Response of Deutsches Aktieninstitut and GDV to the Consultation Document Legislation on Legal Certainty of Securities Holding and Dispositions

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1 DEUTSCHES AKTIENINSTITUT Response of Deutsches Aktieninstitut and GDV to the Consultation Document Legislation on Legal Certainty of Securities Holding and Dispositions 11 June 2009 I Introduction The Deutsches Aktieninstitut 1 and the GDV 2 welcome the opportunity to comment on the Consultation Document of the Directorate-General Internal Market and Services (hereinafter the Consultation Document ), to harmonise the European legal framework of securities holding and dispositions. Although this might enhance the effectiveness and integrity of post trading within the EU, it is essential to incorporate the following principles in this harmonisation process carefully: - Corporate law (i.e. issuer law, as it is called in the Consultation Document) and the legal framework with respect to book-entry securities are two different topics. Corporate law, especially the law for listed companies, refers to the relationship between the owner of the company, the ultimate shareholder or end investor, and the company itself. In accordance with the Second Advice of the Legal Certainty Group (LGC) we define end investors as the persons who actually bear the economic risk of an investment in securities (see p. 39). The rights flowing from the securities on the basis of the national corpo- 1 The Deutsches Aktieninstitut e.v. is the association of German exchange-listed stock corporations and other companies and institutions which are engaged in the capital markets development. 2 The German Insurance Association (Gesamtverband der Deutschen Versicherungswirtschaft e.v.; "GDV") [Registration Number ], which has its registered office in Berlin, is the umbrella organisation of private insurance providers in Germany. Its 457 members, which employ 226,000 staff and trainees, offer comprehensive risk protection and provision in the form of 400 million existing policies, both to private households as well as to members of industry, commercial enterprises and public institutions. As risk underwriters and providers of significant amounts of capital (with existing investments totalling 1067 billion Euro), private insurance companies also take on a key role in terms of investment, growth and employment within the German economy. Deutsches Aktieninstitut e.v. Gesamtverband der Deutschen Versicherungswirtschaft e.v. Niedenau 13-19, Frankfurt am Main Wilhelmstraße 43/43 G, Berlin Phone +49 (0) 69 / Fax +49 (0) 69 / Phone +49 (0) 30 / Fax +49 (0) 30 / dai@dai.de Internet berlin@gdv.de Internet

2 DAI and GDV Response: Securities Holding and Dispositions page 2/13 rate law (the law where the security is created) are exclusively the rights of the end investor. However, the legislation on securities focuses merely on the relationship between the intermediary or account provider and the account holder. Nowadays, securities are typically held and administered by an account provider. Thus, the legislation on securities should make sure that end investors are able to exercise their rights provided by the national corporate law. Especially in a cross border context we are far away from the situation that the end investors can exercise their rights untrammelled. Therefore, we regret that the Consultation Document only deals with the rights of the account holders and remains silent about the rights of the end investors. Furthermore we fear that the functional approach that is adopted in the Consultation Document could inadmissible interfere in the relationship between the issuer and the end investor, that has to be the mere subject of the corporate law. - We consider the integrity of the issue of securities as crucial within the harmonisation process. The efficiency of modern financial markets depends heavily on the confidence of the end investor that the system of account providing is functioning well. The position of the end investor must be valid and defendable against third parties, especially in the case of insolvency of the intermediary. Furthermore, from the point of view of an end investor it is necessary to prevent a so called overbooking of securities, meaning that the number of securities issued by the issuer does not equal the number of securities that are credited in the book entry system. A proven instrument to avoid overbooking is the notary function that is generally provided by the central securities depository and which should be a very important aspect in the harmonisation process. In addition, the property law approach in Germany is a successful legal concept that efficiently protects the investor s securities in case of the intermediaries insolvency and is an effective mechanism to obviate overbooking. In the interest of German end investors we consider it very important that the harmonised legal framework on securities must not fall behind this high level of investor protection. - The fact to enable end investors to exercise their rights has to be a core duty of the account providers. Although most account providers are cooperative and efficient in serving their clients, some weak links in the chain of intermediaries can be identified. As a consequence the chain can only be as strong as its weakest link. For this reason end investors especially in a cross-border context are often not informed about general meetings of an issuer; they have no practicable and cost-effective way of exercising their voting rights and they cannot give powers of attorney. Considering this, one must conclude that up to now we are far away from an EU-wide single market regarding the exercise of shareholder rights. Therefore, we strongly

3 DAI and GDV Response: Securities Holding and Dispositions page 3/13 advocate a mandatory legal framework with respect to certain basic core duties of intermediaries. - In Germany more and more companies are using register shares. According to the German stock corporation act (Aktiengesetz) the shareholder is the one who is registered in the share register of the issuer. Because of the fact that the effective registration requires a corresponding cancellation of a seller entry, register shares provide a very efficient protection against overbooking. Furthermore, the share register is an efficient instrument to facilitate the communication between the issuer and the shareholder and therefore a prerequisite to enable end investors to exercise their rights. For this reason German issuers that provide register shares are very interested that their registers are complete. Due to a widespread practice other entities than the end investor usually intermediaries are registered as nominees. This particularly applies to foreign end investors, so that companies do not know who their end investors are and how to communicate with them. This led the German legislator to amend the corporate law last year, which would give issuers the right to limit nomineepositions in their share registers and to ask intermediaries who s behind a nominee registered. Registered shares are definitely a success story that should not be negatively affected from an EU-wide harmonisation of the law on securities, which would happen for example if the terms account holder and end investor were not accurately separated. II Questionnaire Question 1: The far greatest part of securities are held and administered through securities accounts maintained by an account provider (e.g., a bank, a broker, a custodian or similar). What is your estimate regarding the percentage of securities which are not held through a securities account? In Germany the percentage of shares that are not hold by an account provider is negligible. Question 2: Do you assume that the application of the legal framework for acquisition or disposition of book-entry securities, including the creation of collateral interest, is more complex as soon as there are cross-jurisdictional elements to be taken into account? Yes, slightly more complex. In particular this results from the negotiation of account agreements between entities from different legal backgrounds. Legal uncertainties with regard to crediting and debiting of securities and the creation of collateral interest have been considerably decreased since the implementation of the Financial Collateral Directive (2002/47/EC).

4 DAI and GDV Response: Securities Holding and Dispositions page 4/13 Question 3: Do you think that harmonisation of the law of holding and disposition of book-entry securities should be done by way of minimum harmonisation, i.e. that in general, Member States' law shall continue to define the general legal characterisation of book-entry securities, whereas certain characteristics of book-entry securities are harmonised? Harmonisation of the law of holding and disposition of book-entry securities should not be an end in itself. It should contribute to the effectiveness of post trading within the EU. As yet we do not think that the functional approach that is adopted in the Consultation Paper is the right way to achieve this (see, for example, the following question). For this reason we consider it as an utterly condition that our principles as mentioned in the introduction must be integrated in the harmonisation process. Question 4: Do you think that book-entry securities should confer upon the account holder the following minimum rights (a) the right to exercise and receive the rights attached to the securities, as far as the account holder itself is identified by the issuer law as the person entitled to these rights; (b) the right to instruct the account provider to dispose of the securities; (c) the right to instruct the account provider to arrange for holding the securities with another account provider or otherwise than with an account provider, as far as the applicable law allows holding otherwise than with an account provider? No. The rights that are listed above must only confer to end investors and not to account holders in general. Account holders can be intermediaries themselves that hold securities not for their own account but for the account of other investors, in particular for the end investors. In extreme, the wording of the question would imply that all intermediaries along the chain are legally in the position to exercise the rights flowing from the security. This can not be meant seriously, as it would contradict the corporate law and implicate problems such as over-voting. The rights mentioned in the question are definitely not the rights of every intermediary in the chain but solely the rights of the end investor who bears the economic risk of an investment in the securities. We therefore strongly advocate that the Consultation Document should clarify that the account holder is used in terms of end investor. Furthermore, in our view the Consultation Document should also take into account that those intermediaries which are not end investors should follow the instructions of the end investors and enable them to exercise their rights. The intermediaries core duties as listed below would considerably help to overcome frictions in the EU-wide single market of shareholder rights.

5 DAI and GDV Response: Securities Holding and Dispositions page 5/13 Therefore, it should be stressed in the forthcoming legislation that account providers must - inform account holders of rights attached to the securities; - inform account holders of certain events affecting the securities; - execute any instruction given by the account holder, to the extent that this does not violate applicable laws (such as holding of sufficient securities); - execute the instruction of restitution of securities, whether by crediting the securities to a securities account held by the account holder in the books of another account provider or by allowing the holding of securities otherwise than with an intermediary; - take all necessary care in the custody of the securities registered to securities accounts; - not use the securities otherwise than for the benefit of the account holder and upon instruction of the account holder. Question 5: Do you think that a fix set of methods for acquisition and disposition of book-entry securities (crediting an account; debiting an account; earmarking book-entry securities in an account, or earmarking a securities account; removing of such earmarking; concluding a control agreement; concluding an agreement with and in favour of an account provider) should be available to market participants throughout all EU jurisdictions? No. The methods mentioned above are incommensurable. While crediting and debiting are methods to completely transfer ownership of the securities with all the rights attached, earmarking and control agreements refer merely to the pledge of securities. These two very different circumstances should be carefully separated. Therefore the Consultation Document should only use the terms acquisition and disposition for a full transfer of ownership following the crediting and debiting of securities. For this reason we think that the methods for acquisition and disposition of book-entry securities should be restricted to crediting and debiting. Other methods like earmarking and control agreements should not be available to market participants within all EU Member States. Question 6: In the event of not all six methods listed in Question 5 becoming available to market participants in all Member States: do you think that the law of any Member State should recognise, in particular in an insolvency proceeding, acquisitions and dispositions effected by one of these methods under the law of another Member State, even if the law of the first Member State does not provide for that method? Yes. As mentioned in question 5 earmarking should not become a method of acquisition and disposition in all EU Member States. Nevertheless, we think that earmarking should be good as a pledge of the security particular in insolvency proceedings. Beyond that, Member States that do not provide

6 DAI and GDV Response: Securities Holding and Dispositions page 6/13 other methods, especially the control agreement, should not be forced to recognize those in a cross border context. Question 7: Do you think that future legislation should leave to Member States the possibility of making the effectiveness of an acquisition or disposition subject to a condition contractually agreed upon between account holder and account provider, in particular a condition that a corresponding acquisition or disposition occurs? No. In particular, future EU-legislation should prohibit the acquisitions and dispositions if the corresponding dispositions and acquisitions do not occur. Referring to the Second Advice of the LCG we consider this so-called no credit without debit principle as the most stringent form to protect the integrity of the issue (see p. 69). First of all this principle avoids overbooking because the credit on the account of the securities buyer mandatory requires a corresponding debit on the sellers account. Secondly, this principle effectively safeguards the account holder in the case of the intermediary s insolvency which is forced to buy a sufficient amount of the respective securities. Question 8: Do you think that there should be a short, harmonised list of conditions giving rise to a reversal of an acquisition or disposition, notably (a) the consent of the account holder; (b) the credit or debit which was made in error; (c) the debit or earmarking or removal of an earmarking which was not authorised? No. This should be left to the contractual relationship between the account holder and the account provider. Question 9: Do you think that account holders in whose favour a credit has been made should be protected against the reversal unless they knew or ought to have known that the credit should not have been made? Yes. This rule is concerned with the protection of the bona fide acquirer of securities. However, one will have to ascertain high scrutiny when defining the meaning of "ought to have known". Such a term could create problems of interpretation in the different EU jurisdictions. The best solution seems to be to leave the legal effects of those terms to the laws under which securities are created. Question 10: Do you think that interests in book-entry securities, notably security interests, which are "visible" in the account, should have priority over book-entry securities which are not "visible" in the account? Yes. The visible book-entry securities should take priority over not visible book-entry securities. Question 11: Do you think that there should be a legal obligation for account providers to maintain, for securities of the same description, a number

7 DAI and GDV Response: Securities Holding and Dispositions page 7/13 of securities or book-entry securities that corresponds to the aggregate number of book-entry securities of that description credited to the accounts of the account holder's clients plus those securities held for its own account, if any? Yes. We think this legal obligation is crucial to protect the account holder in the case of the intermediary s insolvency and to prevent overbooking. Hence, we also believe that this obligation must be carefully supervised and when indicated effectively sanctioned. Question 12: Do you think that, in case of insolvency of the account provider, securities kept by it for its own account shall be attributed to its account holders, as far as the number of securities kept by the account provider for its account holders is insufficient? Yes. Question 13: Do you think that a remaining shortage should be shared amongst account holders of that account provider, in the case of its insolvency? No. We do not think that a shortage should be mutualised among all account holders. Instead only those should bear the shortage that hold securities of the kind the losses actually are related to. To minimize their losses we strongly recommend that their claims with respect to the relevant securities should be regarded as senior in the insolvency proceeding. Question 14: Have you encountered difficulties in the application of the legal framework regarding holding and disposition of book-entry securities that could be fully or partially attributed to an unsatisfactory conflict-of-laws regime? No. We have never experienced or learnt that anyone has had problems related to unsatisfactory conflict of law rules as provided for example by the Financial Collateral Directive (2002/47/EC). Question 15: Do you think that future legislation on the legal framework of book-entry securities holding and disposition should harmonise issues of substantive law as well as the question of which law is applicable to holding and disposition of book-entry securities, including the creation of security interests? The law under which the security in question has been created (corporate law) should always prevail over any other law. We understand the question as referring only to substantive law with regard to the account providing, not the law under which a security is created.

8 DAI and GDV Response: Securities Holding and Dispositions page 8/13 Once this is considered, this question is answered with yes. It potentially could bring some benefits, but only under the condition that any harmonisation does not depart from the current efficient principle of the localisation of the account as determining the applicable law. In particular, it could be useful to provide a list making clear what is not a securities account or what is not the activity of providing accounts (for instance, the maintenance of IT systems or platforms in a specific location is not an activity of account providing, which would allow to determine the applicable law as being the law of this location). Question 15bis: If yes: do you think that a uniform conflict-of-laws rule should govern the issues within the scope of the Settlement Finality Directive, the Directive on Winding-Up of Credit Institutions and the Financial Collateral Directive plus the aspects which are to-date not included in the scope of the three directives? As mentioned in our answer to question 15 we also understand this question as referring only to substantive law regarding the account providing, not the law under which a security is created. Additionally to a useful blacklist of what is not providing securities accounts, the choice of a connecting factor, if any, should absolutely avoid to create ambiguity and this criteria should efficiently point towards the exact branch which actually maintains the account (and not to any head office of this intermediary). Question 16: Do you think that holding and disposition of book-entry securities is more costly in cases where the situation involves a cross-jurisdictional element? We don t know. But the main problem are not the costs; the main problem is the ability for end investors to exercise their rights in a cross-border environment (see our answer to the following question). Question 17: Do you think that investors face difficulties in exercising rights flowing from securities as soon as they hold through a cross-border holding chain? Yes. In a cross-border context end investors face serious difficulties to exercise their rights. These complications start with the refusal of some intermediaries to pass on general information from the issuer to the end investor. It continues with the arbitrary application of dead lines made up by some intermediaries that not comply with the law of the issuers. Furthermore, end investors are often practically not able to exercise voting rights due to the fact that they are not registered with the company or the intermediary refuses to issue a certificate of entitlement which proves the position of the end investor to the issuer. As a consequence, the EU fails to reach one important aim of

9 DAI and GDV Response: Securities Holding and Dispositions page 9/13 the Shareholder Rights Directive (2007/36/EC) to achieve a single voting market. Question 18: Do you think that the law of Member States should bind account providers to facilitate the exercise of rights flowing from the securities (e.g. by providing the investor, upon demand, with a certificate confirming his holdings; or, by making the investor the account provider s representative with respect to the exercise of the relevant rights [proxy]), where the exercise of rights would be impossible or cumbersome without the assistance of the account provider? Yes. The ability of end investors to exercise their rights dependents highly on the willingness of the account providers to cooperate. Harmonisation in the field of intermediaries duties is absolutely needed in order to achieve a single EU-wide market for exercising shareholder rights. This means precisely that the intermediaries should pass the necessary information to the end investor and back to the issuer. In the case of registered shares intermediaries should be obliged to pass on shareholder data thereby enabling the issuer to directly inform the end investor. That would give the end investors the option to exercise their rights effectively without being forced to rely on the services of an intermediary. Making the investor the account provider s representative with respect to the exercise of the relevant rights is only the second best answer to the problem mentioned above. In this context we consider it to be very important that the intermediary only exercises the rights on behalf of the end investor if he is instructed from the end investor to do so. Question 19: Do you know other cases where assistance of the account provider is a prerequisite for the exercise of the right by the investor? See our answer to question 18. HV-Informationen und Investordaten Question 20: Do you think that Member States' law should make possible the exercise of rights flowing from securities by an account provider on behalf of the investor where the exercise of the rights by the investor himself is impossible? No. Obviously this question refers to an example on p. 84 et seq. of the Second Advice of the LCG where the intermediary, although he does not hold the security for his own account, is regarded as the legal proprietor of the security. Due to this judicial framework end investors are not able to exercise their rights for their own and are not allowed to instruct the intermediary to do this on their behalf. Therefore, we think it is very important to remove these legal barriers to enable end investors to exercise their rights for themselves. The execution of rights on behalf of the end investor is only a second best solution. In this case the end investors rights should never be exercised by

10 DAI and GDV Response: Securities Holding and Dispositions page 10/13 account providers without a mandate (which may be a general mandate), by default or by a general contractual clause or market rule. Question 20bis: In the affirmative case, do you think that this possibility should be subject (a) to feasibility on the side of the account provider [Yes/No/I don't know, please specify, in particular, the exact scope of such feasibility exemption], and/or (b) to contractually agreed levels of service between the account holder and the account provider? Not applicable. Question 21: Do you think that Member States' law should make possible the exercise of rights flowing from securities by an account provider on behalf of the investor, in a scenario where the investor does not want to exercise the rights himself? No. The end investors rights should never be exercised by account providers without a mandate (which may be a general mandate), by default or by a general contractual clause or market rule. Question 21bis: In the affirmative case, do you think that this possibility should be subject (a) to feasibility on the side of the account provider, and/or (b) to contractually agreed levels of service between the account holder and the account provider? Not applicable. Question 22: Do you think that an account provider should be bound to exercise, on behalf of the investor, the following rights flowing from securities: (a) Rights entailing a change of the relevant security itself (e.g. conversions, reorganisation); (b) Collection of dividends or other payments and subscription rights; (c) Acceptance or refusal of takeover bids and other purchase offers; (d) Other rights? We thoroughly reject a general duty for intermediaries to exercise certain rights attached to the securities on behalf of the end investor. It is solely the personal decision of the end investor to exercise his rights himself or to instruct the intermediary to do so on his behalf. Furthermore, in most countries the rights listed above are core issues of the national corporate law. In these cases the question misses the point. The term "exercise of rights" is not appropriate in the context of question 20 and should be replaced by "execute instructions". a. Yes, and if a response from the investor is needed the "exercise of rights" can only be accomplished according to the investor's instruction;

11 DAI and GDV Response: Securities Holding and Dispositions page 11/13 b. The Collection of dividends is not an exercise of rights but a receipt of cash payment to be credited to the cash account in the name of the investor; c. No, this is a pure investment decision that only the end investor (or his attorney) should take; d. No answer. Question 23: Do you think that account providers should be bound to pass on information with respect to book-entry securities which is required in order to exercise a right enshrined in the securities which exists against the issuer? Yes. As mentioned above in question 18 we think that especially in a crossborder context end investors have serious difficulties to get the relevant information that enables them to exercise their rights properly. These are precisely the notice to convene a meeting, the entitled position on record date along with the proof of entitlement and the notification of attendance including possible votes/voting instructions. Question 24: Do you think that this obligation should be restricted to information (a) which is received "through the holding chain", (i.e. directly either from the issuer or an account provider which maintains an account for the account provider in question, or from the investor or another account provider for which the account provider in question maintains an account.); (b) which is directed to all investors in securities of that description? Account providers should be obliged to pass on information that enables the end investors to exercise their rights enshrined in the security. Question 25: Would you advise other/additional restrictions to this duty? No. We would not advise other restrictions to this duty. Question 26: Do you think that the processing of rights flowing from securities is more costly in case where the situation involves a cross-jurisdictional element? Yes. Empiric evidence shows that end investors incur much higher costs when trying to obtain information or trying to exercise their rights cross-border. Question 26bis: If yes, could you give your best estimate of the additional cost and specify what types of cost arise? To forward the general meeting information from the issuer to the end investor the costs are on average 200 to 300 percent higher than in the domestic situation.

12 DAI and GDV Response: Securities Holding and Dispositions page 12/13 Question 27: Do you think that an issuer incorporated under the law of an EU Member State should be allowed to arrange for its securities to be initially entered into holding and settlement structures (in particular those maintained by a central securities depository) in, or governed by the law of, another EU Member State? Yes. But only if strong prerequisites are fulfilled ensuring that the integrity of the issue are being ascertained. This is achieved best by the notary function provided by the issuer, a state entity or another entity under close state supervision. Question 28: Do you think that holding and settlement structures for securities, in particular those maintained by a Central Securities Depository, which are governed by the law of an EU Member State, should be open for securities constituted under the law of another EU Member State? Yes. We think that enhancing the competition between the CSDs could reduce the costs in the EU-wide post trading and result in considerable benefits for the end investors. Question 29: Are there, in your view, issues stemming from other branches of law, such as corporate law, fiscal law, etc., or regulatory/supervisory concerns that could advise against the establishment of free choice by an issuer, as set out above? No. Question 30: Do you at present incur additional cost because either or both of the above possibilities of choice do not exist? No. Question 30bis: If yes, could you give your best estimate of the additional cost and specify what types of cost arise? No answer. Question 31: Do you think that all providers of securities accounts established in the EU should be subject to authorisation and supervision in relation to their services of maintaining securities accounts? Yes. Provision of custody services should be a subject to specific regulations and supervision. Question 31bis: If no, which account providers should not be subject to authorisation and supervision by competent authorities? Not applicable.

13 DAI and GDV Response: Securities Holding and Dispositions page 13/13 Question 32: Do you think that the service of safekeeping and administration of financial instruments for the account of clients, including custodianship and related services such as cash/collateral management (which is a so-called ancillary service under MiFID) should be made an investment service in the sense of MiFID (i.e. inserted in Section A of Annex I of the MiFID and be deleted from Section B)? We think it is more important to EU-wide codify the core duties of intermediaries. Question 32bis: If yes, do you see any specific difficulties in including certain types of account provider in the full or even a limited scope of MiFID? No answer.