| Introduction to securities lending |
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| Lorcan Tiernan and Peter Stapleton examine the development of securities lending, which was introduced in Ireland in 1999. |
Securities lending is a generic term generally used to cover a broad range of transactions including stocklending and repurchase (repo) activities. Transactions involve the temporary transfer of stock or securities from a lender (typically long-term holders of equities such as pension funds, collective investment schemes and insurance companies) to a borrower with commitment to reverse the transaction at some point in the future. These transactions are a valuable revenue stream for the lenders, an essential facility for borrowers (typically investment banks or securities brokers who wish to take short positions or support trading strategies) and a key component of any developed financial centre.
Unfavourable taxation provisions hindered initial growth in the Irish market for securities lending. However, these were largely addressed in an information notice on the tax treatment of stocklending/sale and repurchase transaction issued by Revenue Commissioners in April 1999.
While the changes to Irish tax laws have greatly facilitated the growth in the market, tax is only one factor in a securities lending framework. Participants also have to consider numerous risk factors, including systemic, insolvency and legal risk. The proper evaluation of such risks has proved difficult where there are cross-border issues owing to the differing laws of EU Member States and indeed the absence of a global consensus on principles such as the determination of the lex situs1 of secured assets. In the absence of clarifying legislation, lenders have relied upon legal opinions issued by specialist lawyers for comfort on a variety of matters such as the effectiveness of contractual netting provisions in the event of the insolvency of the borrower. However, this situation is changing and the existing Irish securities lending framework is being reinforced by the adoption of new domestic legislation, the implementation of EC Directives, e.g. the Collateral Directive and by the proposed ratification of international conventions.
It is beyond the scope of this article to examine the numerous provisions which impact on the regulation of securities lending in detail, but some of the key provisions of the current Irish framework are the Netting of Financial Contracts Act 1995 and Netting of Financial Contracts Act, 1995 (Designation of Financial Contracts) Regulations 20002 and UCITS/Non-UCITS Regulations and Irish Financial Services Regulatory Authority (IFSRA) Notices.
Use of market standard documentation
In addition to the above statutory provisions, participants have been offered further safeguards by the development of market standard documentation. It is common practice for lenders and borrowers to lend securities pursuant to the provisions of ISDA, OSLA, GMSLA and similar agreements. These agreements have been developed as a result of industry discussion and are specifically designed to offer the legal protection and certainty required by participants.
However, although these agreements provide a good basis for agreeing a securities lending transaction they are by no means a perfect solution. The differing nature of particular transactions and the individual requirements of counterparties mean that it is usually necessary to agree specific amendments to the agreements and their annexes.
PRIMA and Future Developments
A topic very much related to the enforcement of security interests when dealing with transfers and charging of collateral is the determination of the ‘lex situs’ of assets held by counterparties.
Securities lenders have long identified that the security they created over collateralised assets was susceptible to being struck down due to conflict of laws, e.g. non-compliance with the laws of the jurisdiction in which the securities were held. This legal risk became greater with the development of complex sub-custodial arrangements and the increased holding of dematerialised securities in clearing systems, e.g. Clearstream or Euroclear.
In Ireland, the general rule is that the law governing the proprietary effect and perfection of the interest will be determined by the lex situs (i.e. location) of the secured assets. However, it is not clear whether the Irish courts will use the ‘look through’ approach or ‘place of the relevant intermediary approach’ (PRIMA) to determine the lex situs. The ‘look through’ approach involves looking through a chain of intermediaries to either the jurisdiction of incorporation of the issuer of securities, the location of the security register or the location of the actual security certificates.
Obviously, such an approach is very difficult when dealing with a diverse portfolio of securities (multiple issuers and therefore multiple jurisdictions) and indeed different jurisdictions rely on either place of incorporation, place of the register or certificates to determine lex situs, again leading to multiple jurisdictions. The PRIMA approach has been heralded as the solution to many of these complications and has received widespread global backing, culminating in the recent agreement of the Hague Convention on the Law Applicable to Certain Rights in respect of Securities held with an Intermediary. PRIMA provides a uniform conflict of laws rule for securities held through intermediaries and looks to the law of the location where the intermediary maintaining the account to which the securities are being credited as the lex situs.
Ireland has begun tackling the above-mentioned concerns of market participants by the adoption of PRIMA into its laws. This is being accomplished on a phased approach.
Conclusion
The firm establishment of a securities lending framework in Ireland has brought many benefits. For IFSRA and the Irish Stock Exchange it has been viewed as helping to maintain market liquidity and facilitates settlement. It provides lenders with an additional source of revenue and offers borrowers access to a pool of equities to facilitate trading strategies.
However, it is important that participants are fully aware of the existing and proposed legislative provisions regulating the market. There is potential for greater growth in the sector and participants who are best advised as to current and future developments will be well placed to take advantage of such growth.
1. Under the doctrine of lex situs an agreement in relation to securities is governed by the law of the place where the securities are located
2. The Netting Regulations added new definitions of ‘financial contracts’, thereby extending the protection afforded by the Netting Act to a greater number of transactions. |
Lorcan Tiernan and Peter Stapleton are solicitors with Dillon Eustace.
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| Article appeared in the December 2003 issue.
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