учебный год 2023 / Haentjens, Harmonisation Of Securities Law. Custody and Transfer of Securities in European Private Law

9 HARMONISATION INITIATIVES

9.1 INTRODUCTION

9.1.1 The case for harmonisation

As has been indicated in Chapter 4.4, legal harmonisation by legislative instruments in the field of capital markets can be justified by an analysis of the risks currently inherent in the settlement of international securities transactions. In such an analysis, harmonisation reduces legal risk, thus increasing the stability and efficiency of the financial markets as a whole. In other words, harmonisation contributes to the reduction of systemic risk and is thereby justified.

On the other hand, this argument would leave out important objections to harmonisation and would therefore not present a balanced view. Such a balanced view must be obtained by weighing the pros and cons, or, in economic terms: the costs and benefits.1 These costs include, firstly, the expenses of the necessary changes to national laws and (perhaps) its procedures. As a general matter, however, these costs represent static or ‘one-off’ losses, whereas it is submitted that harmonisation leads to both static and dynamic benefits and growth.2 Moreover, it will be shown that where harmonisation in the field of capital markets is concerned, both the dynamic and static benefits are considerable.

Secondly, harmonisation has been said to reduce or minimise competition between legal systems. The minimisation of competition should be taken seriously as it is generally agreed that competition between legal systems furthers (legal) innovation and satisfies the differing preferences of the subjects of these systems. It may therefore represent a way to identify the most efficient solution to a certain problem.3 It is the author’s view, however, that the harmonisation of securities custody and transfer law does not necessarily exclude all competition between the relevant legal systems.

1An impressive amount of publications has been produced on this subject, also from a ‘law and economics’ perspective, but mainly on the harmonisation of contract law; see, e.g, G. WAGNER (2002) and H. WAGNER (2005) and the references provided there. In the context of the present study, it is only possible to summarise the main argumentation.

2Cf. H. WAGNER (2005), 33-35.

3G. WAGNER (2002), 1001-1003 and SMITS (2006), 79-80. Cf. also HESSELINK (2001), 57.

9 Harmonisation initiatives

Competition is only minimised when legal systems are fully harmonised or unified.4 In European legislation, on the other hand, various types of harmonisation instruments preserve the possibility of competition without foregoing all benefits of harmonisation. But even if the European jurisdictions were to be wholly unified, competition would remain possible on the global level as complete harmonisation on this level is highly unrealistic.5 In short, competition between legal systems will always be possible on the global level, whereas on the European level, certain instruments of harmonisation such as directives, might allow for some competition to be preserved.6

Moreover, while the choice of applicable law by (physically) relocating has been shown not to be a realistic option, especially not for most European corporations and citizens,7 competition as just referred to must be ensured by a conflict of laws rule that ensures party autonomy. It will be seen that under the Hague Securities Convention, the law applicable to many securities custody and transfer issues is within certain limits determined by the law that is chosen by the parties.8

Thirdly, it has been argued that harmonisation involves costs that cannot be quantified in an economic analysis, or but with great difficulty. These ‘costs’ relate to socio-cultural aspects that would be harmed by harmonisation. However, these costs are indeed virtually impossible to quantify and therefore difficult to take into account in an objective cost-benefit analysis. Although possible harm to socio-cultural aspects cannot be denied all value as an objection against harmonisation in general, it is difficult to imagine its worth when harmonisation concerns a field of law that is mainly financial in nature and where harmonisation is claimed not only to result in substantial economic benefits, but also to contribute significantly to investor/consumer protection.

Harmonisation of securities custody and transfer law will contribute to enhanced investor protection as it will safeguard the investor to a large

4On the distinction between these terms, see supra, Ch. 1.1, n.15.

5Global competition presupposes a global marketplace, and it is submitted that with regard to securities custody and transfer law, the marketplace is indeed increasingly global. That statement is proven by the (intended) transatlantic merger of the stock exchanges Euronext and NYSE, the countries that participate in the drafting of the UNIDROIT instrument on this subject and the jurisdictions that have been taken into account by the EU Legal Certainty Group in the preparation of a future EU harmonisation instrument; see infra.

6Cf. infra, Ch. 12.4.1. Furthermore, such a restricted form of legal competition will prevent the sometimes much feared ‘race for the bottom’. Cf. G. WAGNER (2002), 1003-1006, who argues that a race for the bottom can only occur in a market where participants can choose the applicable law and doubts that – should it in fact occur – it would have negative consequences.

7See G. WAGNER (2002), 1007-1008.

8See also, Ch. 3.3.3 and 9.3.4.

236

9 Harmonisation initiatives

extent against legal uncertainty, i.e. the current uncertainty in the identification of the law applicable to his rights and duties, the current multiplicity of rules and the difficulty in understanding them.9 In the words of the New York legislature; clarity and certainty as well as uniformity must be attained ‘so that the securities market will function in such a way that it will be more stable, and so that investors, both individual and corporate, will be more secure and their rights and interests better protected.’10 Moreover, it will be shown that harmonisation will directly enhance investor protection through the modernisation of less protective systems, notably in the cases of intermediary insolvencies.11

Another ‘cost factor’ that is difficult to quantify, but might outweigh the benefits of harmonisation, is the encroachment on the coherence of national systems. Indeed, especially in the field of capital markets where harmonisation must necessarily address matters of property law, contract law, company law and insolvency law, encroachment may present a realistic fear.12 In this vein, it might be argued that the preservation of the coherence of national systems of law does not permit the harmonisation and accompanying modernisation of securities custody and transfer law.13 It is this objection that will be the main subject of the following chapters, where it will be shown that the harmonisation and modernisation of securities custody and transfer law are not likely to cause the jurisdictions investigated to become incoherent.

On the benefit side, it has already been mentioned that the reduction of legal risk or legal uncertainty through harmonisation results in considerable (economic) benefits while contributing to enhanced investor protection. More in particular, it has been shown that the reduction of legal uncertainty as described in Chapter 4.4.2, i.e. uncertainty as to what the applicable law is and what its consequences are, is likely to imply (economic) growth.14 In this view, legal uncertainty both statically and dynamically requires additional time and money spent on contractual agreements and operational measures.15 Moreover, these so-called transaction costs are exacerbated by higher costs of litigation under foreign laws and for foreign forums, and by the costs of instability that is caused by changes in foreign laws.16

9 See LAMBRECHT & HALJAN (1999), 259-260: ‘The best form of protection is to give investors certainty as to their rights and responsibilities.’ Cf. BLOM (1999), 376.

10Laws 1997, Ch. 566, § 5 (Legislative Intent formulated at UCC § 8-101).

11See, e.g., Ch. 10.2.6.

12Cf. FIALHO DE OLIVEIRA (2005), 831: ‘(…) we must set the level of harmony that can be achieved among systems against the need for changes in internal rules and decide to what extent the former compensates for the latter.’ Cf. also SMITS (2006), 71.

13Cf. MICHELER (2006).

14H. WAGNER (2005) and see the references provided there.

15Explanatory Notes to the Preliminary Draft UNIDROIT Securities Convention, 52. Cf. TAYLOR (1978), 104.

16G. WAGNER (2005), 1014.

237

9 Harmonisation initiatives

As a result, legal uncertainty translates into higher prices for services rendered and lower revenues enjoyed, as a consequence of which, respectively, less consumption and less investments are made.17 The final result is less national income. Furthermore, it is generally believed that harmonisation has a positive influence on the competitiveness of participants in the relevant marketplace and that, as a consequence, the uniform enactment of (efficient) rules is economically beneficial.18

With regard to securities custody and transfer law, economic analyses have been carried out both for the regional (US and EU) and the global level that confirm these arguments. Generally, they focus on the operational consolidation of the settlement industry, but this implies a legal interoperability.19 For the US, it has been concluded that ‘The lack of harmony amongst various state laws detracts from the liquidity of the clearance and settlement system by making it burdensome (and in some cases, impracticable) for investors to finance their payment obligations

(…).’20 For the EU, it has been calculated that the settlement of international, i.e. intrastate, transactions costs 7-10 times more than it would in the US,21 while a recent study commissioned by the European Commission estimated that the harmonisation of national laws and, more generally, a reduction in post-trading costs would lead to a higher GDP of between 0.2% and 0.6% in the subsequent years.22

17It has to be noted that the transaction costs will be prohibitively high where it concerns relatively low-value transactions, whereas high-value transactions may absorb these costs. See H. WAGNER (2005), 32-35.

18See SPINK & PARÉ (2004), 323 (with regard to Canadian harmonisation with US law) and LÖBER (2006), 4 (with regard to possible future EU harmonisation). SPINK & PARÉ (2004), 345-346, further argue that in the light of the integration of the Canadian and the US markets, Canada should harmonise with the US UCC Article 8 ‘to take advantage of the proven effectiveness of Rev8 [Revised UCC Article 8]’, while UCC Article 8 ‘enjoys the highest level of global system-confidence’.

19SCOTT (2006), Ch. 10, 25, for instance, refers to the problems encountered when ICSDs try to enter national markets. He concludes (Ch. 10, 41): ‘Harmonization has been demanded because of the economies of scale achievable from using common systems worldwide and because of the high cross-border level of transaction. In this area, home or host country rules do not appear acceptable.’ Cf. also LAMBRECHT & HALJAN (1999), 275.

20ROGERS (1996), n.25.

21SCOTT (2006), Ch. 10, 26. The Center for European Policy Studies however, estimated this to be 2 to 8 times; see G30 2003 Plan of Action, 4. The sources Scott cites calculate that one single CCP would reduce costs by $950 million per year. Yet, he must conclude that the creation of a single clearing and settlement organisation is prevented by the ‘vertical silo’ of ownership, where national exchanges are linked to national clearing and settlement systems; SCOTT (2006), Ch. 10, 28.

22This estimate is robust in different model specifications; EC Economic Impact Study (2006), 18.

238

9 Harmonisation initiatives

In other fields of law, a growth in national income may not outweigh the costs that the harmonisation of laws imply.23 But it is submitted that both economic and other reasons require a different conclusion when it comes to the reduction of legal uncertainty through the harmonisation of securities custody and transfer law. First, legal uncertainty in securities custody and transfer law involves systemic risk. Although systemic risk might not be quantifiable and has to be inferred from circumstantial evidence,24 legal risk in the field of capital markets materialises dramatically in times of stress, unlike in other fields of law.25 This became painfully clear in 1987, as a major US firm in the securities industry became bankrupt and trading on the NYSE could therefore not be resumed, except after intervention by the United States Government.26

Where, under normal circumstances, legal risk may materialise simply as economic inefficiency, legal risk in financial markets is likely to materialise in times of stress as a dramatic devaluation of securities and the unavailability of credit when parties are deterred from entering into uncertain and costly international transactions.27 Moreover, legal risk in the field of securities custody and transfer law is particularly increased during the last few decades because of the fundamental change in market practices from physical certificates to an intermediated holding system with immobilised or dematerialised securities. An enormous increase in the volume of securities transactions that are settled cross-border and the growing reliance on collateral28 adds to the higher urgency of addressing legal risk in the field of capital markets.29

The argument that legal uncertainty requires the harmonisation of laws, especially in the field of securities custody and transfer law, also follows from the fact that the value of investors’ assets is to a large extent determined by the law.30 A devaluation of investors’ assets because of legal diversity can and should therefore only be addressed by legal

23Cf. SMITS (2006), 73 et seq.

24Report from the Commission, Evaluation report on the Settlement Finality Directive 98/26/EC (EU 25), COM(2005), 657 final/2, 10.

25Cf. the CPSS 1995 Report, 55, where it argues that the difficulty in attaining a complete understanding of the rules and law governing the settlement process directly contributes to

systemic risk.

26REITZ (2005), 360.

27Cf. Explanatory Report on the Hague Securities Convention (2005), 4, SOMMER (1998), 1194 et seq. and ROGERS (2005), 14. Cf. the 1995 comments from Alan Greenspan, then

Chairman of the Board of Governors of the US Federal Reserve System, in the aftermath of the fall of Barings Bank, as quoted by ROGERS (1996), 1438: ‘my experience with financial

crises has convinced me that the greatest threat to the liquidity of our financial markets is the potential for disturbance to the clearance and settlement process for financial transactions.’

28See LÖBER (2006), 7.

29Cf. Explanatory Notes to the Preliminary Draft UNIDROIT Securities Convention, 36 and 44-

30Cf. SOMMER (1998), 1183.

239

9 Harmonisation initiatives

harmonisation.31 Furthermore, securities custody and transfer law mainly has a mandatory character, often to ensure investor protection. It is therefore only the harmonisation of laws that can solve legal uncertainty resulting from legal diversity.32

In sum, it must be agreed with GUYNN33 that harmonisation in the field of capital markets finds its justification in the legal uncertainties and friction costs currently inherent in the legal infrastructure, which will eventually lead to the higher cost of credit and the lower value of securities.34 Moreover, the increase in the volume of the securities markets has contributed to the value of this justification. In the following chapters, it will therefore be assumed that harmonisation by legislative action and the subsequent formation of a pan-EU legal framework is a necessary condition for an efficient EU clearing and settlement environment.35

9.1.2 Three levels of challenge

In his comment that accompanies GUYNN’s influential discussion paper,36 ROGERS discerns three ‘levels of challenge’ in the process of achieving international harmonisation of securities custody and transfer law: first, consensus has to be reached on the fundamental principles that should be implemented; second, these principles must be integrated into the legal regimes of the participating states; and third, common choice of law principles must be agreed upon so that the ‘inevitable elements of international non-uniformity in legal analysis or results will not impair the planning of securities transactions’.37 With regard to the legal infrastructure of securities settlement and custody, the need for global harmonisation and modernisation has been recognised for a long time, but harmonisation has not been achieved on any of the three levels just mentioned.38

31Contrary to, for instance, the law that relates to chattels; see G. WAGNER (2002), 1014.

32Contrary to areas of law where rules are not binding; in those instances, harmonisation may not be necessary. See HARTKAMP (2003), 98-99 and 101.

33GUYNN (1996), 6.

34For the harmonisation of contract law on the other hand, such economic benefits are not that evident; SMITS (2006), 76.

35Cf. the Communication from the Commission to the Council and the European Parliament, Clearing and settlement in the European Union, Main policy issues and future challenges. Communication of 28 May 2002, COM(2002) 257 def., and the Giovannini 2003 Report, 25.

36The discussion paper MODERNIZING SECURITIES OWNERSHIP, TRANSFER AND PLEDGING LAWS

(1996) which Randall Guynn wrote for the International Bar Association sparked international (legal) interest in the harmonisation of securities custody and transfer law.

37GUYNN ET AL. (1996), 59.

38This book focuses on European harmonisation, but the author considers global integration and harmonisation to be equally important for the EU.

240

9 Harmonisation initiatives

Yet harmonisation or even unification seems to be most advanced at the third level. Under the auspices of the Hague Conference for Private International Law, a ‘Convention on the Law Applicable to Certain Rights in Respect of Securities Held With an Intermediary’ (‘Hague Securities Convention’, or ‘HSC’) has been drafted. This convention provides uniform conflict of laws rules for proprietary issues concerning international securities transactions.39 Although on 13 December 2002, all participating states signed the text of the convention, it will only become effective when 3 states have ratified the treaty. But, at the time of writing, it is only Switzerland and the US that have set in motion an internal ratification procedure. The European Commission has recently reiterated its recommendation that the EU and its member states should sign the convention.40 The HSC will be discussed in greater detail below.

With regard to the first level of challenge, various international organisations such as the G30, BIS and IOSCO have expressed their views on the (fundamental) principles that should underlie a global harmonisation instrument. The latest and, until now, the most far-reaching global initiative has been undertaken by the International Institute for the Unification of Private Law (‘UNIDROIT’).41 These and other global initiatives will be discussed in the following section. On the EU level on the other hand, several Directives have harmonised certain aspects of substantive and private international law concerning securities custody and settlement. Moreover, the so-called ‘Legal Certainty Group’ has investigated the desirability of a legislative instrument that will harmonise the legal infrastructure of securities settlement within the EU. The European Directives currently in force and the work of this group will be elaborated upon in the third section of this Chapter.

The extent to which the jurisdictions examined in the preceding chapters satisfy the standards that can be distilled from the recommendations of the G30, BIS, IOSCO and the UNIDROIT project is the subject of the next chapter. The outcome of this test is extremely relevant for a future European harmonisation instrument. It will indicate to what extent the legal infrastructure currently in place in these selected jurisdictions should be modernised so as to bring it up to speed with what is generally considered best practice. In the terminology used in the context of the UNIDROIT project: it will indicate the internal soundness of the jurisdictions examined. In other words: it will indicate to what extent the present rules can do with

39Available at www.hcch.net.

40Proposal for a Council decision concerning the signing of the Hague Securities Convention, COM(2003) 783 final and Legal assessment of certain aspects of the Hague Securities Convention, of 3 July 2006, SEC(2006), 910. But see RANK & BIERMAN (2006) for a critical account of that assessment.

41Available at http://www.UNIDROIT.org/english/workprogramme/study078/item1/main.htm.

241

9 Harmonisation initiatives

modification rather than replacement, a relevant issue also with respect to the second level of challenge.

Whereas relative consensus thus seem to exist on the first and third levels of the challenge, the second level, i.e. how principles or standards of harmonisation should be integrated into the legal regimes of participating states, remains very unclear. However, it is submitted that harmonisation is highly unlikely to be achieved if its consequences for participating jurisdictions are not understood completely. For the European jurisdictions investigated, an impact assessment of harmonisation is therefore made in the second following chapter. The assessment is carried out by an analysis of the relationship or coherence between the securities law of these jurisdictions and the more general areas of the law in which it is embedded. It is this relationship that will determine to what extent the proposed rules of harmonisation will encroach upon the law as a whole and will therefore also be indicative for the extent that modernisation will be feasible.42 In sum, the feasibility of harmonisation depends on both the extent to which modernisation must be realised and on the coherence of national systems.43

9.2 GLOBAL HARMONISATION

9.2.1 Introduction

The following sections will discuss the global initiatives that have been undertaken in the last few decades to achieve a harmonised legal infrastructure for the transfer and custody of securities. First, it will be explained what recommendations have been brought forward in that field by high-level international organisations such as the Group of 30, the Bank for International Settlements, the International Securities Services Association and the International Organisation of Securities Commissions. These recommendations represent the generally accepted standards of securities custody and transfer law, and will therefore be used in the following chapter as the basis for its evaluation of the European jurisdictions previsously analysed. Thereafter, the as yet most far-reaching global initiatives of legal harmonisation will be discussed. These initiatives concern a harmonisation instrument of substantive law set up by UNIDROIT, and a convention on private international law drafted under the auspices of the Hague Conference. It is against the background of these instruments that the chapters that follow will examine how harmonisation and modernisation should be achieved within the EU.

42Cf. SONO in GUYNN ET AL. (1996), 66.

43Cf. GOODE (2003-1), 14-16.

242

9 Harmonisation initiatives

9.2.2 Recommendations

It has just been stated that various international organisations have expressed their thoughts on the principles that should underlie a global harmonisation of securities custody and settlement law and on the problems that the current legal diversity pose. The first of these was the Group of 30 (‘G30’), a nongovernmental organisation that consists of senior members of both the public and private sectors and academia. In 1989, the G30 published its report ‘Clearance and Settlement in the World’s Securities Markets’.

While it concluded that a centralised, single global clearing would not be feasible, this report formulated nine recommendations with which all markets should comply in order to create a safe post-trade process environment. The nine recommendations address operational differences in the practice of clearing and settlement. Most importantly, they recommend a shortening of the time between the trade date and settlement date to three days (T+3), the practice of Delivery versus Payment, the elimination of the movement of physical certificates by dematerialisation or immobilisation at CSDs, and the use of netting systems.

While the drafters of the report recognised that the implementation of these minimum standards would imply alterations to each market’s ‘own history, traditions and practices’, they believed that ‘the investments involved will be more than offset in time by the local as well as international benefits which will result from a concerted effort to modernise and make compatible each of the markets’.44 According to the report, implementation would result in enhanced efficiency and reduced risk.

The Bank for International Settlements (‘BIS’) was created in 1930 and has since then been a forum for central banks. Its Committee on Payments and Settlement Systems (‘CPSS’) has prepared various reports on clearing and settlement. In 1995, the CPSS issued an important report on cross-border securities settlements which, for the first time, also paid attention to its legal aspects. The report provides an overview of various schemes of book-entry securities custody45 and provides an introduction to the problems of the finality of securities transactions and intermediary insolvencies. Further, it links the complexity of different applicable rules and law to the existence of systemic risk.

The International Securities Services Association (‘ISSA’), a private sector group, collaborated closely with the G30 when it drafted its recommendations in 1989. Thereafter, the ISSA regularly reviewed the G30

44G30 1989 Report, iii-iv.

45CPSS 1995 Report, 51.

243

9 Harmonisation initiatives

recommendations and published a full revision in 2000.46 This revision contains 8 recommendations, the last of which is devoted to the legal infrastructure of securities clearing and settlement. It states:

‘Local laws and regulations should ensure that there is segregation of client assets from the principal assets of their custodian; and no possible claim on client assets in the event of custodian bankruptcy or a similar event. Regulators and markets, to further improve investor protection, should work: to ensure clarity on the applicable law on cross border transactions, to seek international agreement on a legally enforceable definition of finality in a securities transaction, to ensure that local law fully protects the rights of beneficial owners, to strengthen securities law both to secure the rights of the pledgee and the protection accorded to client assets held in Securities Systems.’47

Recommendation 8 further concludes that, in many countries, securities laws are ‘inappropriate for the age of modern electronic clearing and settlement processes’ and that it is ‘often difficult to establish the prevailing law governing a specific cross border transaction or collateral movement.’48 The recommendation is rather detailed but the ISSA project has not found widespread support or official endorsement.49

In 2001, the CPSS of BIS issued a set of 19 recommendations in a collaborated effort with the International Organisation of Securities Commissions (‘IOSCO’).50 These recommendations identify a set of minimum standards for securities settlement systems. Its first recommendation reads: ‘Securities settlement systems should have a well founded, clear and transparent legal basis in the relevant jurisdictions.’ The 2001 Report does not go into great detail about the specific elements that such a legal basis should consist of, but states that ‘key aspects of the settlement process that the legal framework should support include: enforceability of transactions, protection of customer assets (particularly against loss upon the insolvency of a custodian), immobilisation or dematerialisation of securities, netting arrangements, securities lending (including repurchase agreements and other economically equivalent transactions), finality of settlement, arrangements for achieving delivery versus payment, default rules, and liquidation of assets pledged or transferred as collateral.’

46A similar project was undertaken by the International Federation of Stock Exchanges; See the FIBV Clearing and Settlement Best Practices Report 1996, available at www.worldexchanges.org.

47ISSA Recommendations 2000, 9.

48ISSA Recommendations 2000, 20.

49CPSS/IOSCO Recommendations 2001, 1.

50CPSS/IOSCO Recommendations 2001.

244