UNIDROIT undertook its project substantive rules regarding intermediated securities (Study LXXVIII) in order to create an international instrument for improving the legal framework for securities holding, transfer and collateralisation.
The UNIDROIT Convention on Substantive Rules for Intermediated Securities (Geneva Securities Convention) intends to enhance the internal stability of national financial markets and their cross-border compatibility and, as such, to promote capital formation.
Over the past fifty years, the practice of holding and disposition of investment securities has changed considerably. Departing from the traditional concept of custody or deposit of physical certificates, a system of holding through intermediaries has been developed for reasons of efficiency, operational certainty and speed. In this system, the greater part of securities is immobilised with a central securities depository. The investor holds securities through a chain of intermediaries that are ultimately connected to the central securities depository. The transfer of securities and the creation of security and other limited interests therein are in practice commonly effected by way of book entries to the accounts concerned. The securities themselves are no longer physically moved.
However, the legal framework which underlies this modern system of holding through intermediaries in many countries still relies on traditional legal concepts first developed for the traditional method of holding and disposition relating to tangible assets held in physical custody. As a result, the legal risk in the area of securities holding and disposition is particularly high. This legal uncertainty is multiplied by the fact that securities are increasingly held and transferred across borders, since domestic legal frameworks are not necessarily compatible with each other. Legal risk can, in times of “stress”, even trigger systemic effects. Additionally, persistent legal risk affects the efficiency of the markets, as is easily illustrated by the example of increased transaction costs.
A sound legal framework is all the more important in light of the extremely high value of securities held in intermediated systems and the enormous volume of transactions with such securities carried out every day. The use of securities as collateral in many instances underpins arrangements for high-value cash transfers. Moreover, securities play an important role in central bank monetary policy transactions, and are therefore crucial to the liquidity of the modern financial system as a whole. Only a few countries have tackled the issue of fundamentally modernising the legal framework for securities holding, transfer and collateralisation, confined, of course, to their domestic legal framework. Cross-border holding, transfer and collateralisation of securities suffers from deficiencies regarding the internal soundness of domestic systems and, furthermore, from problems of compatibility between different legal frameworks that govern a given situation.
The issue of harmonising the private international law rules regarding securities held with an intermediary is addressed, at the international level, in the Hague Convention on the Law Applicable to Certain Rights in respect of Securities Held with an Intermediary, which was adopted in December 2002 under the auspices of the Hague Conference on Private International Law. However, the Hague Securities Convention does not, by its nature, address issues of substantive law.
On a regional level, the Directives on Settlement Finality and Financial Collateral set out a fragmented legal framework for securities holding and disposition in the European Union, with special emphasis on collateral transactions.
Consequently, a framework that comprehensively addresses issues of substantive law in the problem areas identified above is needed, particularly at the global level. Such a framework would be a necessary complement to the Hague Securities Convention, to domestic reform in several countries in Asia and the Americas, and to the EU harmonisation efforts.
The UNIDROIT Convention on Substantive Rules for Intermediated Securities is intended to fill this gap. It aims to promote internal soundness and cross-border system compatibility by providing the basic legal framework for the modern intermediated securities holding system.
More in particular, within the context of holding securities with an intermediary, the instrument describes the rights resulting from the credit of securities to a securities account; establishes different methods to transfer securities and to establish security and other limited interest therein; clarifies the rules regarding the irrevocability of instructions to make book entries and the finality of the resulting book entries; precludes “upper-tier attachment”; establishes a priority ranking among competing interests with respect to securities; protects the innocent (“good faith”) acquirer of securities from adverse claims; sets out the rights of the account holder and the responsibilities of the intermediary in the event of insolvency; establishes a regime for loss allocation; and defines the legal relationship between collateral providers and collateral takers where securities are provided as collateral.
The Study Group convened by UNIDROIT to address the subject held its first meeting in September 2002. After five sessions of the Study Group and consultations with practitioners and scholars in 20 countries, on 23 December 2004 the UNIDROIT Secretariat submitted a first preliminary draft Convention to the Governments of UNIDROIT member States for consideration. The instrument was complemented by a set of Explanatory Notes. The preliminary draft Convention served as a basis for an international negotiation process which commenced in May 2005 with the holding of the first session of the Committee of Governmental Experts (CGE) in Rome. In total, four such sessions were held, in the course of which the text of the draft Convention was further developed. After each session the Secretariat circulated the latest text of the draft Convention, as well as a Report of the session.
At its fourth session, the CGE decided that the draft Convention was ready to be laid before a diplomatic Conference. The UNIDROIT Governing Council approved the transmission of the text to such a Conference, the first session of which was held at the invitation of the Government of Switzerland in Geneva from 1 – 12 September 2008.
52 States, 11 international Organisations, the European Community and the European Central Bank participated in the first session of the Diplomatic Conference.
At this session outstanding policy choices in relation to insolvency, rules of central securities depositories and innocent acquisition were successfully accomplished and the second reading of the text of the draft Convention was finalised. Moreover, it was decided that a draft Official Commentary to the draft Convention would be prepared (see CONF. 11/2 – Doc. 5) and that the final session of the diplomatic Conference would be held in Geneva in 2009 with a view to finalising the work and adopting the Convention.
This final session took place from 5 to 9 October 2009 in Geneva, again at the invitation of the Government of Switzerland. Representatives of the Governments of 50 States, 13 international Organisations and groups, as well as the European Community and the European Central Bank participated in the final session. The Conference resolved all remaining issues raised.
On 9 October, the Conference adopted the Convention and gave it the new name UNIDROIT Convention on Substantive Rules for Intermediated Securities (the ‘Geneva Securities Convention’). On the same day, the Final Act was signed by 37 States (Argentina, Australia, Austria, Bangladesh, Belgium, Brazil, Cameroon, Canada, Chile, Czech Republic, Egypt, Estonia, Finland, France, Germany, Greece, India, Ireland, Italy, Japan, Luxembourg, Malta, Netherlands, Nigeria, Poland, Portugal, Korea, Russian Federation, Senegal, South Africa, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States of America and Zimbabwe) and the European Community, and the Convention by one State (Bangladesh). After that the Convention was open for signature at the UNIDROIT Headquarters in Rome.