Legal Issues and Implications of UNIDROIT Convention

Yeon-Wook Kang Lawyer of Risk Management Team

E-mail : ywkang@ksd.or.kr

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Contents

Introduction of UNIDROIT Background of UNIDROIT Convention on Substantive Rules regarding

Intermediated Securities

Progress of UNIDROIT Convention

Main Contents of the Convention

Implications for Korean legislation

Activities of the KSD

The need for cooperation

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Introduction of UNIDROIT International Institute for the Unification of Private Law (Institut International Pour L’Unification du Droit Prive) Independent intergovernmental Organization Purpose

Modernising, harmonizing and co-ordinating private and in particular commercial law as between States and groups of States

Membership : 63 Members States Achievements

UNIDROIT has drew up 11 Conventions, 2 Principles and 2 Model Laws

11 Conventions admitted into municipal law via ratification

2 Principles

2 Model Laws

adopted by an arbitrator and contracting parties freely

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Background of UNIDROIT Convention

Backgrounds Expansion of cross-border securities transactions Enlarging complexity of the intermediation chain Structure of cross-border securities transactions

Multi-tier holding system with a chain of intermediaries ultimately connected to the CSD

Convention on Substantive Rules regarding Intermediated Securities

Increasing awareness of the legal risks from different legal frameworks in many countries

Increasing awareness of the legal risks from different legal frameworks in many countries

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Background of UNIDROIT Convention

Solution (1) : Hague Convention Hague Convention on the law applicable to certain rights in respect of Securi

ties held with an intermediary Final version : December 2002 Basic Purpose : update and unify conflict of laws principles

Solution (2) : UNIDROIT Convention (2002~) UNIDROIT Convention on Substantive Rules regarding Intermediated Secu

rities Modenising and harmonizing substantive rules regarding cross-border inter

mediated securities holding and transaction Framework and issues of substantive law at global market are comprehensiv

ely addressed

Issues of substantive law are not addressed Limited Solution?

Reduction of Legal Risk

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Progress of UNIDROIT Convention

September 2002

~December 2004

First Meeting of UNIDROIT Study Group Preliminary Draft Convention

May 2005

March 2006

November 2006

May 2007

September 2008

October 2009

First Session of the Committee of Governmental Experts

Third Session of the Committee of Governmental Experts

Fourth Session of the Committee of Governmental Experts

First Session of the Diplomatic Conference to adopt a Convention

Final Session of the Diplomatic Conference to adopt a Convention

Second Session of the Committee of Governmental Experts

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Main Contents of the Convention

Features The basic rules for different types of systems for intermediated securities The effects of non-Convention law of Contracting States retain

StructuresDefinition, scope of application and interpretationDefinition, scope of application and interpretationDefinition, scope of application and interpretationDefinition, scope of application and interpretation

Chapter IIChapter IIChapter IIChapter II Rights of account holderRights of account holderRights of account holderRights of account holder

Integrity of intermediated holding systemIntegrity of intermediated holding systemIntegrity of intermediated holding systemIntegrity of intermediated holding system

Transfer of intermediated securitiesTransfer of intermediated securitiesTransfer of intermediated securitiesTransfer of intermediated securities

Special provisions with respect to collateral transactionsSpecial provisions with respect to collateral transactionsSpecial provisions with respect to collateral transactionsSpecial provisions with respect to collateral transactions

Transitional ProvisionsTransitional ProvisionsTransitional ProvisionsTransitional Provisions

Final ProvisionsFinal ProvisionsFinal ProvisionsFinal Provisions

Chapter IChapter I Chapter IChapter I

Chapter IIIChapter IIIChapter IIIChapter III

Chapter IVChapter IVChapter IVChapter IV

Chapter VChapter VChapter VChapter V

Chapter VIChapter VIChapter VIChapter VI

Chapter VIIChapter VIIChapter VIIChapter VII

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Main Contents of the Convention

Rights of an account holder (Article 9) The credit of securities to a securities account confers the right to receive

and exercise the rights attached to the securities (dividends, other distribution, voting right, etc)

Enforceable against third parties

Acquisition and disposition by debit and credit (Article 11, 12) An account holder can acquire/dispose intermediated securities by way

of a credit/debit No further steps are necessary under the non-Convention law to ensure

the effectiveness against third parties Parties are able to create a security or other limited interest in respect of

intermediated securities by way of a debit and credit Other methods to create a security : designating entry, Control

agreement

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Main Contents of the Convention

Acquisition by an innocent person (Article 18) Purpose : Protection to innocent acquirers of intermediated

securities Unless an acquirer actually know or ought to know of an earlier

defective entry, the credit is valid, effective against third parties Unless an acquirer actually know or ought to know that another

person has an interest in securities or intermediated securities and that the credit to the securities account of the acquirer violates the rights of that other person, the credit is valid, effective against third parties

This protection does not apply in respect of acquisitions of securities made by way of gift or otherwise gratuitously

Adoption of principle of public confidence

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Main Contents of the Convention Integrity of the intermediated holding system (Article 21 to 30)

Effectiveness of rights in insolvency proceeding Rights that have become effective against third parties are effective against

the insolvency administrator and creditors in any insolvency proceeding in

respect of the relevant intermediary

Prohibition of upper-tier attachment (No-look-through Principle) A creditor cannot attach positions held for its debtor at any level in the

chain above its debtor’s immediate intermediary

Loss sharing in case of insolvency of the intermediary Where securities have been allocated to single account holder, the loss is

borne by that account holder

In all other cases, the loss is shared among the account holders to whom the

securities concerned have been allocated in proportion to the respective

number or amount of such securities credited to their securities accounts

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Main Contents of the Convention

Insolvency of system operator or participant Instructions for making book entries and of resulting debits, credits and

designating entries are irrevocable in case of insolvency of system operator or

participant

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Main Contents of the Convention

Special provisions with respect to collateral transaction (Article 31 to 38, Chapter V)

Recognition of title transfer agreement The law of a Contracting State shall permit a title transfer collateral

agreement Right to use collateral securities

If and to the extent that the terms of a security collateral agreement, the collateral taker shall have the right to use collateral securities

In order to enhance liquidity Top-up or substitution of collateral

For protecting top-up and substitution against certain provision of insolvency law,

They may not be treated as invalid, reversed or declared void solely in respect of insolvency proceeding

A Contracting State may declare Chapter V shall not apply

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Implications for Korean legislation

The way of transfer of securities between accounts

or control agreement* is also accepted (Article 12)

control agreement is the agreement that pledgor grant “control” (authority

of management and disposition) of the account to secured party

for the purpose of a establishing a security right

Various ways of establishing a security right

UNIDROIT Convention Korean legislation

Effects of statement of account book

Credit/Debit to a securities account is considered to acquire/dispose

intermediated securities(Article 9, 11, etc)

Statement to a securities account is considered to hold respective securities

(FSCMA Article 311)

Protection to the innocent acquirer ofsecurities

Innocent (good faith) acquisition by transfer of securities

between accounts is not yet stipulated expressly

Approval of Innocent (good faith) acquisition by transfer of securities

between accounts(Article 18)

The way of transfer of securities between accountsor control agreement is not accepted

[For the present, a security right is established in the way of statement

to be pledged in account books(FSCMA Article 311)]

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Implications for Korean legislation

UNIDROIT Convention Korean legislation

Prohibition of upper-tier attachment

A Creditor cannot attach positions held for its debtor at any level in the chain above its debtor’s

immediate intermediary (Article 22)

Direct provision doesn’t exist, howeverupper-tier attachment

isn’t performed materially

Right to use collateral securities

None

Collateral taker have the right to use collateral securities

under collateral agreement(Article 34)

Top-up or

substitutionof collateral

Top-up or substitution of collateralmay not be declared void

in respect of insolvency proceeding(Article 36)

Direct provision doesn’t exist, however top-up or substitution of collateral could be declared void,

as the case may be, in respect of insolvency proceeding

(Debtor Rehabilitation And Bankruptcy Act Article 100, 120, etc)

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Activities of the KSD

KSD to attend the Committee of Governmental Experts

KSD submitted comments concerning acquisition by an

innocent person Scope of Innocence

Difference between an individual and a an organization (2008 draft)

An individual

Scope ofKnowledge

Article 14. 4 (b) describes the test of innocence applied to

an individual and requests “a significant probability that the interest or fact exists and

deliberately avoids information,” which means gross negligence.

An organization

 Article 14. 4 (c) asks an organization for

“ought reasonably to have been brought to the attention of

the individual responsible,” which means simple negligence.

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Activities of the KSD

there is no ground for the different treatment between an individual and an organization

the standard of an individual should be applied to an organization in the same way

 Effect of Innocence Acquisition Regarding Article 14.2 (2008 draft), it seemed to be possible that the issuer is

included in the third parties and the innocent acquirer contends his/her rights to the issuer

KSD’s opinion is reflected in the draft 2009

For the effect against the third parties, Article 14.2 (2008 draft) describes: "(a) the credit of interest is not rendered invalid, ineffective against third parties

or liable to be reversed as a result of that defective entry; and (b) the account holder, or the person to whom the interest is granted,

is not liable to anyone who would benefit from the invalidity or reversal of that defective entry."

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Activities of the KSD

the purpose of the innocent acquisition is to protect the trade aspect of the securities

Effect to the issuer is desirable to be regulated by the non-Convention law

KSD’s opinion is expected to be reflected in the Official Commentary

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The need for cooperation

UNIDROIT Convention is expected to be operated as Global Standard of clearing and depository legislation

Commitment to the UNIDROIT Convention implies for the law revisions

The need for productive cooperation in the Asian finance sector Preparation for the change of business environment The necessity for the analysis on the effects on the CSD Preparation for the basis of competitive CSD The necessity for the separate group for study of UNIDROIT Convention at Asian level

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For more information

http://www.unidroit.org/english/workprogramme/study078/item1/http://www.unidroit.org/english/workprogramme/study078/item1/main.htmmain.htm

http://www.unidroit.org/english/workprogramme/study078/item1/http://www.unidroit.org/english/workprogramme/study078/item1/main.htmmain.htm

Thank You