Draft Uncertificated Securities Regulations 2001

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Mr. Howard Flight (Arundel and South Downs): I welcome your chairmanship of our deliberations, Mr. Hurst. I should probably declare an interest as the chairman of an investment management company that will no doubt be affected by the regulation.

The regulation is important. First, it plays a role in the process of reducing dealing and settlement costs, consolidation of settlement arrangements, and ultimately consolidation of stock markets on a Europe-wide basis. I am well aware that the Bank of England and others have been working hard on improving the efficiency of CREST facilities. However, the regulation deals with the operator and not CREST. Although, in practice, everyone refers to it as CREST, that raises the issue of CREST having a monopoly. What would happen if the Treasury were to remove the approval of the operator, or if CREST, like the stock exchange, were to change in future and turn into a profit-making operation? The regulation does not, at least, take into account anything other than CREST fulfilling its role. Perhaps it should.

Secondly, the regulation entails major changes to the law relating to a company's register of interests. That is an important point. In the United Kingdom, as in the United States, part of our custom and law relates acutely to shareholders voting their shares. Indeed, other measures under consideration would encourage pension funds and charities to vote their shares. It is therefore crucial that we do not have practical problems when electronic transfer of title and dematerialisation are introduced. The US and the UK have paid great attention to that issue, whereas in France dematerialisation often results in the disfranchisement of owners of shares. A system that seems as if it should work is therefore a considerable achievement. I would describe it thus: there is the pension fund, its fund manager, the company and its register and, in the middle, a separate register, which is the dematerialised register. Therefore, communication on each side must be virtually instant and entirely reliable.

The points that I want to put on the record have been raised by the Law Society company law committee and the City of London company law committee. They are legalistic points, and some of them seem to refer to a previous draft of the regulation and seem to have been addressed. I want the Minister to confirm that she is confident that the points of concern that were raised have been addressed. The first big issue is to confirm that shareholders, companies and others are likely to be, or should be, disadvantaged by the changes introduced by the regulation. That is important for the reason that the Minister pointed out: the operator is liable only in certain narrow circumstances for a civil liability if a person suffers loss because of a failure of arrangements. The position of system members and others as opposed to the operator is not clear from the regulations. That is especially the case in the matters that relate to certainty about who is a member of a company, and the right to rectify the register if mistakes are made.

Presently, a company or its registrar—as an agent—control the register of members. The regulations will make an important change to that, and that is the most important legal aspect of the regulations in regard to dematerialised securities moving to an operator register in the middle. If the operator makes a mistake, it should be clear that a duty of care is owed to the relevant company and to any person who is affected by the mistake. What happens if a company issues too many shares because the operator who is running the share register has advised it wrongly? If the company believes that the information provided by the operator is wrong when compared against its records, there should be a provision for the company not to act on the information from the operator's register provided that the company has reconciled its information against the operator's register of members. The regulations do not make clear procedures for the rectification of registers. Damages do not seem to be available to a shareholder through civil law if he suffers loss because of such failures.

It is provided that the operator may consult on additional rules that relate to interactions with issuers. However, it would be useful to know what additional territories the consultation and potential changes may cover because it is a mandatory order for companies that have uncertified securities. It would be useful for companies to receive assurances about other obligations or liabilities to which they may be exposed because of such consultation and change.

Regulation 19(3) states that the current terms of a relevant participating security will cease to apply to uncertified units of that security

    ``to the extent that they are inconsistent''

with the new regulations. I understand the reason for that, although it is a considerable legal change for a statutory provision to override the contractual obligation that already exists. It would be helpful if all companies were warned in advance that that is the case to allow them to double check that their records are bang up to date.

There is a lack of clarity about a company's register of members. The regulations relate to the Companies Act 1985 and concern references to a company's register of members. The regulations state that

    ``unless the context otherwise requires'',

references to the register shall

    ``be construed in relation to a company that is a participating issuer''—

a company with dematerialised securities—

    ``as relating to the company's register . . . and Operator register.''

What does

    ``unless the context otherwise requires''

mean? That is not spelt out.

A participating issuer must enter particulars into the operational register of members in its record of uncertified shares but, as far as I can discover, there is no obligation on the operator to provide that information to companies.

In practice, they will and they have, but I do not believe that that is specifically covered. However, it will be important for the operator of the dematerialised register to have to provide such details, and it will be important for record dates for commercial matters and matters such as the straightforward payment of dividends.

Under regulation 23, the operator is obliged to maintain a register of securities, which should not give rise to a form of civil liability for breach of statutory duties. However, I believe that the commentary advises that the operator would be liable for fraud or negligence. If that is correct, it might usefully be highlighted.

Regulation 24(3) states that if a person's name is entered on a company issuer's register of members, that is insufficient to make a person a member—that is, he is not legally definitely a shareholder of the company. If the person holds the shares in uncertified form, the operator register must also show the individual holding shares in that form. However, a member or other party may inspect only the company's register, and not the operator's demutualised register of shares. Doing so may be difficult physically, but both registers should be able to be checked.

If someone applies to a court for damages and rectification of a register of members and the court issues an order to that effect, will the ruling apply to both the issuer register and the operator register? Section 359 of the Companies Act refers only to the register of members. Is the matter already covered in the regulations, or will section 359 be amended to make it clear that both registers would be involved?

The argument has been advanced that it is not clear that the obligation of participating issuers is to register transfers or transmission as a mediate obligation. That can be relevant to commercial interests in circumstances in which dates matter. A dematerialised security starts off on the operator's register, and surely there should be an obligation to enter it on the company's register on the date that the deal is struck.

The regulations deem a system's member to continue to be a member of the company even though there may be no entry in the register of members. That is, again, a major change to the Companies Act definition. It would be helpful if the regulations were to state specifically that section 22 of the 1985 Act will be modified accordingly. There seems to be no obligation on the operator to comply with the requirement to enter a person's name on the operator's register at a precise time. That could be commercially important, especially in relation to, for example, tax liabilities.

Regulation 36 limits the liability of the operator to £50,000 for forged dematerialised instruments. I believe that that figure was first set five years ago, and has therefore fallen in real value. Does the Treasury believe that it might have the power to vary or increase that figure as time goes by?

Schedule 4 contains the word ``regularly'', which is not defined. What is meant by it? It is potentially important because a company might not be in a regular situation because of a computer crash. These are specific and important legal issues, but we broadly welcome the regulations. As the Minister said, they relate to the centre of an industry that earns Britain about £33 billion each year, and the regulations address complicated territory and, in particular, facilitate electronic transfer of title. I raise my questions purely with the objective of avoiding legal issues emerging in future that should have been considered now.

4.55 pm

Ruth Kelly: I thank the hon. Member for Arundel and South Downs (Mr. Flight) for his comments, which I take in the spirit of co-operation. This uncontroversial proposal has widespread backing in the City of London and will increase its attractiveness as a financial centre. It will move the City much more into line with best practice and to the forefront of changes in the electronic transfer of title and delivery versus payment. The hon. Gentleman recognised some advantages of the proposed regulations and how they deal with dematerialisation. As he will recognise, I may have to come back to him later on some of his detailed comments, but I can deal with others now.

The hon. Gentleman asked how members will know whether they are on the operator register. Paragraph 11 of schedule 1 requires a relevant system to

    ``enable each system-member to obtain a copy of any records relating to him'',

which will allow them to ascertain whether they are members of a company, by virtue of being entered on the operator register. The hon. Gentleman asked about the liability of the operator to the issuer for negligence, fraud and so on. That concern has also been met by inserting specific references to negligence, fraud and other wilful default in regulation 23(1). CREST consults on its rules. Issuers do not have contracts with it, so it cannot impose obligations or liabilities on them.

The hon. Gentleman questioned whether the £50,000 limit could be raised to reflect the passage of time. That limit is not fixed, although it reflects broadly the size of retail transfers. I should like to point out that CRESTco wrote to all issuers of CREST securities to point out that no action was required for issuers under the modified and re-enacted regulations. In particular, the letter also pointed out that any term of issue that was inconsistent with re-enacted regulations was disapplied.

The hon. Gentleman asked about the provision of information by the operator to the issuer. For the record, I believe that the key regulation on the provision of information is that at regulation 27(7), which requires the operator to send the issuer a notification of a transfer of uncertificated securities. The hon. Gentleman asked what precisely was meant by the word ``regularly'' in paragraph 5 of schedule 4. We considered that precise point but decided that no further clarification of ``regularly'' was needed or desirable; of course, the term ``once every leap year'' could be described as regular. However, under paragraph 23 of schedule 1, the operator's rules, which will bind issuers and, therefore, impose legally binding obligations on them, must deal with reconciliation. In practice, it will be possible to refuse or withdraw authorisation from any applicant or operator whose rules are inadequate in that respect.

The hon. Gentleman raised a point about section 359 of the Companies Act 1985 and regulation 20. We also considered that fully but did not think that there was any context in which there would be any uncertainty about the meaning of a reference in the Companies Act to a company's register of members.

The hon. Gentleman made several comments about the change in the regime. The starting point for the regulation is section 207(4) of the Companies Act 1989, which requires the regulations to maintain, as far as practicable, the same rights and obligations that existed without the regulations. That has been our guiding light in drafting the new regulations and has been reflected, in spirit, by CREST in consulting on the contracts that it has with its system members and others who have a stake in the system.

Of course, there are some practical differences between the present regime and the new one. The register of securities participating in CREST will now be split into uncertificated and certificated parts. The main difference is the change of context, from which no significant differences will emerge. Clearly, the precise details of how the regulations affect individuals who use the system will change. The public will still have the right to inspect the share register and records; thus, the provision is maintained under the new regulations.

I hope that I have addressed most of the detailed points that the hon. Gentleman raised. If he thinks that others need substantive consideration, I am happy to provide him with more information.

5.3 pm

Mr. Flight: I was seeking to tease out information on issues about which I believe the industry wants legal certainty. I believe that one or two points were not addressed, and I would be grateful for further comments later.

Question put and agreed to.


    That the Committee has considered the draft Uncertificated Securities Regulations 2001.

        Committee rose at four minutes past Five o'clock.

The following Members attended the Committee:
Hurst, Mr. Alan (Chairman)
Flight, Mr.
Green, Matthew
Kelly, Ruth
Kirkbride, Miss
Lewis, Mr. Terry
Luff, Mr.
Singh, Mr.
Southworth, Helen
Squire, Rachel
Sutcliffe, Mr.
Swire, Mr.
Tipping, Paddy
Wareing, Mr.
Worthington, Tony

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Prepared 7 November 2001