STOCK MARKETS INTEGRATION: Legal certainty of securities holdings in cross-border operations The EU case Comments by Professor MAURICIO BAQUERO HERRERA Legal Consultant Banking, Financial Markets and Economic Integration Observatory of Banking and Financial Law Externado University of Colombia ACSDA´s First Legal Workshop August 29th y 30th 2011 Santiago de Chile

2 JUSTIFICATION The former presentation explained the process towards the implementation of MILA and its main practical, technical and legal issues. I am going to focus on some of them. Maria del Pilar Jacome, (present here today with us) in a chapter of a book recently published by Externado University of Colombia, has made an interesting revision of the main legal issues that may arise in cross border operations vis a vis Colombian regulation. I keep thinking about some of the interesting questions that she raised, mainly those related to property rights and the granting of collateral in such operations. As many of them seem to share the same basis which is the legal certainty of securities holdings in cross-border operations, I decided to focus on this subject considering the nature of this legal Workshop. At the same time, it fits very well with this morning conference on the current status of the Hage and Unidroit conventions.

3 THIS PRESENTATION 1. Revises the significant European regulation, advise and proposals related to the legal certainty of securities holdings in cross-border operations. 2. Focuses on the three legal barriers identified and listed by the Giovannini reports ( ), emphasizing on the work that has been done by the Legal Certainty Group on Barrier 13 (2008). 3. Points out the main aspects that a future EU Securities Law Directive (SLD) may include according to the consultations made recently. 4. Opens the floor for discussion and exchange of ideas, experiences and opinions.

4 1. The significant European regulation and advice related to Financial Markets Infrastructure

The Process How to achieve Integrated Financial Markets? (Lamfalussy 2001) Financial Market Infrastructure was not included in the Financial Services Action Plan, agreed for the period , but become one of the priorities for the post-2005 period. A consultative group or experts was asked by the European Commission to address the most basic pillar of the infrastructure that supports financial markets: the system that ensures that securities exchanged within the European economy are properly delivered from the seller to the buyer. In 2001 the (Alberto) Giovannini Group identified the sources of inefficiency that existed in the arrangements at the time. The Group listed 15 barriers to efficient cross- border clearing and settlement. The barriers were categorized under the three headings of national differences in Technical requirements/market practice (10) (SESAME GROUP) National differences in tax procedures (2) (FISCO GROUP) Issues relating to legal certainty (3) (LEGAL CERTAINTY GROUP) How to achieve Integrated Financial Markets? (Lamfalussy 2001) Financial Market Infrastructure was not included in the Financial Services Action Plan, agreed for the period , but become one of the priorities for the post-2005 period. A consultative group or experts was asked by the European Commission to address the most basic pillar of the infrastructure that supports financial markets: the system that ensures that securities exchanged within the European economy are properly delivered from the seller to the buyer. In 2001 the (Alberto) Giovannini Group identified the sources of inefficiency that existed in the arrangements at the time. The Group listed 15 barriers to efficient cross- border clearing and settlement. The barriers were categorized under the three headings of national differences in Technical requirements/market practice (10) (SESAME GROUP) National differences in tax procedures (2) (FISCO GROUP) Issues relating to legal certainty (3) (LEGAL CERTAINTY GROUP) 1 IDENTIFYING (LEGAL) BARRIES WITHIN EU C&S SYSTEMS Main Conclusion of the two reports ( ) The process to create an adequate clearing and settlement infrastructure in European financial markets is made up of two ingredients: (a) a concerted system of initiatives designed to replace the fifteen barriers with standards, regulations, and laws adequate to an efficient and barrier-free market, and (b) adequate regulatory/supervisory structures that ensure that the benefits of a barrier- free market will be made available to all market participants through low-cost and safe post-trading services The process to create an adequate clearing and settlement infrastructure in European financial markets is made up of two ingredients: (a) a concerted system of initiatives designed to replace the fifteen barriers with standards, regulations, and laws adequate to an efficient and barrier-free market, and (b) adequate regulatory/supervisory structures that ensure that the benefits of a barrier- free market will be made available to all market participants through low-cost and safe post-trading services

Barrier 13: The absence of an EU-wide framework for the treatment of interests in securities: (including procedures for the creation, perfection and enforcement of security) it has been identified as the most important source of legal risk in cross-border transactions. It is the issue of whether the securities in question actually belong to those in whose names they were held. ¿Is this an issue of finality, i.e. whether a transfer of securities from A to B made by accounting entry is final? Barrier 14: National differences in the legal treatment of bilateral netting for financial transactions. The principle that mutual obligations arising in financial market transactions may be netted has been accepted throughout the EU. However. the removal of all remaining legal uncertainties as to netting is necessary. Barrier 15: Uneven application of national conflict of law rules. Some EU legal systems treat as different the ownership of a security outright and an entitlement (against a settlement system or intermediary) to own such a security. Others elevate such an entitlement to being equal to ownership of the underlying security. Where legal systems of both types are in play, there can an irreconcilable conflict. It seems to be unanimously accepted that only legislation can resolve this problem. Barrier 13: The absence of an EU-wide framework for the treatment of interests in securities: (including procedures for the creation, perfection and enforcement of security) it has been identified as the most important source of legal risk in cross-border transactions. It is the issue of whether the securities in question actually belong to those in whose names they were held. ¿Is this an issue of finality, i.e. whether a transfer of securities from A to B made by accounting entry is final? Barrier 14: National differences in the legal treatment of bilateral netting for financial transactions. The principle that mutual obligations arising in financial market transactions may be netted has been accepted throughout the EU. However. the removal of all remaining legal uncertainties as to netting is necessary. Barrier 15: Uneven application of national conflict of law rules. Some EU legal systems treat as different the ownership of a security outright and an entitlement (against a settlement system or intermediary) to own such a security. Others elevate such an entitlement to being equal to ownership of the underlying security. Where legal systems of both types are in play, there can an irreconcilable conflict. It seems to be unanimously accepted that only legislation can resolve this problem. Giovannini Barriers related to legal certainty of securities holdings in cross-border operations 1 IDENTIFYING (LEGAL) BARRIES WITHIN EU C&S SYSTEMS

MiFID 1 November 2007, the Markets in Financial Services Directive (MiFID) entered into force on 1th November Its goals are to build a single market for investment services and trading venues allowing for much greater competition on the basis of a uniform, higher standard of investor protection across Europe. It orders the way in which market actors are required to behave. It is also principles- based (while it does introduce detailed rules in some areas). Single Passport enables authorised investment firms and credit institutions to provide their services freely across borders. on the basis of authorisation in their home Member State. 1 November 2007, the Markets in Financial Services Directive (MiFID) entered into force on 1th November Its goals are to build a single market for investment services and trading venues allowing for much greater competition on the basis of a uniform, higher standard of investor protection across Europe. It orders the way in which market actors are required to behave. It is also principles- based (while it does introduce detailed rules in some areas). Single Passport enables authorised investment firms and credit institutions to provide their services freely across borders. on the basis of authorisation in their home Member State. EC Directive on financial collateral arrangements (2002/47/EC), adopted on 6 June It creates a uniform EU legal framework to limit credit risk in financial transactions through the provision of securities and cash as collateral. It is aimed at Removal of the major obstacles for the (cross-border) use of collateral Creation of clear, effective and simple regimes for financial collateral arrangements Limitation of administrative burdens, formal acts and cumbersome procedures to create and enforce financial collateral Recognition of specific risk mitigation techniques used in the financial markets Recognition of the right to re-use pledged collateral Creation of legal certainty on the applicable law. See Directive 2009/44/EC EC Directive on financial collateral arrangements (2002/47/EC), adopted on 6 June It creates a uniform EU legal framework to limit credit risk in financial transactions through the provision of securities and cash as collateral. It is aimed at Removal of the major obstacles for the (cross-border) use of collateral Creation of clear, effective and simple regimes for financial collateral arrangements Limitation of administrative burdens, formal acts and cumbersome procedures to create and enforce financial collateral Recognition of specific risk mitigation techniques used in the financial markets Recognition of the right to re-use pledged collateral Creation of legal certainty on the applicable law. See Directive 2009/44/EC Code of Conduct on Clearing and Settlement The McCreevy Code is based upon three pillars: price transparency, access and interoperability and service unbundling and accounting separation. (2006) 2 IDENTIFYING (LEGAL) BARRIES WITHIN EU C&S SYSTEMS EC Directive on Financial Collateral Arrangements DIRECTIVE 2009/44/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 6 May 2009 (Amends Directive 98/26/CE on Settlement Finality in Payment and Securities Settlement systems of 19/5/1998) It contains provisions regarding transfer orders and netting (e.g. legal enforceability of transfer orders and netting, irrevocability of transfer orders, no unwinding of netting, etc.), insolvency proceedings (e.g. non-retroactivity of insolvency proceedings, determination of applicable law, etc.), collateral security (e.g. insulation from insolvency proceedings, determination of the law applicable to cross- border provision of collateral security) Settlement Finality Directive If a credit institution with branches in other Member States fails, its winding- up will be subject to a single bankruptcy proceeding initiated in the Member State where the credit institution has its head office. Winding- Up Directive for Credit Institutions The European Commission’s Clearing and Settlement Advisory and Monitoring Expert group (the “CESAME” group): to achieve the goal of a barrier-free Single European Market. CESAME (1 and 2) It analyses issues of legal uncertainty relating to the integration of EU securities clearing and settlement systems, and advise the Commission accordingly. LEGAL CERTAINTY GROUP The European Commission’s Clearing and Settlement Fiscal Compliance (“FISCO”) expert group FISCO GROUP The Monitoring Group of the Code of Conduct on Clearing and Settlement (MOG) MOG Expert Group on Market Infrastructures. Its mission is to contribute to the development of an efficient, safe and sound European post-trade market. EGMI GROUP Committee of European Securities Regulators (CESR) Post-trading Expert Group (PTEG)

8 2. The work that has been done by the Legal Certainty Group on Barrier 13 (2008)

.. Legal Certainty of Security Holdings Nature of the Book Entries Main Legal Issues Book entry securities? Is this a new kind o a neutral option to name them The rights arising from the security are now attached to inscriptions in a registry ? The intermediated security challenge: Direct or Indirect Holding of Securities? The "in rem" analysis relies on the autonomy of the securities vis-a-vis the custodian as to its valuation: the securities have a value by themselves, irrespective of the custodian's identity. (protective approach). (Paribas). Intermediaries are mere record-keeping insititurions ( Garcimartín 2006). Does the book-entry create a valid property right? Interest in Securities Approach A neutral Approach 2 IDENTIFYING (LEGAL) BARRIES WITHIN EU C&S SYSTEMS Does Finality create property ? The question of the date of transfer must not be confused with the very different issue of finality. Is finality linked to the transfer of ownership? It aims at avoiding any cancellation of settlement procedures which may likely cause unexpected and very quick needs of cash, source of eventual defaults and bankruptcy.. (Paribas) Legal Certainty Group, Second Advice on solutions to legal barriers related to post-trading within the EU, (First Advice 2006). The treatment of "book-entry securities“: This issue had been identified by the Giovannini Reports as the single most important legal obstacle to a legally sound cross-border framework for post-trading arrangements. The LCG Advice addresses it in its Recommendations 1 – 11, Legal Certainty Group, Second Advice on solutions to legal barriers related to post-trading within the EU, (First Advice 2006). The treatment of "book-entry securities“: This issue had been identified by the Giovannini Reports as the single most important legal obstacle to a legally sound cross-border framework for post-trading arrangements. The LCG Advice addresses it in its Recommendations 1 – 11, Barrier 13

10 4. Main aspects that a future EU Securities Law Directive (SLD) may include according to the consultations made recently

The (future) EU Securities Law Directive (SLD) The Commission Services are currently preparing a draft Directive on legal certainty of securities holding and transactions (Securities Law Directive – SLD) A first public consultation on this issue was held between 16 April and 11 June In November 2010, the European Commission launched a second public consultation which contains 22 sections which cover the full scope of the possible legislative approach. The dead line for sending replies was set in January The consultation paper recognizes that in the EU the cross-border holding and disposition (outright sale, pledge, etc) of securities held through securities accounts across borders: a. suffers from legal uncertainty and it is often not clear what an investor owns, b. is ineffective, and c. does not allow investors to exercise the rights attached to those securities (receipt of dividends or interests, voting, agreeing to corporate measures like stock splits, etc) without major obstacles. The Commission Services are currently preparing a draft Directive on legal certainty of securities holding and transactions (Securities Law Directive – SLD) A first public consultation on this issue was held between 16 April and 11 June In November 2010, the European Commission launched a second public consultation which contains 22 sections which cover the full scope of the possible legislative approach. The dead line for sending replies was set in January The consultation paper recognizes that in the EU the cross-border holding and disposition (outright sale, pledge, etc) of securities held through securities accounts across borders: a. suffers from legal uncertainty and it is often not clear what an investor owns, b. is ineffective, and c. does not allow investors to exercise the rights attached to those securities (receipt of dividends or interests, voting, agreeing to corporate measures like stock splits, etc) without major obstacles. 1 HOW TO DEAL WITH LEGAL UNCERTAINTY IN CROSS BORDER SECURITIES OPERATIONS IN THE EU

1 – Objectives 2 – Shared Functions 3 – Account-held securities Compatible with the Geneva Securities Convention 4 – Methods for acquisition and disposition 5 – Legal effectiveness of acquisitions and dispositions 6 – Effectiveness in insolvency 7 – Reversal 8 – Protection of acquirers against reversal 1 – Objectives 2 – Shared Functions 3 – Account-held securities Compatible with the Geneva Securities Convention 4 – Methods for acquisition and disposition 5 – Legal effectiveness of acquisitions and dispositions 6 – Effectiveness in insolvency 7 – Reversal 8 – Protection of acquirers against reversal 9 – Priority 10 – Protection of account holders in case of insolvency of account provider 11 – Instructions 12 – Attachment by creditors of the account holder 13 – Attachment by creditors of the account provider 14 – Determination of the applicable law: Keeps different approach but there is a consultation on the Hague Convention 15 – Cross-border recognition of rights attached to securities 9 – Priority 10 – Protection of account holders in case of insolvency of account provider 11 – Instructions 12 – Attachment by creditors of the account holder 13 – Attachment by creditors of the account provider 14 – Determination of the applicable law: Keeps different approach but there is a consultation on the Hague Convention 15 – Cross-border recognition of rights attached to securities 2 HOW TO DEAL WITH LEGAL UNCERTAINTY IN CROSS BORDER SECURITIES OPERATIONS WITHIN THE EU 16 – Passing on information 17 – Facilitation of the ultimate account holder's position 18 – Non- discriminatory charges 19 – Holding in and through third countries 20 – Exercise by account provider on the basis of contract 21 – Account provider status 22 – Glossary 16 – Passing on information 17 – Facilitation of the ultimate account holder's position 18 – Non- discriminatory charges 19 – Holding in and through third countries 20 – Exercise by account provider on the basis of contract 21 – Account provider status 22 – Glossary The (future) EU Securities Law Directive (SLD)

13 4. Exchange of views, ideas and conclusions