69. Recent developments on investment securities in UNIDROIT (July 30, 2007)
TO: Chair, Committee on Federal Regulation of Securities
Chair, Committee on the Uniform Commercial Code
FROM: Harold Burman
REPORT ON THE STATUS OF CONVENTIONS ON INVESTMENT SECURITIES
This report as before covers developments broadly and does not review particular provisions; separate documentation is available on article-by-article issues. The two securities law projects discussed below are the first multilateral efforts to seek harmonization of private transactional law in the field of cross-border securities practice. One, the 2006 Hague Convention on law applicable to intermediated securities, has been concluded and we are examining possible US ratification. The second, the draft Unidroit convention on transactional securities law may be concluded in the fall 2008. It is not very likely that a third international project in this field may emerge for some years.
Both projects reflect the need for greater certainty in globalizing markets, and each can boost liquidity in markets, transactional commerce and trade, promote effective securities practices, and lower both market and systemic risks. Since both projects in the U.S. rest on uniform state law, state securities law interests as well as federal have been fully involved, along with the ABA and securities and market associations. Federal and public agency participation has included primarily SEC, Treasury, the New York Federal Reserve Bank, CFTC, State Department.
THE HAGUE CONVENTION:
We will not repeat here the analysis provided previously, but note that the United States together with Switzerland signed the Convention in 2006 and the ABA has adopted a policy endorsing US ratification. Its provisions cover rules to determine applicable law, treatment of pre and post-convention interests, multi-unit states such as the U.S., etc. We expect to proceed with inter-agency clearance for a recommendation that the Administration transmit the Convention to the Senate for its advice and consent to US ratification. The Uniform Law Commissioners are expected to review the treaty as to its compatibility with UCC, in light of their recent action presenting such a review of the Uncitral Convention on assignments financing (UCC Article 9) together with proposed Senate report language to the floor at their annual meeting, which was approved by that body.
As securities trades and transfers as collateral or otherwise rose to very high volumes through computerized means, especially in countries employing intermediation, the inability of traditional property-based securities laws to effectuate the tracing of rights and interests in a timely manner, sufficient to permit current valuation or prevent significant systemic risk, became clear. The Convention's principal effect is to set out a means of rapidly determining law applicable to intermediated securities as they move from point to point, largely tracking UCC 8-110.
Notwithstanding the treaty, several countries primarily in the EU continue to question allowing party choice of law governing account agreements to play an important role in determining applicable law. We expect to continue exploring with the EU options to resolve the concerns expressed. We anticipate that with US and Swiss ratification, important securities market countries, other than those within the EU, may join the new treaty system.
THE DRAFT UNIDROIT CONVENTION:
Following conclusion of the Hague Convention (although concluded in November 2002, the practice of the Hague is to date conventions as of the year they are first signed), the second round on securities treaties was started at UNIDROIT as an effort to harmonize relevant areas of substantive transactional law. As cross-border transfers become increasingly common, and accounts increasingly hold securities from differing country origins, the uncertainties of what interests are actually effectively transferred have become significant issues for the international capital markets, and that is one point of focus of this draft second convention. Other important aspects include recognition of rules of securities settlement and clearing entities, and special rules on collateral transactions, closeout netting, etc. The objectives of the financial community on this project range from achieving a text that the U.S. can affirmatively seek to ratify, to being satisfied with a text that brings disparate securities systems closer together, or with a text that facilitates cross-border transactions regardless of differences remaining in underlying securities laws.
A Diplomatic Conference is expected to be set during 2008 to finalize the Convention; many financial community participants in the U.S. support that. Several EU countries have recommended deferring it for continued negotiations. The viewpoint of most is that deferral is tantamount to shelving the project. While it is of course not certain that sufficient agreement will be found or can result in a treaty text that makes substantial progress, this is likely to be the last international project on this area of law for some years (see comment on the OAS below).
It became clear during 2007 negotiations that gaining wider support for the draft treaty also meant bringing within its provisions so-called "directly-held" systems as well as intermediated systems (early drafts were limited to the latter). The existence of directly-held systems (such as those in China, Brazil, Finland, Spain, Greece and others), while significantly different amongst themselves, often involve requirements incompatible with US-style intermediated systems, such as matching debits and credits, traceability and limited scope of actions for intermediaries. The draft convention was altered at the recent May 2007 meeting so as to accommodate such systems where possible.
It also became clear that the world was not at this stage going to move robustly toward U.S. style intermediation, which in turn affected the nature of changes and amendments sought by the U.S. Indeed, a number of views have been expressed that fully developed intermediated systems if implemented in countries lacking strong securities regulation and other protective mechanisms, could pose risk. Thus the focus now on the treaty is to find as much common ground as is feasible, clarify what types of interests result from cross-border transfers, the extent of BF acquirer's rights, the extent of intermediaries' protection, etc.
Various regional developments need to be taken into account. Canada is currently moving closer to the UCC 8 framework, which might the affect changes at some point in Mexico as well so there is a harmonized North American securities market. Both conventions discussed, whether or not ratified, can play a role in that process. An earlier proposal by the U.S., supported by some Central and South American countries, to develop a new treaty on securities transactional law amongst the OAS states, was unsuccessful, in part because of the concurrent effort at UNIDROIT. Once UNIDROIT has concluded, the prospects for supplementary work within the OAS may be reexamined, although it is not clear at this point that there would be sufficient support for UCC-style securities laws in the region.
Progress within the EU and EU positions on either of the two treaties remains in doubt. There remain internal issues within the EU as to how if ever to rationalize their disparate securities markets, whether that would center around the EC or the ECB, whether it would be more regulatory than the U.S., etc. These and other issues, including preference by some EU states to have such negotiations take place within the EU and not at multilateral bodies such as the Hague and UNIDROIT, where non-EU states such as the US are major factors, make consensus within the EU on either convention difficult to achieve. In addition, under current EU procedures, a small group of states can constitute a blocking minority so as to prevent the European Council from authorizing individual EU states on ratify treaties. Such practices are likely to prevent for some time favorable action on the Hague Convention, and may lead to impasse as well at UNIDROIT. As a result, assessment of goals within the US financial community needs to look beyond the EU, except as such developments may promote parallel action within the EU (developments within the European Commission (EC) may reflect these treaties regardless of ratification).