The Law Commission has published a scoping paper on intermediated securities, which identifies issues concerning investors rights in relation to securities held through intermediaries. In this article, Senior Associate Harry McGowan considers the Law Commission’s paper.
When an investor invests in shares or bonds today, they are unlikely to receive a paper certificate. Instead, most investors “own” securities through computerised credit entries in a register through a chain of financial institutions such as banks, investment platforms and brokers (“intermediaries”). For UK securities the registry is the Certificateless Registry for Electronic Share Transfer (“CREST”). Holding securities through intermediaries has made trading quicker and cheaper but has raised issues of corporate governance and transparency. There is also uncertainty about investors’ legal redress against the issuer for malfeasance, on the insolvency of an issuer of securities or an intermediary. In June 2019, the Department for Business, Energy and Industrial Strategy (“BEIS”) asked the Law Commission to undertake a scoping study into investor rights in relation to securities held through intermediaries ie intermediated securities.
The full terms of reference asked the Law Commission to provide:
- An accessible statement of the current law, including a clear explanation of how shares and bonds are “owned” and held.
- A description of the corporate governance and other legal issues associated with intermediated shareholdings and an assessment of whether the issues cause difficulties in practice.
- A range of possible solutions, both legislative and non-legislative, presented in a sufficiently developed form to provide a basis for future-focused policy development and consultation by BEIS.
- A summary of technological developments that might make it easier for underlying investors to exercise shareholder rights.
- A summary of the costs and benefits of the potential solutions (in a form that will be useful to BEIS analysts), and suggestions about where further analytical work might be needed (eg interview, survey, and/or behavioural research with stakeholders).
- A view on whether systems being put in place to remove paper certificates by 2025 (with the issue of new paper certificates phased out in 2023) offers opportunities to enhance the rights of investors already holding shares electronically as well as maintain in full the existing rights of holders of paper certificates.
- An account of the views of the main stakeholders.
In its scoping paper published on 11 November, the Law Commission presented a range of solutions for enhancing investor rights, improving corporate governance and increasing legal certainty. These included:
- the creation of a new obligation on intermediaries to arrange for ultimate investors, upon request, to attend meetings and to vote and receive information that the company sends to its members;
- the possible extension of the application of the Shareholder Rights Directive II to enhance the rights of ultimate investors;
- potential improvements to the statutory procedure which enables companies to identify ultimate investors;
- potential amendments to facilitate the confirmation to ultimate investors that their votes have been received and counted by the company;
- targeted solutions to ensure that ultimate investors can take advantage of certain statutory rights and exceptions to the no look-through principle, and of the good faith purchaser principle; and
- clarification of the distribution of omnibus accounts on insolvency.
The commission also considered technological developments such as distributed ledger technology and whether that offered the government a systemic approach to move away from the current intermediated system and making all ultimate investors the legal owners of their investments, thereby creating a direct relationship between the investor and the company.
While the scoping paper represents a move in the right direction with its suggested solutions to attempt to address the lack of basic investor protection rights e.g. that an investor can vote and ensure their vote is counted at a shareholding meeting, it is our view that legislative changes need to be accelerated. The next step will be for the government to consider the scoping paper and then to make recommendations which would then be followed by an industry consultation before any recommended changes would be implemented. We do not expect any changes for at least three years which is too slow as there is a current need to enhance investor protection especially for retail investors.
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