Conclusion of the XIXth Diplomatic Session

25 Juni 2003


New Hague Convention increases legal certainty for cross-border securities transactions

The Hague, 13 December 2002 – For the financial markets, the exposures involved in cross-border securities transactions are extremely large – with securities worth hundreds of billions of dollars, Euros and Yen provided cross-border every day as collateral all around the globe. Until now, in many jurisdictions it has been somewhat alarmingly uncertain which law is applicable to cross-border securities transactions, leaving market participants exposed to a substantial amount of legal risk. Today, the Hague Convention on the Law Applicable to Certain Rights in respect of Securities held with an Intermediary (Hague Securities Convention) was adopted and is now open for signature and ratification by the 62 Member States of the Hague Conference on Private International Law, as well as by all other States. The new Hague Convention resolves this conflict of laws issue on a global level and makes clear what steps need to be taken in order to ensure in advance what law governs securities transaction to the benefit of market participants and the financial system as a whole. The Convention draws on the “Place of the Relevant Intermediary Approach” (“PRIMA”) which has found favour around the world.

In recent times, with the move from paper based securities to book entry securities that are immobilised at an intermediary or are in dematerialised form, some of the risks inherent in transfers of paper based securities across long distances were eliminated. However, the development of a legal regime governing these indirectly held securities transactions has lagged behind, leaving the financial markets with unacceptable levels of legal uncertainty.

Collateral providers are able to reduce borrowing costs if collateral takers are willing to accept securities held by the collateral provider as collateral. Collateral takers, however, need to be certain that they have an interest in the securities that is enforceable both against the collateral provider and against third parties. Today, in many jurisdictions, existing conflict of laws rules with respect to proprietary issues, such as perfection and priorities of competing securities interests, are by no means clear. In fact, in some jurisdictions multiple answers are possible resulting in a collateral taker’s need to perfect in a number of jurisdictions.

The traditional conflict of laws rule for determining the enforceability of a transfer or pledge of securities is based on the lex rei sitae principle. Under this principle, the validity of the disposition is determined by the law of the place where the securities are located. However, there are severe conceptual, legal and practical difficulties potentially arising from the application of this approach in the modern context of indirect holding patterns for securities. For example, a holding through various tiers of intermediaries may not enable the collateral taker to discover where the national central securities depositary actually stores the certificates, if any exist.

The Hague Conference on Private International Law, an intergovernmental organisation with currently 62 Member States which prepares multilateral conventions in different fields of private international law, agreed in May 2000 to find a uniform conflict of laws rule for proprietary aspects of dispositions of securities held through indirect holding systems. In view of the immediate practical need for legal certainty, the Hague Conference adopted a “fast-track” procedure, which made it possible for the Convention to be finalised today, after less than three years. This is a remarkably short time for the completion of negotiations of an international legal instrument. During the entire process, representatives of the private sector from around the world (including global custodians, credit institutions and broker-dealers) were heavily involved in the evolution of the Convention and ensured that the rule adopted by the diplomats and legal experts would work in practice.

The approach adopted by the Hague Convention is modelled on the “Place of the Relevant Intermediary Approach” (“PRIMA”). The major advantages of PRIMA are that the rule provides a clear and certain answer to the parties to the securities at the time they enter into the securities transaction and that the question of whether the collateral taker receives a perfected interest will be governed by the law of one single jurisdiction even where a portfolio of securities of issuers from different countries is involved.

The main issue during the negotiations was to determine how to substantiate the PRIMA principle. Today, most intermediaries do not restrict the maintenance of their securities accounts at a single office. The maintenance of the accounts is dispersed among numerous offices which are located in different States. Against this background, the Hague Securities Convention does not attempt to “localise” the place of the relevant intermediary and instead refers directly to the law chosen by the parties to the account agreement:

· The first step is to look to the law expressly agreed between the account holder and its direct intermediary to govern the securities account in their account agreement as the determining factor. The choice of law, however, is constrained in that the intermediary must have an office in the chosen state that regularly maintains securities accounts.

· If the account agreement does not contain such a choice of law clause, but expressly and unambiguously states that the relevant intermediary entered into the account agreement through a particular office, the applicable law is the law of the location of such office, again, provided that it regularly maintains securities accounts.

· If this test also provides no answer, the Convention looks, as the ultimate fallback, to the law of the place of incorporation or organisation of the relevant intermediary.

In addition, transitional rules make sure that the Convention determines an appropriate regime for existing securities accounts and transactions so that the current expectations of parties are respected.

Finally, in an insolvency procedure, an interest perfected in accordance with the law applicable under the Convention is recognised but is still subject to the forum’s insolvency law, such as preference and avoidance rules. Thus, to a large extent, the Convention respects a country’s insolvency regime.