Abstract
The purpose of this study is to analyze the shadow banking issues related to financial collaterals in the form of book-entry securities, as defined in EU under the Financial Collateral Directive (Directive 2002/47/EC, as in force), the so-called ‘FCD’. It examines different legal approaches related to the activities of securities reuse or re-hypothecation that financial intermediaries, mainly as collateral takers, conduct in modern markets. Despite its positive aspects, it is beyond any doubt that re-hypothecation poses risks to the markets. The collapse of too large both in number and size entities in recent times that negatively affected investors properties in securities pointed out that the ‘too big to fail’ myth is not rather real. To this end, further measures have to be taken in addressing these risks. The study points out the following as areas on which EU regulation should focus in this respect: (a) Collaterals reuse and re-hypothecation should not be regarded as a pure contractual choice but as a specific service or activity that should be subject to further EU regulation and supervision for its provision by the intermediaries. In achieving this goal, it would be appropriate for a reform of the custody activities to be accelerated for the purposes of distinguishing from a prudential regulatory perspective any ‘non-banking type of safekeeping services’, that is, the custody activities that by definition do not include any securities reuse, from the ‘banking type of safekeeping services’, that is, the custody activities that as banking-like credit intermediation activities may include such a reuse. (b) There should be a clear definition of ‘who owns what’ that should operate as a uniform substantive law rule. This definition should cover the need of proprietary aspects and rights in book-entry securities to be recognized on an EU level regardless of the legal nature of the chains of the securities holding systems and intermediaries involved, that is, regardless of the definition of ‘who holds what’. The ‘who owns what’ definition would be appropriate to be based not on the existing ‘securities account’ approach, as adopted by FCD, which in concept reflects the ‘PRIMA’ (‘Place of the Relevant Intermediary Approach’) principles, but on an approach able to accommodate the ownership and the other proprietary aspects in book-entry securities more accurately from a legal perspective. This approach should take seriously into account the concepts of the ‘law under which the securities are constituted’ as an aspect of the lex societatis rule. In this regard and for the purposes of establishing proprietary rights in book-entry securities, the actual owners (shareholders) should be registered as such in the official registrars of the country of the securities constitution. (c) Furthermore and in terms of addressing the issues of cross-border securities holdings, there should be a clear conflict of laws rule in determining the applicable law for all the proprietary aspects in such securities. This rule should be based on the above ‘who owns what’ substantive law definition. In this regard, the applicable law that should define the proprietary rights in securities should be the law under which the securities are constituted. Therefore, any investor registered, for example as a shareholder, under the registry system applicable in accordance with the law under which the relevant securities are constituted, shall be considered as the owner of the securities regardless of the systems and chains of intermediaries to which the investor entrusted their property in such securities to be held. The study considers all these parameters as of extreme importance in addressing the ‘shadow banking’ issues in the securities and collaterals sector and, to this regard, in achieving a real protection for the markets and the investors in EU.
This article was submitted to the Journal on 21 November 2014
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes and References
A synopsis of this study has been presented by the author in the ‘DTCC Systemic Risk Forum 2014’ (Brussels, 27 March 2014). A previous version of this study has been presented in the international conference ‘Banking, Finance, Money and Institutions: The Post Crisis Era’ of the Centre for Money, Banking and Institutions (CMBI) of the University of Surrey and the Center of Research in the Contemporary Finance of the Fordham University, USA(Surrey, 2–3 November 2013).
[2002] O.J. L 168/43. FCD has been amended by the Directive 2009/44/EC amending Directive 98/26/EC on settlement finality in payment and securities settlement systems and Directive 2002/47/EC on financial collateral arrangements as regards linked systems and credit claims [2009] O.J. L 146/37.
COM (2013) 614.
COM (2014) 40.
COM (2012) 350.
COM (2014) 213.
See paras 3, 4 and 5 of the preamble of FCD. For an analysis of the FCD’s objectives and other related issues, see Working Group of the Financial Law Committee of the City of London Law Society, EU Directive on Financial Collateral Arrangements: Replies of a Working Group of the City of London Law Society Financial Law Committee to the Questionnaire of February 2006 to the Private Sector from the European Commission for the Drafting of the Evaluation Report (2006) Butterworths Journal of International Banking and Financial Law, June, at 263 et seq.
See paras 9 and 10 of the preamble and article 3 of FCD.
Article 2 par. 1 (d) of FCD.
Article 2 par. 1 (e) of FCD.
Article 2 par. 1 (g) of FCD.
Paras 5, 14 and 15 of the preamble and articles 7 and 8 of FCD. For an analysis of the financial collaterals and the FCD financial collateral arrangements from an English law perspective, see among others Hughes, M. (2006) Legal principles in banking and structured finance, at 93 et seq., mainly at 101.
Article 2 par. 1 (c) of FCD.
Article 2 par. 1 (b) of FCD.
Article 2 par. 2 and 3 and article 3 of FCD.
Article 1 par. 5 of FCD.
From an EU perspective custody in securities has been defined as an ancillary service under the Directive 2004/39/EC on markets in financial instruments [2004] O.J. 145/1 (MiFID); see para 1 of Section B (Ancillary Services) of Annex I (List of services and activities and financial instruments) of MiFID, where the relevant service is defined as ‘(1) Safekeeping and administration of financial instruments for the account of clients, including custodianship and related services such as cash/collateral management’; see also the section ‘EU legislative initiatives in addressing shadow banking in securities collaterals’ for our regulatory suggestions on custody in securities under the view of strengthening the transparency in the securities field. See also the EU initiatives of reviewing MiFID at http://ec.europa.eu/internal_market/securities/isd/mifid/index_en.htm and the references in Section 5, (a) and infra note, 58.
CSDs are systemically important entities in the financial sector as they provide main services for the proper functioning of the securities markets consisting of registration, safekeeping, settlement of securities in exchange for cash and others. For an EU definitional and regulatory approach of CSDs, see the Proposal for a Regulation on improving securities settlement in the European Union and on central securities depositories (CSDs) COM(2012)73. See also at http://ec.europa.eu/internal_market/financial-markets/central_securities_depositories/index_en.htm, where the main importance of CSDs is underlined as follows: ‘While securities markets traditionally relied on the physical exchange of papers, CSDs now assume a critical role to guarantee a safe and efficient transfer of securities that exist to a large extent only in book entry form. They have now become a central point of reference for an entire market. Furthermore, being located at the end of the post-trading process, CSDs witness all the settlement fails occurring during the settlement period. They are therefore a key element of any policy of settlement discipline. Given the systemic importance of CSDs and their strategic position at the end of the post-trading process, there is a strong need for an appropriate regulatory framework for CSDs’.
For an analysis of this direct concept of securities holdings based on the ‘individual client segregation’ approach, see Kouretas, G.P. and Tarnanidou, Ch. (2014) ‘Shareholding in EU: is “indirect holding” approach appropriate in achieving financial integration?’ Journal of Financial Regulation and Compliance, 22(1) at 15–25. An earlier version of the above article has been presented at the International Conference on ‘Improving Financial Institutions: The Proper Balance Between Regulation and Governance’, Hanken School of Economics (Helsinki, 19 April 2012) and at the Conference on Research on Economic Theory and Econometrics (Milos, 11–15 July 2012).
For the direct and indirect holding systems and the relevant collateral approaches, see European Commission. Directorate General Internal Market and Services. Financial Markets Infrastructure, Summary of the Seventh Meeting of the Member States Working Group on the Securities Law Legislation (2013) Brussels, 24 May and Summary of the Meeting of the Member States Working Group on Securities Law Legislation (2012), Brussels, 19 Nov. at http://ec.europa.eu/internal_market/financial-markets/securities-law/index_en.htm. For a legal analysis of the open issues of securities holdings and collaterals at an international level (Convention on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary (5 July 2006), see at http://www.hcch.net/index_en.php?act=conventions.text&cid=72, ‘Hague Securities Convention’) and at an EU level, their aspects under the direct and indirect systems, their cross-border interactions and the relevant concerns on the conflict of laws rules, see Tarnanidou Ch.I. (2006) Derivatives Contracts of the Financial Sector. Legal and Practical Analysis (Greek edition), at 25–135 (for the book-entry nature of securities), 320–378 (for the collaterals in such securities provided as margin in derivatives contracts) and 393–420 (for the cross-border provision of such collaterals and the concepts of the ‘Place of the Relevant Intermediary Approach’ (PRIMA) under the Hague Convention and FCD), as well as the above book’s relevant references mainly to Benjamin J. (2001), Easy of Transfer and Security of Transfer in the Securities Market. Butterworths Journal of International Banking and Financial Law, May, at 219 et seq.; (ibid) (2000) Immobilized Securities-Perfection of Security Interests, at 61 et seq., In: Hudson, Al. (ed.), Modern Financial Techniques, Derivatives and Law, (ibid) (2000) Interests in Securities. A Proprietary Analysis of the International Securities Markets; Bernasconi, Ch., Potok, R. and Morton, G. (2002) General Introduction: Legal nature of interests in indirectly held securities and resulting conflict of laws analysis, In: Potok, R. (ed.), Cross Border Collateral: Legal Risk and the Conflict of Laws, at 7 et seq.; Guynn, R.D. (1996), Modernizing Securities Ownership, Transfer and Pledging Laws, Capital Markets Forum; Potok, R. (2001), The Hague Conference on Private International Law – An important step to legal certainty in relation to indirect-held securities, Butterworths Journal of International Banking and Financial Law, April, at 166 et seq. For an analysis of the indirect holding systems, FCD and Hague Convention – PRIMA, see also Alexander, K. (2003), Private Law Approaches to Enhancing Financial Stability: The Hague Convention on Indirectly Held Securities and European Union Collateral Directive, In: Andenas, M. and Avgerinos, Y. (eds.), Financial Markets in Europe. Towards a Single Regulator?, at 121 et seq., mainly at 126–127, 134–140. See also for more recent literature among others Mooney, Ch. W. (Rev. dr unif. 2010) Private Law and the Regulation of Securities in Intermediaries: Perspectives under the Securities Convention and United States Law, Private Law and the Regulation of Securities Intermediaries, at 801 et seq; Paech, Ph. (2013) Market needs as paradigm: breaking up the thinking on EU securities law, in Intermediated Securities. Conac, P.H., Segna, Ul. and Thevenoz, L. (eds.), The Impact of Geneva Securities Convention and the Future European Legislation, at 22 et seq., mainly at 48–49; Thevenoz Luc. (2007), Intermediated Securities, Legal Risk and the International Harmonization of Commercial Law (http://works.bepress.com/luc_thevenoz/1), at 1–69; Tarnanidou Ch. I. (2009) Special Shareholders Rights in Listed Companies (Greek edition, Sakkoulas publ.), at 178.
Article 4 of FCD. For an analysis of the implementation of FCD by the EU member states, see Löber, Kl. and Klima, E. (2006) The implementation of directive 2002/47 on financial collateral arrangements, Journal of International Banking Law and Regulation, 4, at 203 et seq. For a legal analysis of FCD’s enforcement provisions based on the Greek laws, see Tarnanidou, Derivatives Contracts, op. cit. note 21, at 306 and 366, et seq.
Article 1 par. 2 of FCD.
Article 2 par. 1 (f) of FCD.
See mainly article 7 of the FCD for the recognition of close-out netting provisions and article 8 of FCD on the disapplication of certain insolvency provisions. See also Benjamin, Interests in Securities …, op. cit. note 21, at 125–126; for comments on netting, (ibid) (2003) Overview of Post-Trade Infrastructure, Part 3, Butterworths Journal of International Banking and Financial Law, Jun., at 223 et seq., mainly at 225; Henderson, K. (1997) Termination Netting of Derivatives, at 4 et seq.; Dale, R. (1999) Risk Management in US Derivatives Clearing Houses in Issues in Derivative Instruments Swan ed. J. (ed.), at 101 et seq. (mainly at 105 and 122 et seq.); Hardig, M. (1986) Some practical and legal aspects of financial futures, Journal of International Banking Law, 1, at 30 et seq.; Löber – Klima, op. cit. note 22, at 210. For an analysis of FCD and the relevant close-out netting and insolvency provisions, see also Raffan, M. (2006) The Collateral Directive, in A Practitioner’s Guide to EU Financial Services Directives, Raffan, M. (consultant ed.), at 222–224.
Articles 2 par. 1 (m) and 5 of FCD.
See Goode, R. (2003) Legal Problems of Credit and Security, at 232 et seq.; Turing, D. (2002) The EU Collateral Directive Butterworths Journal of International Banking and Financial Law, May, at 187; Keijer, Th. (2003) Introduction, (ibid), Dutch and German Law. The right of use based on a security interest as envisaged in the Collateral Directive, (ibid), Right of use under English law in Report on a ‘Right of Use’ or Collateral Takers and Custodians, July, Keijser, Th. (ed.), Researcher – Business and Law Research Centre, University of Nijmegen, The Netherlands, at 4, 31 et seq., 48 et seq., mainly at 56; Benjamin, Interests in Securities, op. cit., note 21, at 119 et seq.; Raffan, op. cit., note 25, at 220–222; Tarnanidou, Derivatives Contracts …, op. cit. note 21, at 302–311 and 367–375. For an analysis of the two legal aspects of the collaterals, as pledge and title transfer, including the repurchase agreements, see Alexander, op. cit., note 21 at 124–125.
Articles 2 par. 1 (a), (b) and 6 of FCD; supra, note 27. See Hughes, op. cit. note 13, at 98–99.
See,Turing, op. cit., note 27, at 187; Benjamin, Interests in Securities, op. cit. note 21 at 121; Alexander, op. cit., note 21 at 31; Keijer, op. cit. note 27 at 3; Raffan, op. cit, note 25, at 220–222; Tarnanidou, Derivatives Contracts …, op. cit., note 21, at 311–315 and 375–378.
Articles 2 par. 1(a), (c) and 5 of FCD. For a rather comprehensive analysis of the right of use and its impact to the collateral taker’s legal position, mainly as an investor-user of custody services, see Keijer op. cit. note 27, at 4, 10, 53–59; Tarnanidou, op. cit., note 21, at 303 et seq.
For a relevant analysis under the UK law and system, see Working Group of the Financial Law Committee of the City of London Law Society, op. cit. note 8, at 264. As the above Group notes, the right of use given for the collateral taker to use and dispose of financial collateral has had a beneficial effect both because it puts beyond doubt the legality of the grant of such right and also because the availability of such a right allows for greater flexibility in the structuring of transactions and increases liquidity in the collateral pool available for financial markets transactions. However, following the collapse of too many financial entities (Lehman, MF Global etc.) and the relevant ‘collapse’ of the ‘too big to fail’ myth, the aforementioned views on the right of use is reasonable to be reviewed. For these issues see also the analysis below in Section 5, (a).
For the references to MiFID, see supra, note 18. For AIFMD, see [2011] O.J. L 174/1 and for all other relevant EU regulations at http://ec.europa.eu/internal_market/investment/alternative_investments/index_en.htm.
Different is, however, the concept of the ‘new MiFID’ that prohibits title transfer collaterals when the collateral giver is a retail investor. For this prohibition, see below in Section ‘To further regulate or not?’ (a) of this study.
Article 4 par.1 (af) of AIFMD. For the AIFMD legislation, see at http://ec.europa.eu/internal_market/investment/alternative_investments/index_en.htm.
See article 4 of FCD. For a comprehensive analysis of close-out netting, its protection against insolvency risk and mainly the concerns on systemic repercussion related to its massive use, see European Parliament Directorate-General. For Internal Policies Policy Economic and Scientific Policy (2003) Shadow Banking: Legal Issues of Collateral Assets and Insolvency Law (author: Paech Ph.), at 7–12.
See Financial Stability Board (2011) Shadow Banking Scoping the Issues A Background Note of the Financial Stability Board, 12 April, at 2 et seq.; (ibid.) (2011) Shadow Banking Strengthening Oversight and Regulation Recommendations of Financial Stability Board, 28 October, at 3 et seq.; (ibid.) (2012) Securities Lending and Repos: Market Overview and Financial Stability Issues. Interim Report of the FSB Work Stream, 27 April, at 6, 8 et seq., 16 et seq.; (ibid.) (2012) Consultative Document Strengthening Oversight and Regulation on Shadow Banking An Integrated Overview of Policy Recommendations, 18 November, at 3 et seq.; European Commission, Green Paper Shadow Banking (Text with EEA relevance) COM(2012)102, at 3 and the Communication of the Commission to the Council and the European Parliament Shadow Banking – Addressing New Sources of Risk in the Financial Sector, COM(2013)(614), at 3 et seq., for which see also the analysis in Section ‘EU legislative initiatives in addressing shadow banking in securities collaterals’ (a); European Central Bank (2013) Enhancing the Monitoring of Shadow banking, Monthly Bulletin, February, at 89; see for relevant literature, among others, Adrian, T. and Ashcraft, A.B. (2012) Shadow Banking: A Review of the Literature. Federal Reserve Bank of New York Staff Reports, October, Staff Report No. 580, 2 and examples at 5 et seq.; Noeth, B.J. and Sengupta, R. (2011) Is Shadow Banking Really Banking? Regional Economist, October, at 8, 9 (‘Shadow banking comprises a chain of intermediaries that are engaged in the transfer of funds channeled upstream in exchange for securities and loan documents that are moving downstream’.).
Supra note 36. For the definition of re-hypothecation from an English law perspective, see also Benjamin, Interests in Securities …, op. cit., note 21, at 94–95, 229 et seq. and 260 et seq. (shortfall risk); Hughes, op. cit., note 13, at 103.
For a relevant analysis, see Singh, M. and Aitken, J. (2009) Deleveraging after Lehman - Evidence from Reduced Re-hypothecation 1 (International Monetary Fund (IMF), Working Study No. 09/41; (ibid.) (2010) The (sizable) Role of Re-hypothecation in the Shadow Banking System, International Monetary Fund WP/10/172, at 4 et seq.; Gorton, G. and Metrick, A. (2009) The Run on Repo and the Panic of 2007–2008, at 8; Benjamin, Interests in Securities, note 21, at 111–118 and 237–238, with conclusions on transfer outright as an appropriate route when the collateral taker uses the collateral; Turing, op. cit., note 27.
See Schwarcz, St L. (2011–2012) Regulating shadow banking, inaugural address for the inaugural symposium of the review of banking and financial law, Review of Banking and Financial Law 31, at 619 et seq., mainly at 624; Deryugina, M. (2009) Standardization of securities regulation: Re-hypothecation of securities commingling in the United States and the United Kingdom, Review of Banking and Financial Law 29, at 253 et seq., mainly at 257 and 261–262.
For the commingling and related consequences mainly under English law, see Benjamin, Interests in Securities …, op. cit., notes 21 and 37. For an analysis of re-hypothecation, hypothecation, commingling and the resulting consequences mainly from a US law perspective, see Deryugina, op. cit. note 21 at 266–273. For an analysis of the indirect concepts and the related consequences in cross-border transactions and securities holdings, see also Thevenoz, op. cit. note 21; Paech, op. cit. note 21, at 39 et seq.; Deryugina, op. cit. note 21.
Commission Directive 2006/73/EC implementing Directive 2004/39/EC of the European Parliament and of the Council as regards organizational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive [2006] O.J. L 241/26.
For these issues, see also recital 27 of MiFID where the following are laid down ‘(27) Where a client, in line with Community legislation and in particular Directive 2002/47/EC of the European Parliament and of the Council of 6 June 2002 on financial collateral arrangements, transfers full ownership of financial instruments or funds to an investment firm for the purpose of securing or otherwise covering present or future, actual or contingent or prospective obligations, such financial instruments or funds should likewise no longer be regarded as belonging to the client’. Therefore, MiFID allows an investment firm to be a collateral taker with regard to its clients’ obligation and in this context to obtain full title transfer of the financial instruments transferred by the client as collateral giver to cover relevant client’s obligations to the investment firm. See, however, article 16(10) of MiFID’s recast COM(2011) 656, where the scope of application of transfer outright in collaterals excludes retail investors as collateral givers in relation to the services provided by an investment firm to them. See also Section ‘EU legislative initiatives in addressing shadow banking in securities collaterals’, (a) of this study where the relevant approach under the new MiFID is analyzed.
See among others, Singh – Aitken, Deleveraging after Lehman …, op. cit. note 38, at 5 and 6; Schwarz, op. cit. note 39, at 625 (analysis on the systemic risk issues).
See Schwarz, Deryugina, op. cit. note 39.
For a relevant analysis, see Deryugina, op. cit., note 39.
See 17 C.F.R. §240.15c3–3(e).
For a relevant analysis, see Architzel, P.M. and Walker, P.P. (2012), CFTC’s rulemaking on the segregation of cleared swaps, customer collateral: LSOC and beyond, Journal of Investment Compliance 13 (3), at 36–45.
See also CFTC’s consideration of the segregated models in Architzel – Walker, op. cit. note 47, at 39.
For the US approach, see Deryugina, op. cit. note 39.
See at http://fshandbook.info/FS/html/FCA/CASS/6/4.
See relevant references in European Commission, Directorate General Market and Services (2012) Legislation on Legal Certainty of Securities Holding and Dispositions, 6th meeting of the Member States Working Group (10th Discussion Study of the Services of the Directorate-General Internal Market and Services, Brussels, 16 October at 4–8; for an analysis of the US aspects, see Deryugina op. cit., note 39.
For these elaborations, see European Commission Internal Market and Services DG, Report of the Alternative Investment Expert Group, Managing, Servicing and Marketing Hedge Funds in Europe (2006), July at 29 et seq. (http://ec.europa.eu/internal_market/investment/docs/other_docs/reports/hedgefunds_en.pdf).
See supra, note 52.
However, it should be noted that re-hypothecation as a practice used by the intermediaries as clearing members to reuse the collateral pledged by their clients in discharge of margining obligations to central counterparties (CCPs) or other clearing houses related to such clients’ positions, should not be prohibited to intermediaries when providing only non-banking type of safekeeping services as referred to above. In this case, re-hypothecation could be considered as an acceptable practice, as it purely relates to services that intermediaries provide within their agency activities and not for their own funding purposes. For the relevant rules under the US law, see 17 C.F.R. § 240.15c2–1(c)(2009) under which margin customer accounts are exempted from the general prohibition on hypothecation so long as the customers are notified of the exact terms of the hypothecation and commingling that the prime broker is engaging in. For relevant references and observations, see Deryugina, op. cit., note 39, at 267–268.
This study does not focus on analyzing the capital and other relevant prudential requirements related to the proposed banking type of safekeeping services, as these issues go beyond its scope and nature. However, it should be important such issues to be further analyzed by regulators in terms of addressing the re-hypothecation shadow banking problem in an effective manner.
See European Commission, supra note 51. See also for relevant analysis in haircuts and circuit breakers as measures mitigating the risk of stock lending and repos, European Parliament (Paech), op. cit. note 35, at 12–20.
For the CSDR Proposal, see supra, note 19, and also below in paras (b) and (c) of the section ‘To further regulate or not?’.
See mainly article 16 par. 10 of the Proposal for a Directive on markets in financial instruments repealing Directive 2004/39/EC of the European Parliament and of the Council, COM(2011)656 (MiFID-2).
For the new EU initiatives in this area of investor identification and the need for more transparency, see the analysis on the ‘new SHRD’ in the section ‘EU legislative initiatives in addressing shadow banking in securities collaterals’ par. (e).
Worthy of note is that under the upcoming CSDR (see Council of the Union, Central Securities Depositories: Council confirms agreement with EP’, Brussels, 26 February 2014, 7006/14 (OR. en) Press 100), and specifically under its article 38 par. 4 point 3 the following have been laid down: ‘However, a CSD and its participants shall provide individual client segregation for citizens and residents of and legal persons established in a Member State where this is required under the national law of the Member State under which the securities are constituted as it stands at … This obligation shall apply as long as the national law is not amended or repealed and its objectives are still valid’. It should be noted that under the relevant references of the above CSDR text the date to which the above provisions refer will be the date of entry into force of CSDR (and alternatively, under the relevant drafting suggestion, ‘nine months after its entry into force’). Considering the rationale behind these provisions, it should be noted that they were deemed to serve the need of ‘neutrality’ among CSDs’ securities holding systems, that is, the need the harmonization not to affect such systems either acting as direct or indirect. In this respect, direct holding systems are included. However, the aforementioned provisions reflecting the ‘direct holdings’ should be considered as rather restrictive for CSDs as direct systems as they limit the application of individual client segregation only to such systems as ‘existing systems’ at the entry into force of CSDR and, moreover, only as long as they operate as such. To this end, under the drafting and meaning of said provisions CSDs will be prohibited to introduce a ‘genuine direct holding’ concept to their operations after the entry into force of CSDR. In view of the above, it should be highlighted that it is rather questionable whether CSDR is rather accurate in achieving its neutrality goals.
Article 46 (Applicable law to proprietary aspects) of the CSDR Proposal defined the following: ‘1. Any question with respect to proprietary aspects in relation to financial instruments held by a CSD shall be governed by the law of the country where the account is maintained. 2. Where the account is used for settlement in a securities settlement system, the applicable law shall be the one governing that securities settlement system. 3. Where the account is not used for settlement in a securities settlement system, that account shall be presumed to be maintained at the place where the CSD has its habitual residence as determined by Article 19 of Regulation (EC) No 593/2008 of the European Parliament and the Council24. 4. The application of the law of any country specified in this Article shall comprise the application of the rules of law in force in that country other than its rules of private international law’.
For the Convention on the Law Applicable to Certain Rights in Respect of Securities Held with an Intermediary (5 July 2006), see at http://www.hcch.net/index_en.php?act=conventions.text&cid=72. For a relevant analysis of the Convention’s concepts, see PRIMA Convention brings certainty to cross-border deals (Government representatives have agreed on an international convention governing which law applies to cross-border securities transactions. Christophe Bernasconi and Richard Potok, who have spearheaded the negotiations over the past two-and-a-half years, explain the need for the Convention and how it will benefit the securities industry (2003) International Financial Law Review, Jan., at 11 et seq., mainly at 12–13; Paech, op, cit. note 21, at 36 et seq. For the PRIMA’s reflections in FCD, see also Pitt, C. (senior analyst, Market Infrastructure Division, Bank of England) (2003) Improving the legal basis for settlement finality, Butterworths Journal of International Banking and Financial Law, Oct., at 341 et seq., mainly at 344. For the account approach and the indirect holding elaborations before PRIMA, see Benjamin, op. cit. note 21, at 155 and 158 et seq. For the enunciation of PRIMA in FCD, see Raffan, op. cit, note 25, at 225–227. For an analysis of Hague Convention and the relevant opinion of the European Central Bank (ECB), see Alexander, op. cit. note 21, at 133 et seq. As Alexander notes, ECB criticized that the Hague Convention failed to make a clear distinction between contractual and property rights. ECB argued, among others and mainly in relation to the United States approach on interests (entitlements) in securities under art. 8 of the Uniform Commercial Code, that jurisdictions that have not adopted a complementary substantive law framework to accommodate the implementation of conflict of laws rules for determining ownership interests in property may suffer competitive disadvantages vis-à-vis jurisdictions like the United States that already have a comprehensive framework of substantive and choice of law rules to regulate securities holdings practices. For a relevant analysis related to the diversity of the substantive rules, see also Bourbon-Secret, Ch.(2005) Cross-border security interests in movable property: An attempt at rationalising the international patchwork: Part 1, Journal of International Banking Law and Regulation (9), at 419 et seq., mainly at 421. See also the Commission’s withdrawal of the proposal for a Council Decision concerning the signing of the Hague Convention on the Law applicable to certain rights in respect of securities held with an intermediary, for which see at http://ec.europa.eu/internal_market/financial-markets/hague/index_en.htm. For the Geneva Securities Convention, see UNIDROIT Convention on Substantive Rules for Intermediated Securities (‘Geneva Securities Convention’) at unidroit.org/english/conventions/2009intermediatedsecurities/main.htm. For a comprehensive analysis of Geneva Convention, see, among others, Thevenoz, L. (2013) The geneva securities convention: objectives, history and guiding principles in intermediated securities: In: P.H. Conac, Ul. Segna and L. Thevenoz (eds.), The impact of geneva securities convention and the future of the European legislation, at 3 et seq.
See supra, note 62.
For a relevant definition in EU law, see the Directive 2007/36/EC, the so-called Shareholders Rights Directive (SHRD).
For a relevant analysis of this ‘direct registration’, see Kouretas – Tarnanidou, op. cit. note 20, mainly at 21 (section ‘EU legislative initiatives in addressing shadow banking in securities collaterals’ of the article). See also the EU initiatives on the new SHRD in section ‘EU legislative initiatives in addressing shadow banking in securities collaterals’ (e).
For these issues, see article 49 of the upcoming CSDR.
See Kouretas-Tarnanidou, op. cit., note 20.
[1998] O.J. L 166/45. See also the amendment of SFD by the Directive 2009/44/EC, for which see also supra note 3.
Specifically, article 6 par. 2 of the SFD provides that: ‘[W]here securities (including rights in securities) are provided as collateral security to participants and/or central banks of the Member States or the future European central bank as described in paragraph 1, and their right (or that of any nominee, agent or third party acting on their behalf) with respect to the securities is legally recorded on a register, account or centralised deposit system located in a Member State, the determination of the rights of such entities as holders of collateral security in relation to those securities shall be governed by the law of that Member State.’, while article 9 of the FCD provides that ‘[A]ny question with respect to any of the matters specified in paragraph 2 arising in relation to book entry securities collateral shall be governed by the law of the country in which the relevant account is maintained’, where said paragraph 2 refers to all proprietary aspects in relation to book-entry securities, including its legal nature, its requirements of its perfection and provision and so on.
For the regulatory treatment of this approach from an EU law perspective, see article 13 of the Directive 2007/36/EC on the exercise of certain rights of shareholders in listed companies ([2007] O.J. L 184/17). For this Directive, the so-called SHRD, and its upcoming amendment see also in section ‘EU legislative initiatives in addressing shadow banking in securities collaterals’ (e).
For the Commission’s Green Paper and the Communication, see supra, note 36.
See section 3.3 of the Communication.
See section 3.2 of the Communication.
Supra notes 71–73.
Supra, notes 71–73.
SeeEuropean Commission Internal Market and Services DG, Mandate (2005), Jan., at http://ec.europa.eu/internal_market/financial-markets/clearing/certainty/index_en.htm#maincontentSec1. For a very comprehensive analysis of the securities issues and post-trading barriers, see Legal Certainty Group – LCG, Second Advice of the Legal Certainty Group. Solutions to Legal Barriers relating to Post-Trading within the EU at http://ec.europa.eu/internal_market/financial-markets/docs/certainty/2ndadvice_final_en.pdf.
Seeat http://ec.europa.eu/internal_market/financial-markets/securities-law/index_en.htm.
Seesupra, note 21 and also at http://ec.europa.eu/internal_market/financial-markets/docs/securities-law/index_en.htm.
For this EU recast initiative, see at http://ec.europa.eu/internal_market/securities/isd/investor/index_en.htm.
[2012] O.J. L 201/1. EMIR constitutes an EU law cornerstone for the establishment of harmonization in the field of central counterparties, that is, of the entities that carry out clearing by novation as central counterparties to the trades they clear. For EMIR and other related EU regulatory measures, see at http://ec.europa.eu/internal_market/financial-markets/derivatives/index_en.htm.
For the trade repositories development under EMIR, see the EU page, supra, note 80.
See the analysis in section ‘To further regulate or not?’ paras (b) and (c).
For relevant references see supra notes 21 and 62, including the Commission’s withdrawal of the proposal for a Council Decision concerning the signing of the Hague Convention.
COM (2014) 40.
See at Proposal at 4.
Supra note 85.
Supra note 85.
See for relevant references to EMIR, supra notes 80, 81.
For such concepts, see also recitals 6 to 10 of the preamble of the Proposal.
Based on the respective definitions of such counterparties under EMIR, the Proposal defines them in article 3 par. 2 as ‘financial counterparties’ and ‘non-financial counterparties’ as defined in points (8) and (9), respectively, of article 2 of EMIR (Regulation (EU) No 648/2012), as well as ‘CCPs’ as defined in point (1) of article 2 of EMIR. In this respect such ‘financial counterparties’ include any investment firm authorised in accordance with Directive 2004/39/EC, a credit institution authorized in accordance with Directive 2006/48/EC, an insurance undertaking authorized in accordance with Directive 73/239/EEC, an assurance undertaking authorized in accordance with Directive 2002/83/EC, a reinsurance undertaking authorized in accordance with Directive 2005/68/EC, a UCITS and, where relevant, its management company, authorized in accordance with Directive 2009/65/EC, an institution for occupational retirement provision within the meaning of Article 6(a) of Directive 2003/41/EC and an alternative investment fund managed by AIFMs authorized or registered in accordance with Directive 2011/61/EU. Accordingly, as ‘non-financial counterparties’ are defined any undertakings established in the Union other than CCPs and financial counterparties.
For the use of SFTs by fund managers and the respective measures of the Proposal, see the analysis under the recitals 11 to 16 of the preamble of the Proposal.
[2009] O.J. L 302/32. This is the so-called ‘UCITS IV’.
[2011] O.J. L 174/1. This is the so-called ‘AIFMD’.
Recital 14 of the preamble of the Proposal.
Proposal, at 7.
A risk mitigant in this respect could be considered, for example, an introduction of a cap on the amount of securities collateral that could be permitted to be re-hypothecated, or an introduction of measures similar to those referred to in section ‘To further regulate or not?’ para (a) of this study, related to the distinction from a prudential perspective of non-banking type and banking type of safekeeping services. These prudential measures could be further supported by the reporting rules under the Proposal.
COM (2012) 350.
See recital 11 of the preamble of the upcoming UCITS V.
See article 1 par. (5) of UCITS V, as elaborated under the compromise texts of the Council of the European Union.
Kouretas-Tarnanidou, op. cit., note 20.
COM (2014) 213.
[2007] O.J. L 184/17. For the EU perspectives on SHRD and corporate governance in general, see European Commission: The EU Single Market, Company Law and Corporate Governance at http://ec.europa.eu/internal_market/company/index_en.htm. See for an SHRD analysis, Tarnanidou, Special Shareholders Rights, op. cit., note 21.
See the Proposal at 5, 6, 9 and 10.
Supra note 20.
See section ‘To further regulate or not?’ paras (a) to (c).
See article 3a par. 4 (no breach of disclosure information) and par. 5 of the Proposal and also article 14a par. 2 thereof (Commission’s implementing acts on the relevant information transmission requirements).
Article 3a of the Proposal (new SHRD).
[2004] O.J. L 390/38.
Author information
Authors and Affiliations
Additional information
The author is a legal counsel of the Legal Affairs Division at Hellenic Exchanges S.A. The views and opinions expressed in this article are solely those of the author and do not necessarily coincide with the views of the Hellenic Exchanges S.A.
Rights and permissions
About this article
Cite this article
Tarnanidou, C. EU financial collateral arrangements and re-hypothecation in the shadow of ‘shadow banking’: To further regulate or not?. J Bank Regul 17, 200–238 (2016). https://doi.org/10.1057/jbr.2014.22
Published:
Issue Date:
DOI: https://doi.org/10.1057/jbr.2014.22