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Session 2001- 02
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Delegated Legislation Committee Debates

Draft Uncertificated Securities Regulations 2001

Third Standing Committee on Delegated Legislation

Wednesday 7 November 2001

[Mr. Alan Hurst in the Chair]

Draft Uncertificated Securities Regulations 2001

4.30 pm

The Economic Secretary to the Treasury (Ruth Kelly): I beg to move,

    That the Committee has considered the draft Uncertificated Securities Regulations 2001.

I am pleased to be under your chairmanship, Mr. Hurst.

We are debating changes to the legislative structure for CREST—the computerised system that transfers gilts, shares and corporate bonds electronically, without using certificates.

CREST is a key component of the London financial market, which, as my right hon. Friend the Chancellor of the Exchequer said, is a vital asset to the British and the European economies, attracting investment and boosting competitiveness. The legal framework for CREST's operations is provided by the Uncertificated Securities Regulations 1995, and the measure re-enacts these regulations with modifications.

It had originally been hoped that the changes I shall outline could have been introduced by amending the Companies Act 1985, but it became apparent that they would have to be far more extensive than was first thought. In addition, changes would also have been needed to the uncertificated securities regulations and other secondary legislation. We did not think that it would be helpful to have provisions on uncertificated securities scattered across half a dozen or so pieces of primary and secondary legislation, so instead we decided to revoke the 1995 regulations and re-enact them, with the modifications now before the Committee. A strong legal framework for CREST helps financial stability and improves the competitiveness of the UK's financial sector.

The new regulations will improve the CREST legal framework by introducing two new reforms: first, the electronic transfer of title—ETT—delivery of securities within CREST's electronic accounts will represent the legal transfer of title and remove the interval between settlement in CREST and registration of ownership; secondly, delivery versus payment in central bank money—DvP—will reduce the risk between CREST settlement banks, which carry out payment on behalf of CREST members for securities transferred in CREST. The main advantage of the changes will be that the legal transfer of ownership of securities and fully secure payment occur together at the same time. That will bring one of the major pieces of UK financial infrastructure into the forefront of international best practice.

The present arrangements are already secure. CREST has operated for more than five years, settling about £200 billion in cash and securities a day without any loss to customers. CREST members have had a quality of DvP that is close to best practice, but with such high values it is important to eliminate risk in all parts of the system rather than simply to contain it at low levels. The moves to electronic transfer of title and DvP were one of the recommendations of the Bank of England securities settlement priorities review published in 1998, and there has been strong support from the City for their implementation. Settlement is an important source of revenue and one determinant of the location of financial activity. Since issuers and investors nowadays have an ever-increasing choice of where they do business, it is essential that the UK remains attractive to them. Electronic transfer of title and DvP will therefore benefit not only themselves but be an important factor in maintaining the UK's competitive position. It is against that background that the Government are seeking approval for the proposal.

The regulations revoke the Uncertificated Securities Regulations 1995 and re-enact them with modifications to continue governing transfers through the CREST system. Most of the amendments are technical and designed to facilitate and to give legal backing to the upkeep of registers and records and the transfer of securities between owners. However, the changes to bring in ETT and DvP are important and the Committee may welcome a more detailed explanation.

As for the electronic transfer of title, the Companies Act 1985 provides for the ownership and transfer of shares. A share register is kept by the company that records the legal owners of shares. Shareholders also receive share certificates. When they sell their shares, they transfer ownership by sending the certificates plus a stock transfer form to the company, which then adjusts the register appropriately and issues a certificate for the new owner. Under the new regulations, the issuer register will continue to exist, but will relate only to shares that continue to be held in certificated form and not in the CREST system.

The Uncertificated Securities Regulations 1995 removed the need for a share certificate for those shareholders who use CREST. The regulations refer to an operator, although CRESTCo, the company that operates the CREST system, is currently the only operator. When someone transfers an uncertificated security, the operator debits or credits stock accounts in the system. Notification of the change of ownership is then sent down a secure network to the company registrar, who updates the register. That register currently records legal title to the securities and membership of the company.

The Uncertificated Securities Regulations 2001 define a new concept—the operator register. That records holders of uncertificated shares held in CREST. The operator register is mainly, in information technology and data terms, the same as the current CREST records relating to the particular share. However, it will have the legal status of a register, so a change in it represents a change in legal ownership, which is the electronic transfer of title.

The regulations impose on CRESTco certain responsibilities such as keeping the operator register and set out in statute the relationship between CREST, companies and other issuers.Issuers will not be liable for the operator's maintenance of the register, except to the extent that they instruct a change to be made or are themselves at fault. CREST will not be responsible for other functions carried out today by registrars. For example, arrangements for dividend payments will not be affected. Registrars will keep a record of the operator register for those and related purposes. They will be able to rely on the record, providing that it is reconciled regularly with the operator register. The record will also enable the continued public right of access to share registers.

We do not intend CREST to have an unlimited civil liability relating to its responsibilities. Like any other company, it will be liable for its own fraud, wilful default or negligence subject to limitations that may be affected by its contracts with its members. Certain penalties are imposed by the regulations if CREST fails in the duties imposed by the regulations. Limited liability under the 1995 regulations will be continued. That imposes a liability on the operator in the event of loss resulting from unauthorised access to the system, or hacking.

As for delivery versus payment, we have discussed the change to the regulations that concerns the sale of a security, which is the delivery. The other side—payment for the security—is also vital. Payment in CREST is made by several settlement banks. That allows competition in the provision of credit to CREST members, each of whom has an account with a settlement bank. When the securities are delivered through CREST, the buyer's settlement bank agrees irrevocably to pay the seller's settlement bank. That is called the assured payments regime. The payment system is, of course, electronic. The settlement banks make final payment between themselves across accounts at the Bank of England at the end of the day.

The buyer's bank guarantees the payment to the seller's bank, but the seller's bank is exposed to the risk that the buyer's bank goes insolvent in the course of the day, between delivery of the securities in CREST and the end-of-day transfers between the respective settlement banks' accounts with the Bank of England. The system of assured payment has served CREST members well for the past five years, but it involves settlement in so-called commercial bank money.

There is a better international standard: delivery versus payment in central bank money. It removes the risk of the settlement banks being exposed to one another during the day. Instead, they settle their payments to each other immediately on a gross basis. That process requires a higher level of liquidity. Each bank must have more cash in its account at the Bank of England if it has to settle each of its customer's payments immediately than under the assured payment regime when the payments are settled only on a net basis at the end of the day. The Bank of England has set in place arrangements to provide a higher level of liquidity for the buyer's bank to pay the seller's bank.

The Bank of England needs some collateral to support that liquidity. To provide that, the buyer of the securities and his bank will repo them to the Bank of England during the day, temporarily obtaining sufficient central bank money to enable the seller's bank to be paid. A repo is a sale and repurchase agreement—the securities are sold to the Bank of England for the necessary funds and bought back later in the day when the funds are no longer needed. For DvP and central bank money, that repo needs to be automatic. Schedule 1 of the regulations has been modified slightly to allow CREST and the bank to set up such a facility.

I apologise if I have spoken at length about the new regulations. However, our objective is simple: ensuring that legal transfer of ownership of securities and fully secure payment occur at the same time in the CREST system. That will enhance the competitiveness of the infrastructure of UK financial markets, which will be welcomed in the City. I therefore commend the regulations to the Committee.

4.40 pm


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