicable to intermediated holdings (Art IX.-1:201(7), (8)) (financial collateral).

5. Regulatory structures of uniform law

A global model on modern securities holdings has been elaborated under the auspices of UNIDROIT, ie the (Draft) Convention on Substantive Rules regarding Intermediated Securities adopted in Geneva in October 2009 (Geneva Securities Convention). The Convention does not aim at full harmonization but uses a functional approach to implement a compromise between legal certainty in cross-border cases and the preservation of national regulatory structures (‘internal soundness’). Inter alia, a securities credit gives rises to an insolvency-protected (Arts 14, 21) claim of the investor to the fruits attached to the underlying securities as well as the right to issue transfer orders (Art 9). Intermediated securities are acquired by credit and disposed of by debit (Art 11; on security interests financial collateral), good faith acquisition (acquisition of ownership from a non-owner) being possible (Art 18). However, the Convention leaves the question of the validity of a credit or the possibility of its reversal almost completely up to the applicable national law (Art 16) which undermines the intended legal certainty to a certain extent. The Convention similarly refers to the applicable law in numerous other provisions so that national law will continue to have considerable impact and therefore so will the rules on conflicts of laws.

6. Private international law

As to the private international law (PIL) of intermediated securities, both European and uniform law provide for special regimes (financial collateral).

Literature

Dorothee Einsele, Wertpapierrecht als Schuldrecht (1995); James Steven Rogers, ‘Policy Perspectives on Revised U.C.C. Article 8’ (1996) 43 UCLA Law Review 1431; Joanna Benjamin and Madeleine Yates, The Law of Global Custody (2nd edn, 2002); Frédéric Nizard, Les titres négociables (2003); Eva Micheler, Wertpapierrecht zwischen Schuldrecht und Sachenrecht (2004); Matthias Haentjens, Harmonisation of Securities Law, Custody and Transfer of Securities in European Private Law (2007); Philipp R Wood, Set-Off and Netting, Derivatives, Clearing Systems (2nd edn, 2007) paras 18-001 ff; Luc Thévenoz, ‘Intermediated Securities, Legal Risk, and the International Harmonisation of Commercial Law’ (2008) 13 Stanford Journal of Law, Business & Finance 384; Law Commission, The UNIDROIT Convention on Substantive Rules regarding Intermediated Securities, Further Updated Advice to HM Treasury (May 2008); Legal Certainty Group, Second Advice of the Legal Certainty Group: Solutions to Legal Barriers related to Post trading within the EU (August 2008); Hideki Kanda, Charles Mooney, Luc Thévenoz and Stéphane Béraud (eds), Draft Official Commentary on the draft Convention on Substantive Rules regarding Intermediated Securities (2009); Mathias Lehmann, Finanzinstrumente (2009); Matthias Haentjens, ‘Clearing, Settlement and Legal Infrastructure: Ways Forward’ [2011] Journal of International Banking Law and Regulation 243.

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