In a forthcoming article, Global Standards for Securities Holding Infrastructures: A Soft Law/Fintech Model for Reform, Michigan Journal of International Law (forthcoming 2019), I advocate an approach for Fintech innovation: Experienced and knowledgeable experts on financial markets and their legal and regulatory environments should formulate functional, result-based standards and goals—a “request for proposal.” Having identified the needs, it is for the Fintech community to find solutions or concede failure. Unfortunately, the legal establishment seems to be following technological developments like apocryphal lemmings jumping off of cliffs. In the article I propose the development of such standards for securities holding infrastructures and suggest that the International Organization of Securities Commissions (“IOSCO”) would be an appropriate sponsor of the project.
Publicly traded securities generally are held through “intermediated” holding systems. Most systems involve hierarchical relationships with a “central securities depository” (CSD) at the “top,” which maintains securities accounts for its participant account holders (intermediaries such as stockbrokers and banks), which in turn maintain securities accounts for their account holders, some of which are “ultimate” account holders or their representatives and some of which are intermediaries that maintain securities accounts for their “downstream” account holders. The nature of the legal relationships and characteristics involved in these systems vary enormously. These systems also reflect a wide variation in “transparency”—the extent to which the identity of ultimate account holders are reflected at the CSD level. The “omnibus” account systems of the United States, the United Kingdom, and most major markets in Europe occupy the nontransparent end of the spectrum. At the transparent end are systems such as those in some Nordic states, some smaller European markets, Brazil, Japan, and elsewhere. In some transparent systems the CSD even acts as the registrar for the issuers of securities.
In September 2016, inspired in part by preparation for and participation in the first of several intermediated securities-related workshops at the University of Oxford, I proposed the outline of a new securities holding infrastructure. As the final step in the settlement of securities market transactions, the system would directly connect investor with issuers—a “direct,” transparent holding system. I suggested that the utilizing distributed ledger technology (DLT) for the operation of such a system could offer substantial benefits. Such a holding system would benefit in particular both investors and issuers, but a political economy analysis suggested that implementation would likely require a top-down regulatory intervention. Professor Kumiko Koens and I have developed this proposal and presented it at seminars and conferences in China, Japan, the Netherlands, the UK, and the US in 2017 and 2018. The paper will be available in the near future. In another recent paper with Thomas Keijser, Intermediated Securities Holding Systems Revisited: A View Through The Prism Of Transparency, in Intermediation and Beyond (Louise Gullifer & Jennifer Payne eds. 2019), we explain that adopting more transparent holding systems would alleviate many current legal and regulatory problems, even without any change in law, and would provide a roadmap for law reforms.
Others have recently explored the benefits of transforming nontransparent, indirect holding systems into more transparent, direct holding systems, including Geis, Nougayrède, and, most recently, Donald & Miraz. These are welcome contributions. Our proposal differs in several material respects. In particular we view the elimination of intermediary risk—the potential for loss or damage arising from the insolvency or default of an investor’s intermediary—to be the principal goal and benefit of disintermediation. Of course we do not discount the other benefits of reforming holding infrastructures. Other differences include (i) treatment of existing issues of debt securities evidenced by “global” certificates, (ii) flexibility for NOBO/OBO US shareholder options, (iii) divesting intermediaries of control over securities even in transparent, direct-holding systems, (iv) development of safe, non-custody methods of direct investor control of assets in a DLT environment, (v) eliminating cross-border custody chains, and (vi) imposition of the new system as a nondisruptive, politically expedient step while preserving, possibly as an interim stage, current methods of trading, clearing, and settlement.
Charles W Mooney Jr., University of Pennsylvania Law School