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Tue, 1 December 2020

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By Lord Garnier
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Law Commission says improvements are required to the way shares are held

Law Commission

4 min read Partner content

Holding shares and other investments through intermediaries means investors do not really “own” their shares. This excludes them from shareholder rights and can lead to legal uncertainty, according to a scoping paper published by the Law Commission today.

If an individual or institution (the “ultimate investor”) holds their investments through an intermediary, such as a broker, an online investment platform, or a bank, they are not the legal owner of the investments. Instead, they only own a “beneficial” interest in the investments. There could be numerous organisations in an intermediated securities chain between the ultimate investor and the company they are investing in.

It is possible for an investor, whether an individual retail investor or an institutional investor such as a pension fund to own securities directly, even where they are held electronically. However, it has  become more common for investors to hold their investments through an intermediated securities chain.

The Law Commission’s scoping paper outlines the advantages and disadvantages of the current system and suggests some potential reforms.

Advantages and disadvantages of the intermediated securities system

Advantages

The Commission found a number of strengths of the intermediated securities system, including increased efficiency and economies of scale, and convenience for ultimate investors, who may hold a diverse, cross-border portfolio of investments through a single intermediary.

Disadvantages

On the other hand, there are well-founded concerns relating to corporate governance and transparency, and uncertainty as to the legal rights and remedies available to an ultimate investor.

An ultimate investor is not a “member” or shareholder of the company under the Companies Act 2006, and it is therefore unlikely that they will receive information from companies, have voting rights (for example at AGMs) or be able to attend meetings.

Even where an ultimate investor is able to vote, they may find it difficult to confirm that their vote was received and counted by the company.

There is also legal uncertainty around a number of scenarios that could play out, including what happens when an intermediary in the chain becomes insolvent, and the legal position when intermediated securities are wrongly sold.

Potential reforms

The Law Commission was asked by the Department for Business, Energy & Industrial Strategy to produce a scoping study which would inform public debate and develop a broad understanding of potential options for future reform (without making recommendations).

The Law Commission is suggesting that the system of intermediation is retained but improved through reforms targeted at alleviating some of the problems caused by intermediation. This would ensure that the benefits of the system remain, whilst minimising the impact of the disadvantages.

Possible future reforms include:

  • The creation of a new obligation on intermediaries to arrange for ultimate investors, upon request, to attend meetings, vote and receive information that the company sends to its members.
  • Amendments to ensure ultimate investors have their voices heard on votes for a binding compromise or arrangement between a company and its creditors or members (a “scheme of arrangement”, which can be used in a variety of ways, including to effect a takeover of the company, such as happened recently in relation to Sirius Minerals plc) (section 899 of the Companies Act 2006)
  • Amendments to enable ultimate investors to challenge a resolution to re-register a public company (section 98 of the Companies Act 2006)
  • Amendments to increase legal certainty in relation to intermediated securities transactions, which will benefit the entire market

Further potential reforms are outlined in the summary of the scoping paper, available on request.

Professor Sarah Green, Commercial and Common Law Commissioner, said:

“Millions of investors in the UK  hold their investments through the system of intermediated securities, which has made trading easier and more efficient.”

 “However, issues with intermediated securities mean that investors are losing out on some of the benefits of share ownership and there is a potential lack of certainty. The reforms we have suggested would help ensure intermediated securities work for everyone.”

Next steps

The Scoping Paper outlines particular problems with the system of Intermediated Securities and possible solutions. It is now for the Government to decide whether there should be further work, either by the Government or by the Law Commission, on these potential solutions.

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