274 On 11 March 2005, the Government adopted Royal Decree-Law 5/2005 Introducing Urgent Reforms to Increase Productivity. It entered into force 15 March 2005. The Royal Decree-Law amends Law 24/1988 on the Securities Market and Other Regulations in order to: (i) implement the Prospectus Directive (2003/71/EC); (ii) implement the Collateral Directive (2002/47/EC); and (iii) introduce some modifications to the energy sector and to the law on public procurement.

In addition, some Member States (including Cyprus, Estonia, Finland, Greece, Ireland, Italy, Lithuania, Malta, Portugal, Slovenia, and the United Kingdom) have implemented the Financial Collateral Directive in the form of a single act; others, such as Belgium, Czech Republic, Denmark, Germany, France, Hungary, the Netherlands, Slovakia, Spain, and Sweden, have implemented it by amending existing provisions of or integrating new provisions into existing national legislation. Three Member States (Austria, Latvia, and Poland) have combined both methods. Further, some Member States, including Cyprus, Ireland, Malta, and the United Kingdom, have implemented the Financial Collateral Directive verbatim.282

#### *3. Amendments*

In 2008, the Commission released a proposal for a new directive to amend the Financial Collateral Directive and the Settlement Finality Directive. The goal was to adapt these two directives to the latest market and regulatory developments by extending the scope of the Financial Collateral Directive to protect a new type of asset (credit claims eligible for the collateralisation of central bank credit operations) and to facilitate its use throughout the European Union. Moreover, several simplifications and clarifications were proposed to facilitate application of the Financial Collateral Directive.283 The Commission also noted that some Member States, including France, Germany, Spain, Austria, and the Netherlands, had recognised credit claims as collateral. This necessitated a harmonisation to create a level playing field among central banks and to stimulate cross-border use of collateral.284 As mentioned above, the Financial Collateral Directive was amended in 2009.285

282 European Financial Market Lawyers Group (*supra* n 252) 10.

283 Explanatory Memorandum to the Proposal for a Directive to Amend the Settlement Finality Directive and Financial Collateral Directive, 17 March 2008, 2.

284 Explanatory Memorandum (*supra* n 283) 2. Unlike cash or financial instruments, credit claims are not fungible from the view point of the Commission. Therefore, it was not appropriate for the right of use contained in Article 5 of the Financial Collateral Directive to govern credit claims. Indeed, at the end of the transaction, the collateral taker could not return equivalent collateral to the collateral provider.

285 *See* Directive 2009/44/EC of the European Parliament and of the Council of 6 May 2009 amending Directive 98/26/EC on settlement finality in payment and securities settlement systems and Directive 2002/47/EC on financial collateral arrangements as regards linked systems and credit claims (Text with EEA relevance) (OJ L 146, 10.6.2009, 37–43).

### *III. Scope of Application*

#### *1. Personal Scope*

# *a) History of the Provision in Article 1(2) of the Financial Collateral Directive*

During the process of elaborating the Financial Collateral Directive, the first question was whether it should only apply to collateral arrangements between financial institutions or instead be broader in scope.286 The originally proposed directive was narrow in its personal scope.287 Its Article 2(4) required that both the collateral taker and the collateral provider be:

The monetary thresholds were subject to many criticisms and later abolished, allowing all companies to benefit from the Directive, as long as their counterparty was a financial institution.288

In addition, the Commission contended that the scope of the Directive should not be extended to natural persons since they are normally absent from the wholesale markets.289 The Commission also thought including natural persons might increase consumer related issues outside the main focus of the Directive.290

#### *b) Description of the Personal Scope of Application of the Directive*

Unlike Articles 146 et seq of the OHADA Uniform Act on Security Interests, which is not limited in personal scope, the Financial Collateral Directive applies if collateral taker and collateral provider both belong to one of the following categories:

286 Geoffrey Yeowart et al (*supra* n 75) s 1.33.

287 Proposal for a Directive of the European Parliament and of the Council on financial collateral arrangements, COM/2001/0168 final, OJ C 180E, 26.6.2001, 312–318.

288 Diego Devos (*supra* n 212) 39 for further discussion on this matter.

289 Commission of the European Communities (*supra* n 248) 9.

290 Geoffrey Yeowart et al (*supra* n 75) s 1.37.

a. A public authority;291

The way the Directive's personal scope is implemented differs from one Member State to another. Indeed, some Member States opted for a broader

292 OJ L 126, 26 May 2000, 1. Directive as amended by Directive 2000/28/EC (OJ L 275, 27 October 2000, 37).

293 This includes: (i) a credit institution as defined in Article 1(1) of Directive 2000/12/EC, including the institutions listed in Article 2(3) of that Directive; (ii) an investment firm as defined in Article 1(2) of Council Directive 93/22/EEC of 10 May 1993 on investment services in the securities field (OJ L 141, 11 June 1993, 27); (iii) a financial institution as defined in Article 1(5) of Directive 2000/12/EC; (iv) an insurance undertaking as defined in Article 1(a) of Council Directive 92/49/EEC of 18 June 1992 on the Coordination of Laws, Regulations and Administrative Provisions Relating to Direct Insurance Other than Life Assurance (OJ L 228, 11 August 1992, 1) and a life assurance undertaking as defined in Article 1(a) of Council Directive 92/96/EEC of 10 November 1992 on the Coordination of Laws, Regulations and Administrative Provisions Relating to Direct Life Assurance (OJ L 360, 9 December 1992, 1); (v) an undertaking for collective investment in transferable securities (UCITS) as defined in Article 1(2) of Council Directive 85/611/EEC of 20 December 1985 on the Coordination of Laws, Regulations and Administrative Provisions Relating to Undertakings for Collective Investment in Transferable Securities (UCITS)(OJ L 375, 31 December 1985, 3); (vi) a management company as defined in Article 1a(2) of Directive 85/611/EEC.

294 This includes similar institutions regulated under national law acting in option and derivative markets to the extent not covered by Directive 98/26/EC, and a person, other than a natural person, who acts in a trust or representative capacity on behalf of any one or more persons that include any bondholders or holders of other forms of securitised debt or any institution as defined in Article 1(2) (a) to (d) of the Financial Collateral Directive.

295 Gulenay Rusen (*supra* n 235) 251.

291 Article 1(2)(a) of the Financial Collateral Directive excludes publicly guaranteed undertakings unless they fall under Article 1(2)(b) to (e) of the Financial Collateral Directive. Moreover, the term "public authority" in Article 1(2) of the Financial Collateral Directive includes (i) public sector bodies of Member States charged with or intervening in the management of public debt and (ii) public sector bodies of Member States authorised to hold accounts for customers.

scope than what it set out in the Financial Collateral Directive; for instance, Belgium included natural persons in all but title transfer transactions; under Estonian law, the collateral taker can be a private person; in Italy, the Directive's personal scope was extended to cover transactions involving nonprofit organisations, political parties, trade unions, and associations. Similarly, in Spain the other party can even be a private person if one of the parties is a financial or governmental institution as listed in Article 1(2)(a) to (d) of the Directive. In Luxembourg, the Directive's personal scope has been extended to cover transactions between two corporate entities.

The Financial Collateral Directive in Article 1(3) first sentence nevertheless provides an opt-out mechanism whereby a Member State may exclude from the scope of the Directive financial collateral arrangements one of the parties to which is other than a natural person, perhaps an unincorporated firm or partnership (Article 1(2)(e) of the Directive). A Member State that makes use of this option must inform the Commission, which must then inform the other Member States of the fact (Article 1(3) second sentence of the Financial Collateral Directive). This opt-out mechanism was a compromise: some Member States had expressed concerns that the principle of *paritas creditorum* (the equal treatment of creditors) would be eroded otherwise.

Some Member States have indeed opted out under Article 1(3) of the Financial Collateral Directive. The EFMLG report296 divides them into three groups:

(i) Full opt-out: Austria;

Other Member States have not opted out and have included persons other than natural persons as well as unincorporated firms provided that the other party is a financial institution. The Member States that have taken this ap-

296 European Financial Market Lawyers Group (*supra* n 252) 10, 11.

proach are Cyprus, Greece, Hungary, Ireland, Latvia, Lithuania, Malta, the Netherlands, Poland, Portugal, and Slovakia.

### *2. Material Scope*

The material scope of the Financial Collateral Directive originally included collateral provided in the form of both cash and financial instruments.297 In 2009, following the ECB's 2007 decision to make credit claims eligible to serve as collateral in Eurosystem credit operations, its scope was extended to include collateral in the form of credit claims.298 The Financial Collateral Directive now covers bilateral collateral arrangements consisting of title transfer financial collateral arrangements and security financial collateral arrangements (collectively, SCAs) between a collateral taker and a collateral provider. Article 2(1)(a) of the Financial Collateral Directive defines an SCA as "an arrangement under which a collateral provider provides financial collateral by way of security in favour of, or to, a collateral taker, and where the full ownership of the financial collateral remains with the collateral provider when the security right is established". As to title transfer financial collateral arrangements, Article 2(1)(b) of the Financial Collateral Directive defines them as arrangements "including repurchase agreements, under which a collateral provider transfers full ownership of financial collateral to a collateral taker for the purpose of securing or otherwise covering the performance of relevant financial obligations."

The definitions of these terms, title transfer financial collateral arrangements and SCAs, are essentially similar to those in the Geneva Securities Convention.299 Indeed, Article 31(3)(b) of the Geneva Securities Convention defines the term "security collateral agreement" as "an agreement between a collateral provider and a collateral taker providing (in whatever terms) for the grant of an interest other than full ownership in intermediated securities for the purpose of securing the performance of relevant obligations." Under Article 31(3)(c) of the Geneva Securities Convention, a "title transfer collateral agreement" is "an agreement, including one for the sale and repurchase of securities, between a collateral provider and a collateral taker providing (in whatever terms) for the transfer of full ownership of intermediated securities by the collateral provider to the collateral taker for the purpose of securing or otherwise covering the performance of relevant obligations."300 However, unlike Chapter V of the Geneva Securities Convention, whose scope is limited to intermediated securities used as collateral unless explicitly specified

297 Thomas Keijser, Guy Morton & Marcel Peeters (*supra* n 118) s 2.11.

298 *See* recital (5) of Directive 2009/44/EC (OJ 2009 L146/37).

299 Changmin Chun (*supra* n 143) 140.

300 For more details on the definition of these terms under the Geneva Securities Convention, *see* Hideki Kanda et al (*supra* n 87) ss 31-20 et seq.

otherwise, as in Article 34 and 36 of the Geneva Securities Convention,301 the Financial Collateral Directive also applies to cash, credit claims,302 and financial instruments303 used as collateral (Article 1(4)(a) of the Financial Collateral Directive).

In respect of cash, it is widely used as collateral in financial markets:

"Cash collateral arrangements may involve either a deposit with a right of set-off against the secured obligations or some form of pledge. The latter case often arises in practice from the use of cash in substitutions for securities – for example where securities are held in a pledged account with a third party such as a central securities depository and the pledgor is permitted to substitute cash for securities. In these cases, the pledge of cash parallels the pledge of securities collateral – indeed the pledged cash may even be credited to the same account. The pledgor should therefore retain ownership of the pledged cash. Otherwise, were the pledgee to go bankrupt, the pledgor cash would belong to the bankruptcy estate even though it was held by a third party. […] It appears that pledges of cash may be analysed in a number of ways. The pledge may be regarded as attaching to the account in which the cash is deposited, to the debt claim or right arising from the deposit or to the deposited cash itself. In some jurisdictions it is also possible to create an irregular pledge, under which title to the deposited cash passes to the pledgee and which therefore in some respect resembles a deposit and set-off arrangement."304

In light of the above, cash was included into the material scope of the Financial Collateral Directive. It is defined in Article 2(1)(d) of the Financial Col-

303 Financial instruments are shares in companies and other securities equivalent to shares in companies, bonds and other forms of debt instruments if these are negotiable on the capital market, and any other securities which are normally dealt in and which give the right to acquire any such shares, bonds, or other securities by subscription, purchase, or exchange or which give rise to a cash settlement (excluding instruments of payment), including units in collective investment undertakings, money market instruments, and claims relating to or rights in or in respect of any of the foregoing (Article 2(1)(e) of the Financial Collateral Directive). This definition encompasses nearly all debt and equity instruments in the capital market, including security entitlements. *See* Changmin Chun (*supra* n 143) 141. On bank notes which may be "financial instruments", *see* Geoffrey Yeowart et al (*supra* n 75) s 3.19 and fn 22.

301 Article 35(1) of the Geneva Securities Convention; Hideki Kanda et al (*supra* n 87) s 31-15.

302 Credit claims are pecuniary claims deriving from an agreement through which a credit institution as per the Banking Directive grants credits in the form of a loan. During the process of elaborating the Financial Collateral Directive, the ECB proposed including all types of assets that were eligible for Eurosystem credit operations, such as credit claims in the form of bank loans. The ECB was of the view that it would promote efficient crossborder use of all assets eligible for European credit operations (*see* European Central Bank, *Opinion of 13 June 2001 on the Proposed Directive on Financial Collateral Arrangements, at the Request of the Council of the European Union Concerning a Proposal for a Directive of the European Parliament and of the Council on Financial Collateral Arrangements* (CON/2001/13)).

304 Commission of the European Communities (*supra* n 248) 14.

lateral Directive as "money credited to an account in any currency, or similar claims for the repayment of money, such as money market deposits". Initially, the proposed Directive did not encompass a definition of the word "cash"; it was added only later, to apply to money credited to an account and to claims for the repayment of money, including money market deposits. However, this definition does not cover banknotes, *i.e.*, physical notes and coins, as it was thought unnecessary to include these in the material scope of the Financial Collateral Directive.305 Moreover, note that the ECB has indicated its view that virtual currencies can be regarded neither as full money from an economic perspective nor as money or currency from a legal perspective.306

Furthermore, the significance of collateral in the market for repo and reverse repo transactions was acknowledged. A 2001 report prepared by the Committee on the Global Financial System Working Group on Collateral contains a useful description of this market:

"A repo is the sale and subsequent repurchase of securities at a specified date and price. As repos have a 'cash leg' and a 'securities leg', collateral is an inherent part of such transactions. Repos are employed to finance and hedge dealer positions and to create short-term assets with low credit risk, underlining the either 'cash-driven' or 'security driven' character of the transactions."307

The Commission also noted that repos mainly relate to bonds, especially governments bonds, and to some extent to equities; it therefore seemed clear that these kinds of assets could be covered.308 Further, during the elaboration process of the Financial Collateral Directive, the Commission contemplated extending the material scope of the Directive to other financial assets such as receivables, simple debt claims, and letters of credit but concluded that it would be preferable to deal with receivables etc. entirely separately since receivable financing was a separate financing technique with its own specific issues.309

Article 1(4)(b) of the Financial Collateral Directive contains an opt-out clause that enables a Member State to "exclude from the scope of the Directive financial collateral consisting of the collateral provider's own shares, shares in affiliated undertakings within the meaning of the Directive on con-

305 *See* recital 18 of the Financial Collateral Directive and Statement of the Council's reasons attached to the Common Position (EC) n° 32/2002 adopted by the Council on 5 March 2002, 22.

306 European Central Bank, *Virtual Currency Schemes – A Further Analysis* (February 2015) 25 and 32–33. *See* also Financial Action Task Force, *Report on Virtual Currencies: Key Definitions and Potential AML/CFT Risks* (June 2014).

307 Bank for International Settlements, *Collateral in Wholesale Financial Markets* (Basel 2001) 6.

308 Commission of the European Communities (*supra* n 248) 10.

309 *See* Geoffrey Yeowart et al (*supra* n 75) s 1.43.

solidated accounts,[310] and shares in undertakings whose exclusive purpose is to own means of production that are essential for the collateral provider's business or to own real property."311 The Member States which opted out under Article 1(4)(b) of the Financial Collateral Directive can be classified as follows:

(i) Full opt-out: Denmark;

In 2009, Article 1(4) of the Financial Collateral Directive was amended314 to include a paragraph c that enables a Member State to exclude from the scope of application of the Directive credit claims where the debtor is a consumer as defined in Article 3(a) of Directive on credit agreements for consumers315 or a micro or small enterprise as defined in Article 1 and Article 2(2) and (3) of the Annex to Commission Recommendation 2003/361/EC of 6 May 2003 concerning the definition of micro, small, and medium-sized enterprises.316 Nevertheless, the opt-out does not apply where the collateral taker or the collateral provider of such credit claims is one of the institutions317 referred to under Article 1(2)(b) of the Financial Collateral Directive (last sentence of

310 Seventh Council Directive 83/349/EEC of 13 June 1983 on consolidated account (OJ L 193, 18.7.1983, 1). This directive as last amended by Directive 2001/65/EC of the European Parliament and of the Council (OJ L 283, 27.10.2001, 28).

311 *See* Article 38(2)(b) of the Geneva Securities Convention which provides that a Contracting State may make a declaration not to apply Chapter V of the Convention to intermediated securities which are not permitted to be traded on an exchange or regulated market. Article 38(2)(b) of the Geneva Securities Convention is to be read together with the definition of "collateral securities" in Article 31(3)(e) of the same Convention, which includes both tradable and non-tradable securities. *See* Hideki Kanda et al (*supra* n 87) s 38-10.

312 If the collateral giver is a business, the use of its own assets or the use of affiliates' shares is excluded from the range of usable collateral.

313 Note that France included claims and several types of rights provided that they are assignable.

314 Article 2(4)(d) of the Directive 2009/44/EC of the European Parliament and of the Council of 6 May 2009 amending Directive 98/26/EC on settlement finality in payment and securities settlement systems and Directive 2002/47/EC on financial collateral arrangements as regards linked systems and credit claims (OJ L 146, 10.6.2009, 37–43).

315 Directive 2008/48/EC of the European Parliament and of the Council of 23 April 2008 on Credit Agreements for Consumers (OJ L 133, 22.5.2008, 66).

316 OJ L 124, 20.5.2003, 36.

317 Such institutions are, for instance, central banks, the ECB, the BIS, etc.

Article 1(4)(c) of the Financial Collateral Directive).318 In view of the importance of cash collateral, the Commission concluded that it was desirable that the Directive should recognise pledges of cash as valid. Provided that valid pledges of cash were possible, the Commission concluded that it did not seem necessary to mandate a specific form of pledge or to require Member States to adopt a common analysis.319

During the elaboration process of the Financial Collateral Directive, the European Parliament thought furthermore that it was important to specify that for financial collateral to fall within the scope of the Directive, there had to be dispossession of the collateral. Hence, a definition of the word "provision" was suggested such that "provided" would mean that the financial collateral has to be delivered, transferred, registered, held, or otherwise designated so as to be in the possession of or under the control of the collateral taker or of a person acting on its behalf. With minor modification, the suggested wording was adopted as Article 2(2) of the Financial Collateral Directive.320 The Commission accepted the requirement of dispossession, underscoring that the compromise reached between the Commission and the European Parliament on the proposed Financial Collateral Directive was aimed at:

"[…] providing a balance between market efficiency, which is the reason behind the exclusion of formal acts, and the safety of the parties to the arrangement and third parties, thereby avoiding, *inter alia*, the risk of fraud. This balance is achieved by the fact that the scope of the Directive only covers those financial collateral arrangements which provide for some dispossession, as set out in Articles 1(5) and 2(2), and where the provision of the financial collateral can be evidenced in writing or in a durable medium, as set out in Articles 1(5) and 2(3), ensuring thereby the traceability of the collateral."321

Against this background, pursuant to Articles 1(5) and 3(2) of the Financial Collateral Directive,322 the Directive only applies to financial collateral once

318 Of all the European Member States, only Denmark has exercised the opt-out provision in Article 1(4)(b) of the Financial Collateral Directive. *See* Klaus M. Löber & Ewa Klima (*supra* n 243) 208–209.

319 Geoffrey Yeowart et al (*supra* n 75) s 1.63.

320 European Parliament, Report of 23 November 2001 on the proposal for a European Parliament and Council directive on financial collateral arrangements (COM (2001) 168, 7).

321 Commission Position (EC) n° 52/2002, Statement of the Commission's Reasons, 23. The Financial Collateral Directive is intended to provide a balance between market efficiency and the safety of the parties to the arrangement and third parties. To achieve this balance, the scope of the Financial Collateral Directive includes only those financial collateral arrangements which are "provided", meaning which provide for some form of dispossession and which can be evidenced in writing or in a durable medium. *See* Recitals 10 and 11 of the Financial Collateral Directive. *See* also Geoffrey Yeowart et al (*supra* n 75) s 4.03.

322 These articles must be read together with Article 2(2) of the Financial Collateral Directive.

it has been provided and if that provision can be evidenced in writing or in a legally equivalent manner. Under the Financial Collateral Directive, the term "writing" includes recording by electronic means and any other durable medium (Article 2(3) of the Financial Collateral Directive).323 As per the second sentence of Article 1(5) of the Financial Collateral Directive, "[t]he evidencing of the provision of financial collateral must allow for the identification of the financial collateral to which it applies. For this purpose, it is sufficient to prove that the book entry securities collateral[324] has been credited to, or forms a credit in, the relevant account and that the cash collateral has been credited to, or forms a credit in, a designated account".

As mentioned above, Article 2(2) of the Financial Collateral Directive determines the meaning of the financial collateral being "provided" or the "provision" of financial collateral. Indeed, these terms refer to the financial collateral being delivered, transferred, held, registered, or otherwise designated so as to be in the possession or under the control of the collateral taker or of a person acting on the collateral taker's behalf. Any right of substitution or to withdraw excess financial collateral in favour of the collateral provider does not prejudice the financial collateral having been provided to the collateral taker as mentioned in the Financial Collateral Directive.

#### *IV. Formal Requirements and Enforcement*

Differences between the Member States in respect of the formal requirements for collateral arrangements have hampered the harmonisation of the European international financial market.325 To limit the administrative burdens for parties, the Financial Collateral Directive is aimed at minimising the different formal requirements.326 Recital 9 of the Financial Collateral Directive notes that to limit the administrative burdens for parties using financial collateral under the scope of the Financial Collateral Directive, "the only perfection requirement which national law may impose in respect of financial collateral should be that the financial collateral is delivered, transferred, held, registered or otherwise designated so as to be in the possession or under the control of the collateral taker or of a person acting on the collateral taker's behalf while

323 It should be noted that such a writing requirement is not contemplated in the Geneva Securities Convention.

324 Under Article 2(1)(g) of the Financial Collateral Directive, "book entry securities collateral" means financial collateral provided under a financial collateral arrangement which consists of financial instruments title to which is evidenced by entries in a register or account maintained by or on behalf of an intermediary.

325 Gulenay Rusen (*supra* n 235) 252.

326 Hallgrímur Asgeirsson, 'Financial Collateral Arrangements' (2003) Monetary Bulletin 88, 89.

not excluding collateral techniques where the collateral provider is allowed to substitute collateral or to withdraw excess collateral."

Moreover, the Financial Collateral Directive recites:

"For the same reasons, the creation, validity, perfection, enforceability or admissibility in evidence of a financial collateral arrangement, or the provision of financial collateral under a financial collateral arrangement, should not be made dependent on the performance of any formal act such as the execution of any document in a specific form or in a particular manner, the making of any filing with an official or public body or registration in a public register, advertisement in a newspaper or journal, in an official register or publication or in any other matter, notification to a public officer or the provision of evidence in a particular form as to the date of execution of a document or instrument, the amount of the relevant financial obligations or any other matter."

Under Article 3(1) of the Financial Collateral Directive, Member States are not allowed to "[…] require that the creation, validity, perfection, enforceability, or admissibility in evidence of a financial collateral arrangement of the provision of financial collateral under a financial collateral arrangement be dependent on the performance of any formal act".327 The Financial Collateral Directive provides some examples of "formal acts": under Article 3, a formal act is the "registration in a public register" (Recital 10 of the Financial Collateral Directive).328

The Commission reached the conclusion that the Financial Collateral Directive should allow the collateral taker to liquidate the collateral speedily and with minimum formalities. Not allowing a rapid liquidation of the collateral could significantly impair the value of the collateral to the collateral taker, who in turn might not be able to fulfil its obligations vis-à-vis other counterparties. Hence, the collateral taker should be able to realise the collateral without any special requirement such as sale at public auction or in any prescribed manner or a notice of intention to sell approved or issued by a public authority.329 Allowing for rapid realisation of collateral helps reduce systemic risk by limiting the overall market disruption caused by an insolvency, so the Financial Collateral Directive ensures financial collateral arrangements can be enforced without cumbersome realisation procedures such as

327 As indicated above, the Financial Collateral Directive applies to financial collateral only if it has been provided, if that provision can be evidenced in writing, and where the financial collateral arrangement can be evidenced in writing or in a legally equivalent manner (Article 3(2) of the Financial Collateral Directive).

328 *See* Under English law Regulations 4(4) and 5 of the FCARs which, in respect of a security financial collateral arrangement or any change created otherwise that derives from a security collateral arrangement, disapply the rules of the Companies Act of 2006 addressing the registration of the Company Registry of mortgages or charges created by UK companies.

329 Commission of the European Communities (*supra* n 248) 16.

court approval, public auction, prior notice, or the elapse of an additional time period (Article 4 of the Financial Collateral Directive).330

Further, Article 4(2) of the Financial Collateral Directive allows the enforcement of the collateral by way of appropriation. It should be noted that the original version of the Directive did not contain a provision allowing securities to be realised by appropriation.331 Nevertheless, the ECB recommended that the Commission consider allowing a collateral taker to appropriate the collateral in case of an enforcement event provided that the creditor is not unduly enriched.332 Furthermore, the Committee on Economic and Monetary Affairs of the European Parliament (hereinafter referred to as the Committee) formulated amendments to the Directive to allow appropriation where the parties have agreed, in the collateral agreement, on terms and a valuation method. The Committee highlighted that realising the collateral by sale during a period of instability in the financial markets might not be in the best interest of the collateral taker.333

Against this background, Article 4(1)(a) of the Financial Collateral Directive allows the collateral taker to realise the collateral by means of appropriation. Article 4(2) specifies that appropriation is possible only if "(a) this has been agreed by the parties in the security financial collateral arrangement; and (b) the parties have agreed in the security financial collateral arrangement on the valuation of the financial instruments." It was feared that introducing appropriation as a means of enforcement only with respect to financial collateral arrangements could lead to legal uncertainty in some Member States where this legal technique was unknown. Therefore, an option was included in the Financial Collateral Directive to allow Member States not to recognise this technique if they did not allow appropriation when the Directive entered into force.334 Indeed, Article 4(3) provided that "Member States which do not allow appropriation on 27 June 2002 are not obliged to recognise it. If they make use of this option, Member States shall inform the Commission which in turn shall inform the other Member States thereof." The EFMLG report indicated not only that all Member States recognised appropriation when implementing the Collateral Directive but also that no implementation problems were identified.335 Hence, the 2009 amendment of the Financial Collateral Directive removed this option (Article 2(7)(c) of Directive 2009/44/EC). Additionally, Article 4(5) provides that Member States must ensure that a financial collateral arrangement can take effect in accordance with its terms

330 *See* also Article 33 of the Geneva Securities Convention.

331 Geoffrey Yeowart et al (*supra* n 75) s 1.70.

332 European Central Bank (*supra* n 302) s 13.

333 European Parliament (*supra* n 320) 12.

334 Geoffrey Yeowart et al (*supra* n 75) s 1.71.

335 European Financial Market Lawyers Group (*supra* n 252) 14.

notwithstanding the commencement or continuation of winding-up proceedings or reorganisation measures in respect of the collateral provider or collateral taker.

# *V. Right of Use*

# *1. The Right of Use throughout the Elaboration Process of the Financial Collateral Directive*

During the process of elaborating the Financial Collateral Directive, the use of pledged collateral by the collateral taker in accordance with the terms of the collateral agreement triggered a robust discussion within the Forum Group.336 The EFMLG indicated that such use could be difficult under the legal systems of most Member States; it would constitute a radical departure from the basic principles of the laws governing the pledging of assets.

"The issue is that the re-use is not consistent with the basic concept of pledge in most Member States (where the debtor providing the assets as collateral nonetheless remains the owner of the collateral, subject to the pledge in favour of the creditor). Thus, the creditor cannot freely use the pledged securities in question. This is not the case where the transfer of title is utilised (and explains why there is pressure to use the transfer of title). The inability to transfer or pledge the relevant securities severely limits the range and type of transactions on offer to participants in market."337

However, the Commission was of the view that allowing a collateral taker to use the financial collateral would increase liquidity in the market and enable investors to buy or sell securities easily and at a fair price.338 It was proposed that the right of use be subject to an obligation to deliver equivalent securities once the loan is repaid.339 Moreover, the Commission perceived two additional advantages in use of collateral: First, both collateral taker and collateral provider could benefit from the right of use the collateral; indeed, the collateral taker stands to gain financially from it and consequently could offer better financing terms to the collateral provider. Secondly, a right of use

336 Commission of the European Communities (*supra* n 248) Annex B, 6. For more details on the right of use of financial collateral under the Financial Collateral Directive, *see* also Geoffrey Yeowart et al (*supra* n 75) ss 11.01 et seq.

337 Commission of the European Communities (*supra* n 248) Annex F, 11.

338 As mentioned above, it was concluded during the process of elaborating the Financial Collateral Directive that allowing a right of use of the collateral in the Directive was regarded as of critical importance where the collateral taker provided a general securities financing facility and participated actively in the securities and derivatives markets (Commission of the European Communities (*supra* n 248) Annex B, 6).

339 Commission of the European Communities (*supra* n 248) Annex F, 10. Later, the same reason would be mentioned for the inclusion of the provision of the right of use of collateral in the Geneva Securities Convention (Article 34). *See* Hideki Kanda et al (*supra* n 87) ss 34-1 et seq.

would lead to a clearer choice between title transfer and security structures. Moreover, a security interest combined with a right of use would allow the collateral provider to determine the extent to which it is willing to incur a credit exposure to the collateral taker. Against this background, the Commission concluded that it would be preferable to include a right of use of the collateral in the Financial Collateral Directive but require parties to define it contractually; this would ensure that only securities with a value not exceeding that of the secured liabilities could be used.340

# *2. Description of the Right of Use under Article 5 of the Financial Collateral Directive*

Under Article 5 of the Financial Collateral Directive, "[t]he collateral taker is entitled to exercise a right of use in relation to financial collateral provided under the security financial collateral arrangement."341 In case a collateral taker exercises a right of use, it has thereby the "obligation to transfer equivalent collateral to replace the original financial collateral at the latest on the due date for the performance of the relevant financial obligations covered by the security financial collateral arrangement" (Article 5(2) of the Financial Collateral Directive). Alternatively, on the due date for the performance of the relevant financial obligations, the collateral taker has two options: It can either transfer equivalent collateral or set off the value of the equivalent collateral against or apply it in discharge of the relevant financial obligations, if and to the extent that the terms of a security financial collateral arrangement so provide (Article 5(2) of the Financial Collateral Directive).342

It is important to recall that under Article 34(2) of the Geneva Securities Convention, a collateral taker who has exercised a right of use incurs an obligation to replace the original collateral securities by delivering to the collateral provider equivalent collateral *no later than the discharge of the relevant obligations*. In contrast, the Financial Collateral Directive provides that a collateral taker who exercises a right of use incurs the obligation to deliver equivalent collateral to replace the original financial collateral *at the latest on the due date* for the performance of the relevant financial obligations (Article 5(2) of the Financial Collateral Directive). Compared to the phrase "at the latest on due date", the formulation "the discharge of the relevant obligations" gives more time to the collateral taker, since the actual discharge of the

340 Commission of the European Communities (*supra* n 248) 12.

341 *See* Article 34 of the Geneva Securities Convention; Hideki Kanda et al (*supra* n 87) s 34-1.

342 If an enforcement event occurs while an obligation described in Article 5(2)(1) of the Financial Collateral Directive remains outstanding, the obligation may be the subject of a close-out netting provision (Article 5(5) of the Financial Collateral Directive).

relevant obligations may not occur on the due date and instead be postponed such that it does not take place when the relevant obligations mature.343

Further, Article 5(3) of the Directive provides that the security financial collateral agreement to which the original financial collateral was subject also applies to equivalent collateral transferred in discharge of an obligation as described in Article 5(1) and (2). In addition, the equivalent collateral is to be treated as having been provided under the security financial collateral arrangement at the same time as the original financial collateral was first provided. However, the use of financial collateral by the collateral taker according to Article 5 does not render invalid or unenforceable the collateral taker's rights under the security financial collateral arrangement in relation to financial collateral it transfers in discharge of an obligation as described in Article 5(2).344

As part of the evaluation process, the Commission revisited the right of use in 2006.345 It reached the conclusion that no change was necessary at that stage; when it was introduced, the right of use was a novelty for many Member States, and according to the EFMLG report, all Member States except Germany introduced specific provisions in their national legislation allowing a right of use in accordance with the Financial Collateral Directive.346 Nevertheless, all Member States had accepted in their legal systems that a collateral taker had a right of use to the extent provided by the collateral arrangement.347 Some Member States, including Austria, Cyprus, Greece, Ireland, Latvia, Malta, and the United Kingdom, have enacted Article 5 verbatim.

#### *VI. Recognition of Title Transfer Financial Collateral Arrangements*

The Financial Collateral Directive removes the risk of re-characterisation by ensuring that title transfer financial collateral arrangements are valid and

343 During the final session of the Diplomatic Conference to adopt the Geneva Securities Convention, the EU Commission submitted that the use of the wording "no later than the discharge of the relevant obligation" introduced an element of uncertainty and suggested replacing it with the words "not later than the due date". But this assertion was not accepted. *See* the comments submitted by the EU Commission on this subject in UNIDROIT 2009 Conf. 11/2 – Doc. 18 (24 August 2009) s 19.

344 *See* Article 2(8) of Directive 2009/44/EC of 6 May 2009.

345 Commission of the European Communities, *Report from the Commission to the Council and the European Parliament: Evaluation Report on the Financial Collateral Arrangements Directive (2002/47/EC)*, Brussels, 20 December 2006, COM(2006) 833 final, 9. *See* Article 10 of the Financial Collateral Directive that provides: "Not later than 27 December 2006, the Commission shall present a report to the European Parliament and the Council on the application of this Directive, in particular on the application of Article 1(3), Article 4(3) and Article 5, accompanied where appropriate by proposals for its revision."

346 European Financial Market Lawyers Group (*supra* n 252) 15.

347 Commission of the European Communities (*supra* n 345) 10.

effective.348 Article 6(1) of the Financial Collateral Directive provides that Member States are to ensure that a title transfer financial collateral arrangement can take effect in accordance with its terms. The Directive also provides that the obligation may be subject to close-out netting if enforced while any obligation of the collateral taker to transfer equivalent collateral under a title transfer financial collateral arrangement remains outstanding (Article 6(2) of the Financial Collateral Directive).

#### *VII. Recognition of Close-Out Netting Provisions*

During the process of elaborating the Financial Collateral Directive, the Commission acknowledged the importance of netting for managing and limiting risk exposure. Hence, it concluded that where netting forms part of a collateral agreement, it should be protected. Indeed, the Commission explained that "close-out" netting is the form of netting particularly linked to collateral arrangements.349 Under close-out netting, there is an acceleration, termination, or replacement of the obligations of both parties with by one party's obligation to pay the other a single net amount that represents the difference between the estimated current values of both their obligations. Although the Commission feared that "close-out" netting provisions might conflict with the insolvency law of some jurisdictions that do not allow or restrict insolvency set-off, it concluded that the Directive should affirm their validity given their importance for title transfer and repo arrangements. 350

Article 7(1)(a) of the Directive recognises close-out netting provisions in spite of the commencement or continuation of winding-up proceedings or reorganisation measures with respect to the collateral provider and/or the collateral taker. Similarly, Article 7(1)(b) ensures that a close-out netting provision can take effect according to its terms despite any purported assign-

348 Article 6 of the Financial Collateral Directive. *See* also Article 32 of the Geneva Securities Convention; Hideki Kanda et al (*supra* n 87) s 32-1.

349 Under Article 2(1)(n) of the Financial Collateral Directive, a close-out netting provision is "a provision of a financial collateral arrangement, or of an arrangement of which a financial collateral arrangement forms part, or, in the absence of any such provision, any statutory rule by which, on the occurrence of an enforcement event, whether through the operation of netting or set-off or otherwise: (i) the obligations of the parties are accelerated so as to be immediately due and expressed as an obligation to pay an amount representing their estimated current value, or are terminated and replaced by an obligation to pay such an amount; and/or (ii) an account is taken of what is due from each party to the other in respect of such obligations, and a net sum equal to the balance of the account is payable by the party from whom the larger amount is due to the other party." This definition of closeout netting provisions excludes "walkaway" clauses under which a defaulting party forfeits any amount due or credit arising in its favour as a result of close-out. *See* Geoffrey Yeowart et al (*supra* n 75) s 1.60, fn 59.

350 Commission of the European Communities (*supra* n 248) 13.

ment, judicial, other attachment, or other disposition of or in respect of such rights.351 Moreover, unless otherwise provided by the parties, a close-out netting provision may not be subject to cumbersome procedures or requirements such as prior notice, court approval, public auction, or the elapse of an additional time period (Articles 7(2) and 4(4) of the Financial Collateral Directive).

With respect to the implementation of Article 7 of the Directive in the Member States, the EFMLG report highlighted that close-out netting is recognised within all Member States except Estonia as a contractual or statutory arrangement which accelerates the parties' mutual obligations upon the occurrence of an enforcement event.352

# *VIII.Certain Insolvency Provisions Disapplied*

One of the greatest advantages that the Financial Collateral Directive offers to collateral takers is the possibility of swiftly enforcing financial collateral arrangements without interference from the insolvency laws of the Member States. The Financial Collateral Directive recites:

"In order to improve the legal certainty of financial collateral arrangements, Member States should ensure that certain provisions of insolvency law do not apply to such arrangements, in particular, those that would inhibit the effective realisation of financial collateral or cast doubt on the validity of current techniques such as bilateral close-out netting, the provision of additional collateral in the form of top-up collateral and substitution of collateral."

# Furthermore, Article 8(1) of the Financial Collateral Directive provides:

"1. Member States shall ensure that a financial collateral arrangement, as well as the provision of financial collateral under such arrangement, may not be declared invalid or void or be reversed on the sole basis that the financial collateral arrangement has come into existence, or the financial collateral has been provided:

A financial collateral arrangement or a relevant financial obligation is legally enforceable and binding on third parties if it has come into existence, or financial collateral has been provided on the day of, but after the moment of the commencement of, winding-up proceedings or reorganisation measures. In such a case, the collateral taker will have to prove that it was not aware,

351 Article 33(3) of the Geneva Securities Convention.

352 European Financial Market Lawyers Group (*supra* n 252) 15.

nor should have been aware, of the commencement of such proceedings or measures (Article 8(2) of the Financial Collateral Directive).

#### *IX. Top-Up and Substitutions*

The Commission recognised the importance of top-up collateral for the limitation of counterparty risk. Top-up collateral allowed market participants to limit their mutual credit exposure to reflect changes in the market values of collateral. It also allowed regulated participants to obtain favourable regulatory capital treatment.353 It was typically done by "market-to-market" calculations.354 Although the Commission concluded that such arrangements were sound market practices favoured by regulators, it was decided that the Directive should not protect instances of top-up collateral based on the deterioration of the collateral provider's credit rating.355

With respect to substitution, the Commission noted that a collateral provider that provides a portfolio of securities often wishes to withdraw specific securities and replace them with other securities of equivalent value and so to continue to trade in the securities that were provided as collateral. But the Commission was of the view that this kind of substitution might result legally in the creation of a new pledge in some jurisdictions and thus in a repetition of all necessary formalities or the beginning of a new "suspect period"356. It might also lead to the pledge being accorded lower priority in an insolvency of the collateral provider unless the collateral taker had retained a right to prevent it. Nevertheless, the Commission concluded:

"In the event of the insolvency of the collateral provider, should the substitution have occurred during the 'suspect period', there may be additional vulnerability under insolvency law even though economically no new collateral has been provided. A clear statutory regime confirming the validity of substitution of collateral should be provided in the Directive. Consequently, the Directive should confirm that substitutive collateral is to be treated as provided at the time when the original collateral was provided."357

Against this background, Article 8(3) of the Financial Collateral Directive provides:

353 Commission of the European Communities (*supra* n 248) Annex A, 12, fn 15.

354 Geoffrey Yeowart et al (*supra* n 75) ss 1.23, 1.66.

355 *See* in comparison Article 36(1) of the Geneva Securities Convention, which protects top-up collateral based on the deterioration of the collateral provider's credit rating.

356 "Suspect period" means the period which runs from the date on which the debtor ceases payments. Suspect periods are in place for instance in Italy and Spain (*see* Article 9(2) n° 4 Legge Fallimentare and Article 10 n° 1 Ley Concursal). *See* also Horst Eidenmüller, 'Abuse of Law in the Context of European Insolvency Law' (2009) ECFR 15; Gerrit Hölzle, 'Wege in die Restschuldbefreiung und Schuldenerlass im Exil –Oder: Lohnt die Flucht nach Frankreich wirklich?' (2007) Zeitschrift für Verbraucher-und Privatinsolvenzrecht 1, 4.

357 Commission of the European Communities (*supra* n 248) 12.

#### 154 *Part II: Reports on National, Regional, and International Substantive Law Rules*

	- (a) an obligation to provide financial collateral or additional financial collateral in order to take account of changes in the value of the financial collateral or in the amount of the relevant financial obligations, or
	- (b) a right to withdraw financial collateral on providing, by way of substitution or exchange, financial collateral of substantially the same value,

Member States shall ensure that the provision of financial collateral, additional financial collateral or substitute or replacement financial collateral under such an obligation or right shall not be treated as invalid or reversed or declared void on the sole basis that:

Here it is worth recalling that the Geneva Securities Convention indicates three instances when a top-up collateral can be triggered in accordance with the collateral agreement:

"[…] (i) in order to take account of changes in the value of the collateral delivered under the collateral agreement or in the amount of the relevant obligations;

Only in one of these three cases do the parties possibly have recourse to topup collateral. But the Financial Collateral Directive by contrast simply provides for the situation that changes will occur in the value of the financial collateral or in the amount of the relevant financial obligations (Article 8(3)(a) of the Financial Collateral Directive). The situation contemplated in Article 8(3)(a) of the Financial Collateral Directive is similar only to the first case in Article 36(1)(i) of the Geneva Securities Convention.360

358 The Financial Collateral Directive leaves unaffected the general rules of national insolvency law in relation to the voidance of transactions entered into during the prescribed period referred to in Article 8(1)(b) and in Article 3(i) of the Financial Collateral Directive.

359 Article 36(1) of the Geneva Securities Convention.

360 Note that in case a Contracting State opts-out of the second case under the Geneva Securities Convention, the result will be somewhat similar to that of Article 8(3)(a) of the Financial Collateral Directive. Nevertheless, under Article 36(1)(iii) of the Geneva Securi-

#### *D. Summary and Evaluation*

ties Convention, the collateral agreement may still provide further cases to the extent the non-Convention law admits. *See* Changmin Chun (*supra* n 143) 143–144.

use (meaning for instance to sell, pledge on, or lend) collateral it has been given under a security financial collateral agreement. It can use the collateral as if it were the full owner, but if it exercises the right, it incurs an obligation to transfer back equivalent collateral which, once transferred back, will be treated as if it were original financial collateral. Such an obligation to return the used collateral can be subject to a close-out netting provision. In addition, since such use may affect the legal position of an investor holding securities, the parties to the collateral agreement must expressly agree to the right of use (Article 5 of the Financial Collateral Directive).

# Chapter 4: Collateralisation of Intermediated Securities under the Law in the United States

# *A. General Overview*

Chapter 4: The Law in the United States

*I. Introduction*

Except for debt securities related to the federal government,361 the intermediated system in the United States is mainly362 organised by Part 5 of Article 8

361 Federal government debt securities, including treasury bonds, bills, and notes are governed by Treasury Reserve Automated Debt Entry System Regulations (hereinafter referred to as TRADES Regulations), which took effect as of 1 January 1997. For more information on federal debt securities, *see* the website of Treasury Direct: <https://www.t reasurydirect.gov/tdhome.htm> (accessed 4 January 2021). For more details on TRADES Regulation, *see* Sandra M. Rocks, Penelope L. Christophorou & Gottlieb Cleary, 'Memorandum Regarding the 1994 Uniform Version of Article 8 of the Uniform Commercial Code and the Federal Book-Entry Regulations (with Addendum Regarding Investment Property Changes Under Article 9)' (2002) SG085 ALI-ABA 143, 166–170. *See* also Dorothee Einsele, *Wertpapierrecht als Schuldrecht: Funktionsverlust von Effektenurkunden im internationalen Rechtsverkehr* (Mohr Siebeck, Tübingen 2015) 378.

362 UCC Article 8 deals with some aspects of the rights of securities holders against issuers. Yet that relationship is primarily governed by the law of corporations, securities, and contract. Likewise, although UCC Article 8 addresses some aspects of the rights and duties

and by further provisions of Article 9 of the Uniform Commercial Code363 (UCC). On one hand, UCC Article 8 addresses issues of investment securities: its first part covers several definitions and concepts, including claim, control, choice of law, clearing corporation, and security intermediaries. Part 2 of UCC Article 8 determines issuance of securities and issuer; Part 3 specifies transfer of certificated and uncertificated securities; Part 4 of UCC Article 8 addresses the registration of transfer; Part 5 of UCC Article 8 provides innovative rules on the intermediated system in the United States. Article 9 of the UCC, on the other hand, deals with secured transactions and was significantly revised in 1998.364

*II. Historical Evolution*

The 1962 version of UCC Article 8 was widely adopted.365 It contained the concept of book-entry transfers of securities and had some limited provisions

365 Russel A. Hakes, 'UCC Article 8: Will the Indirect Holding of Securities Survive the Light of Day?' (2002) 35 Loyola of Los Angeles Law Review 661, 667; Martin J.

of those who transfer securities, it does not cover the law of contracts applying to the purchase or sale of securities. *See* Notes on Scope of Article 8 in the Prefatory Note to 1994 Official Text of UCC Article 8 (Cynthia Lee Starnes).

363 The Uniform Commercial Code is not a statutory law. In addition, it is not a "Code" in the civil-law sense, meaning that it is not a comprehensive enactment covering every situation cognisable by the law. Rather, it is a model law open for adoption by the states and an integrated statute relating to commercial transactions. As of January 2021, all 50 states, the District of Columbia, Puerto Rico, and the US Virgin Islands have adopted the UCC. The UCC is a joint project of the National Conference of Commissioners on Uniform State Laws (NCCUSL) and the American Law Institute (ALI). For a history of the UCC, *see* Soia Mentschikoff, 'The Uniform Commercial Code: An Experiment in Democracy in Drafting' (1950) 36 American Bar Association Journal 419; Walker D. Malcolm, 'The Uniform Commercial Code in the United States' (1963) 12 International & Comparative Law Quarterly 226; Robert Braucher, 'The Legislative History of the Uniform Commercial Code' (1958) 58 Columbia Law Review 798; Randall D. Guynn & James Steven Rogers, 'United States (New York)' in Richard Potok, *Cross-Border Collateral: Legal Risks and the Conflict of Laws* (Butterworths, London 2002) 603.

364 *See* Jean Wegman Burns, 'New Article 9 of the UCC: The Good, the Bad, and the Ugly' (2002) 1 University of Illinois Law Review 29; Harry C. Sigman & Eva-Maria Kieninger, 'Introduction' in Harry C. Sigman & Eva-Maria Kieninger (eds), *Cross-Border Security over Tangibles* (Sellier, München 2007) 36–53; Terry M. Anderson, Marianne B. Culhane & Catherine Lee Wilson, 'Attachment and Perfection of Security Interests Under Revised Article 9: A "Nuts and Bolts" Primer' (2001) 9 American Bankruptcy Institute Law Review 179; Steven L. Schwarcz, 'The Impact on Securitization of Revised UCC Article 9' (2000) 74 Chicago-Kent Law Review 947.

on intermediated securities.366 Its main assumption was that the key elements in the securities holding system were possession and delivery of physical certificates.367 Indeed, possession of certificates traditionally evidenced ownership of securities, and because the paper stock certificate was tangible evidence of the holder's rights, it seemed logical to apply traditional concepts of property law. Ownership changes were realised via delivery of certificates,368 a very slow and labour-intensive process. Because of surging volumes of securities transactions on the NYSE, by the late 1960s the stock market had to close one day a week simply to settle all the trades.369 It seem an obvious solution to eliminate paper certificates and simply have each issuer register its shareholders on its books. The intermediated system therefore gained importance and was being widely utilised by the late 1960s.370

## *b) The 1977 Version of UCC Article 8*

During the 1970s, considerable attention was aimed at establishing legal rules in respect of securities transfers that would allow securities ownership to be evidenced by electronic records maintained by issuers.371 Consequently, the revision effort that led to the 1977 amendments to UCC Article 8 sought to develop rules governing "uncertificated securities". At the time, it was assumed that the problems within the securities trading market resulted from too

Aronstein, 'The New/Old Law of Securities Transfer: Calling a "Spade" a "Heart, Diamond, Club or the Like"' (1990) 12 Cardozo Law Review 429, 430.

366 *See* for instance §§ 9-320 and 8-313(1). For more information on prior versions of §§ 9-313 and their drafting history, *see* Charles W. Mooney, Jr., 'Beyond Negotiability: A New Model for Transfer and Pledge of Interests in Securities Controlled by Intermediaries' (1990) 12 Cardozo Law Review 306, 415–427.

367 Everette L. Martin, 'An Arkansas Practitioner's Guide to Perfecting Security Interests in Securities, Brokerage Accounts, and Other Forms of Investment Property Under Revised Article 8 and Amended Article 9' (1996) 19 University of Arkansas at Little Rock Law Journal 1, 2.

368 Prefatory Note of UCC Article, Part I. A. This probably resulted from the influence of the materialisation theory which permeated the US in the late nineteenth century. For more information on the materialisation in the US, *see* Egon Guttman & Thomas P. Lemke, 'The Transfer of Securities in Organized Markets: A Comparative Study of Clearing Agencies in the United States of America, Britain and Canada' (1981) 19 Osgoode Hall Law Journal 400, 401–407; Grant Gilmore, 'The Commercial Doctrine of Good Faith Purchase' (1954) Yale Law Journal 1057.

369 Everette L. Martin (*supra* n 367) 3.

370 Russel A. Hakes (*supra* n 365) 668; Egon Guttman, 'Investment Securities Law: New Federal and State Developments and their Effect on Article 8' (1992) 24 Uniform Commercial Code Law Journal 307, reprinted in Commercial Law Annual 1993, 453.

371 *See* for instance Richard B. Smith, 'A Piece of Paper' (1970) 25 Business Lawyer 923; Richard B. Smith, 'A Piece of Paper Revisited' (1971) 26 Business Lawyer 1769.

much paperwork, which could be reduced using uncertificated security.372 Consequently, to tackle the problems arising from paper-centred securities transfer processing the 1977 version of UCC Article 8 introduced the concept of uncertificated securities.373 However, rather than constituting a wholesale revision reflecting true conditions in the marketplace,374 the 1977 amendments only gave UCC Article 8 a facelift and did not seek a comprehensive modernisation; and inasmuch as the 1977 revision of UCC Article 8 intended to develop rules for a practice that had not yet developed, it was entirely sensible to adopt an approach of fundamental conservatism. The amendments retained the structure and organisation of the existing law in respect of certificated securities in every way, merely adding new provisions concerning uncertificated securities. This led to a structure in which virtually all provisions of UCC Article 8 encompassed separate but parallel rules: one set for certificated securities and another for uncertificated securities.But as *Rogers* noted, there were difficulties in applying such rules to uncertificated securities:

"Old Article 8 was drafted in light of the transaction patterns of the paper-based system of securities transfers by physical delivery of certificates. The focus and organization of the statutory language itself, the content and emphasis of the accompanying official comments, and the available secondary literature discussing the statute all bespeak the paper-based origins of the statute. Thus, if one is seeking the statutory rules applicable to a securities transfer effected by physical delivery of a certificate, even a novice would have a relatively easy time finding one's way around the statute. By contrast, although old Article 8 does contain rules that apply to the indirect holding system, these matters were added onto a statutory structure devised for entirely different sorts of transactions. Not surprisingly then,

372 It was thought that changes in ownership would continue to be reflected by changes in the records of the issuer. The most significant difference would be that instead of surrendering an endorsed certificate for registration of transfer, an instruction would be sent to the issuer directing it to register the transfer (Everette L. Martin (*supra* n 367) 3, fn 12).

373 Prefatory Note at Part I. A. It is important to note that the amendments that were made to UCC Article 8 were approved in 1977. However, they were included in the 1978 official text of the UCC. For an overview of the 1977 amendments, *see* Martin J. Aronstein, Robert Haydock, Jr. & Donald A. Scott, 'Article 8 is Ready' (1980) 93 Harvard Law Review 889. *See* also Dorothee Einsele (*supra* n 361) 302–390; James Steven Rogers, 'Policy Perspectives on Revized U.C.C. Article 8' (1996) 43 UCLA Law Review 1431, 1441–1448; Jeanne Schroeder & David Gray Carlson, 'Security Interests Under Article 8 of the Uniform Commercial Code' (1990) 12 Cardozo Law Review 557.

374 It is worth recalling that while the *paper crunch* occurred in the late 1960s, UCC Article 8 was revised nearly a decade later. In the interim, the market had addressed this issue by developing an indirect holding system for securities whereby "delivery" is accomplished by an entry on the books. This means that a securities depository, such as DTC, would be used to hold the paper stock certificates on behalf of its members, who were primarily banks and large brokerage firms. In turn, the banks and brokerage firms would hold the securities on behalf of their customers. *See* Everette L. Martin (*supra* n 367) 3 for an illustration of the difference between the direct and the indirect holding system.

it is considerably more difficult even to find the provisions of old Article 8 that apply to the indirect holding system, let alone to be confident about their interpretation."375

In the 1977 version of UCC Article 8, a basic rule of the intermediated system (that a person acquires a property interest when there is a credit of securities to the person's account with an intermediary) was hidden four levels down in the complex paragraph structure of old § 8-313, in subparagraph (iii) of paragraph (d) of subsection (1). Even then, only a person with sufficient knowledge of the meaning of § 8-313(1)(d)(iii) could understand the provision.376

Conceptually, the amendments merely exchanged the term "delivery" for "transfer" while maintaining the same troubled rules for uncertificated securities as applied to certificated securities.377 The difference between the new rules introduced by the 1977 version of UCC Article 8 and the traditional system was that ownership of securities would not necessarily be evidenced by physical certificates. The 1977 version of UCC Article 8 did not take into account the characteristics of the intermediated system; it did not properly reflect practices in the securities markets whereby transfers of securities or settlements of securities trades were realised by computerised book-entries on securities accounts maintained with intermediaries rather than by registration of the transfer in records of the issuers or their transfer agents.378 Moreover, it led to an increase of the workload of documenting the transfer of uncertificated securities.379

Describing the class of concerns that the 1977 version of UCC Article 8 caused, *Reitz*380 notes that it was difficult to know exactly what was created by a credit to a securities account. Indeed, a credit entry in a securities account was definitely not covered by any conventional definition of "security". In addition, *Reitz* notes that it was unknown how the rights of account holders related to the issuers, the depositaries, or the intermediary firms located on other tiers of the intermediated system; it was unknown whether and if so just how an account holder could lose its rights to another who claimed ownership over what the account holder had. Furthermore, it was difficult to determine the legal consequences for an account holder whose intermediary had made a credit entry but did not maintain a comparable position with its upper-tier intermediary.

375 James Steven Rogers (*supra* n 373) 1448.

376 James Steven Rogers (*supra* n 373) 1448.

377 Jeanne L. Schroeder, 'Is Article 8 Finally Ready This Time? The Radical Reform of Secured Lending on Wall Street' (1994) 3 Columbia Business Law Review 291, 312–315. The responsibility of the 1977 Drafting Committee was solely to create a scheme for the transfer of uncertificated securities while leaving the rules on certificated securities intact (Uniform Commercial Code, 2C U.L.A. 39, Prefatory Note (Supp.1996)).

378 Changmin Chun (*supra* n 143) 200.

379 Jeanne L. Schroeder (*supra* n 377) 333–334, who evaluates the 1977 version of UCC Article 8 as a "disaster" (at 303).

380 Curtis R. Reitz, 'Reflections on the Drafting of the 1994 Revision of Article 8 of the US Uniform Commercial Code' (2005) 10 Uniform Law Review 357, 359–360.

Another cause of the novel and uncertain relationship between an intermediary and its account holder under the 1977 version of UCC Article 8 was that the problem of innocent acquisition of intermediated securities was not recognised.381 § 8-313(2) of the 1977 version provided that "[i]f a security so held is part of a fungible bulk, as in the circumstances specified in paragraphs (d)(ii) and d(iii) of subsection (1), the purchaser is the owner of a proportionate property interest in the fungible bulk." And yet official comment 4 to § 8- 313 indicated:

"Unless specific securities are separately identified as belonging to the purchaser, he cannot become a bona fide purchaser […]. If bona fide purchaser status were given to those whose securities are held as part of a fungible bulk, there would be a possibility of inconsistent claims between two or more bona fide purchasers, since if the bulk should prove to be smaller than was expected, the claim of one or both must be compromised."382

It was only after the October 1987 stock market crash or "market break"383 that a wholesale amendment of UCC Article 8 was undertaken. On 19 October 1987,384 stock markets around the world crashed, shedding a huge amount of value in a very short time. The Dow Jones Industrial Average385 fell 508 points, or 22.6%, on a record volume of 604 million shares per day.386 Afterwards, market participants and regulators realised the importance of a well-

381 *See* also Charles W. Mooney, Jr. (*supra* n 366) 330–342, 349–379.

382 It is important to note that the same comment made an exception to this principle of non-recognition of innocent acquisition. Innocent acquisition was acknowledged in case of intermediated securities held by a clearing corporation. Indeed, clearing corporations hold only for others' accounts. Hence, the possibility of innocent acquisition is very small. *See* Jeanne L. Schroeder (*supra* n 377) 334–349; James Steven Rogers (*supra* n 373) 1467– 1968. In spite of the official comment to the 1977 version of UCC Article 8, courts often acknowledged investors' innocent acquisition. For more details on the courts' interpretation of UCC Article 8, Section 8-313(2) of the 1977 version of UCC Article 8, *see* Jeanne L. Schroeder (*supra* n 377) 451–461.

383 Charles W. Mooney, Jr., 'The Roles of Individuals in UCC Reform: Is the Uniform Law Process a Potted Plant? The Case of Revised UCC Article 8' (2002) 27 Oklahoma City University law review 553, 562. For more details on the October 1987 stock market crash, *see* generally Andrew M. Klein, 'The October 1987 Market Crash' (1988) 619 PLI/Corp 79.

384 This date would be later known in finance as "black Monday" (*see* for instance Ryan McKeon & Jeffry M. Netter, 'What Caused the 1987 Stock Market Crash and Lessons for the 2008 Crash' (2009) 8 Review of Accounting and Finance 123).

385 The Dow Jones Industrial Average (or DJIA, the Industrial Average, the Dow Jones, the Dow Jones Industrial, DJI, the Dow 30, or simply the Dow) is an index that shows how 30 large publicly owned companies based in the United States have traded during a standard trading session in the stock market (Arthur O'Sullivan & Steven M. Sheffrin, *Economics: Principles in Action* (Pearson Prentice Hall, New Jersey 2003) 290).

386 Joel Seligman *(supra* n 135) 589–593.

organised clearing and settlement system.387 On 18 March 1988, President Ronald Reagan signed Executive Order 12631, which created the Working Group on Financial Markets (also called the President's Working Group on Financial Markets).388 The Working Group on Financial Markets was established to provide a coordinating framework for consideration, resolution, recommendation, and action on the issues raised by the market break in 1987. Indeed, Section 2 of Executive Order 12631 provided:

"(a) Recognizing the goals of enhancing the integrity, efficiency, orderliness, and competitiveness of our Nation's financial markets and maintaining investor confidence, the Working Group shall identify and consider:

In May 1988 the Working Group on Financial Markets issued an interim report on its progress, actions, and recommendations.389 It recommended that federal legislation be considered to deal with the transfer and pledge of "options" and "certificated and uncertificated stock". The report underscored a prevailing nonuniformity: a substantial number of states had not adopted the 1977 official text of UCC Article 8.390 The following month, David S. Ruder, the chairman of the Securities and Exchange Commission (SEC), sent a letter to the president and the leadership of Congress enclosing a draft of proposed legislation391 to allow the SEC, upon making certain findings of necessity, to promulgate

387 Note that *Mooney* considers that the amendments to UCC Article 8 were triggered by several failures of government securities dealers in the early 1980s which resulted in losses to investorssuch as secured lenders(Charles W. Mooney, Jr., (*supra* n 383) 559 and 562).

388 This Executive Order is available on the website of the US National Archives at <https://www.archives.gov/federal-register/codification/executive-order/12631.html> (accessed 4 January 2021).

389 Interim Report of The Working Group on Financial Markets, Submitted to The President of the United States (May 1988). The report is available at <https://ia800301.us.ar chive.org/3/items/interimreportofw00unit/interimreportofw00unit.pdf> (accessed 4 January 2021).

390 Interim Report of The Working Group on Financial Markets, Submitted to The President of the United States (May 1988) 15–16.

391 Letter from David S. Ruder to The Honorable George Bush (23 June 1988).

regulations governing "the transfer of certificated or uncertificated securities or limited interests (including security interests) therein". Nevertheless, government or agency securities such as the treasury securities covered by bookentry treasury regulations were not to be governed by that legislation.392 Two weeks later, congressman Edward J. Markey introduced the "Securities Market Reform Act of 1988" (the Markey Bill).393 The proposed legislation would have given the SEC the power to issue regulations on the private law of transfers and pledges of securities along lines it had proposed.

In October 1988, SEC chairman Ruder sent a letter to David E. Nelson, the chair of the ABA section on business law, in which he explained that SEC staff had been working with the Subcommittee on Investment Securities on the possibility of establishing an SEC advisory committee. However, the staff concluded that "the rigidities inherent in federal advisory committees would not be conducive to creative study of this critical area."394 Ruder therefore suggested that the ABA "consider sponsoring an expert ad hoc committee that can study the issues and develop intelligent and workable solutions."395 The ABA Advisory Committee thus established an informal task force or drafting group to prepare a report with recommendations accompanied by substantive discussion.396

It is worth noting that in 1989 at the international level, during these developments in the United States, the Group of Thirty397 released a report which "propose[d] standards for clearance and settlement that [could] be set and maintained by national corporate securities markets to reduce the risks and costs".398 The nine recommendations were:

392 Letter from David S. Ruder to The Honorable George Bush (23 June 1988), proposing to add a new subsection (f) to § 17A of the Securities Exchange Act of 1934.

393 H.R. 4997, 100th Cong. (1998).

394 Letter from David S. Ruder to David E. Nelson (October 25, 1988).

395 Letter from David S. Ruder to David E. Nelson (October 25, 1988).

396 This informal group consisted of Professor Charles W. Mooney, Jr., Professor Emeritus Martin Aronstein, Professor Egon Guttman, Jonathan Kallman, (SEC), Robert C. Mendelson, Ernest Patrikis (New York Fed), and Richard B. Smith. The group had no chair. However, most of the drafting was done by Kallman, Mendelson, and Professor Charles W. Mooney, Jr. The informal group was sometimes supplemented by other interested members of the ABA Advisory Committee or observers. *See* Charles W. Mooney, Jr. (*supra* n 383) 565.

397 Established in 1978, the Group of Thirty is a private, non-profit, international body composed of very senior representatives of the private and public sectors and academia. Its purpose is to deepen understanding of international economic and financial issues. It also aims to explore the international repercussions of decisions taken in the public and private sectors.

398 *See* Group of Thirty, *Clearance and Settlement Systems in the World's Securities Markets* (1989) 1. The report is available at <http://group30.org/images/uploads/publica tions/G30\_ClearanceSettlement1988.pdf> (accessed 4 January 2021).

Of the nine recommendations contained in that report, Recommendations 5 and 8 are most relevant to the 1994 version of UCC Article 8. The policy

399 In a rolling system, trades settle on all business days of the week, thereby limiting the number of outstanding trades and reducing market exposure (Group of Thirty (*supra* n 398) 14).

400 Group of Thirty (*supra* n 398) 3, 5, 7, 9, 11, 13, 14, 16, and 18.

behind these recommendations of the Group of Thirty was *finality*, and it is what motivated the drafters of revised UCC Article 8. The project of revising UCC Article 8 was one of several efforts around the world to assure that the clearance and settlement system for securities trading is up to the task of processing the ever-increasing trading volumes of securities.401

The ABA Advisory Committee and its drafting group met throughout 1989 and 1990 and in February 1991 issued an interim report402 proposing *inter alia*:

"A majority of the committee believes that the better view, as a matter of policy, should be to give priority to upper-tier claimants in circumstances where a shortfall in the fungible bulk exists and two similarly situated, different-tier claimants assert an interest in the same fungible bulk. A minority of the Committee believes that the better view in these circumstances, as a matter of policy, should be to give priority to lower-tier claimants."403

While the ABA Committee was at work, the United States Congress was envisaging several legislative packages to amend federal securities laws in response to the October 1987 market break and the failure of Drexel Burnham in February 1990.404 Acknowledging the need to revise the commercial law foundation of the securities holding system,405 the US Congress enacted the Market Reform Act of 1990,406 which added Section 17A(f) to the Exchange Act.407 Un-

401 James Steven Rogers (*supra* n 373) 1435.

402 American Bar Association, Section of Business Law, Interim Report of the Advisory Committee on Settlement of Market Transactions (Exposure Draft, 15 February 1991) (hereinafter Interim Report). As it turned out, that was the only formal report ever issued by the Advisory Committee on Settlement of Market Transactions. It is important to note that the report cited and discussed the following study in support of the majority view: Charles W. Mooney, Jr., (*supra* n 366) 386–397.

403 American Bar Association (*supra* n 402) 36.

404 On 13 February 1990, Drexel Burnham Lambert was forced into filing for Chapter 11 bankruptcy protection by the chairmen of the New York Federal Reserve and the Securities and Exchange Commission. It was the first Wall Street firm to be forced into bankruptcy since the Great Depression. *See* Miles Livingston & Glenn Williams, 'Drexel Burnham Lambert's bankruptcy and the subsequent decline in underwriter fees' (2007) Journal of Financial Economics 472, 476.

405 *See* for instance Coordinated Clearance and Settlement Act of 1990, H.R. Rep. n° 477, 101st Cong., 2nd Sess. 6 (1990). The report indicates that "[a]nother weakness in our system revealed by the October 1987 market break is the lack of uniformity and clarity among state laws governing the transfer and pledge of securities. The lack of harmony among various state laws detracts from the liquidity of the clearance and settlement system by making it burdensome (and in some cases, impracticable) for investors to finance their payment obligations in one market by pledging the value of their positions in another market as collateral for loans."

406 Pub. L. n° 101-432, 104 Stat. 963 (1990).

407 Section 17A(f) to the Exchange Act was similar to provisions proposed by the SEC and in the Markey Bill in 1988 (*see* 15 U.S.C. § 78q-1(f) (2000)).

der subsection (f), the SEC was allowed to adopt rules covering transfers of interests in securities (including limited interests such as security interests) and dealing with the rights of parties to transactions and of third parties.408

The SEC was required to establish a national system for the prompt and accurate clearance and settlement of transactions in securities other than exempt securities and US government securities that are transferred within the book-entry system of Federal Reserve banks.409 Before enacting that rule, the SEC had to take into consideration the views of a federal advisory committee and consult with the secretary of the Treasury and the Board of Governors of the Federal Reserve System. After examining the views of these entities, the SEC reached the following conclusion:

In case the secretary of the Treasury objected in writing to a rule that the SEC proposed, the SEC had to consider "all feasible alternatives to the proposed rule." The SEC was not allowed to promulgate the rule unless it made "an explicit finding that the rule is the most practicable method for achieving safe and efficient operation of the national clearance and settlement system."413 Further, within two years after the promulgation of the rule, a state could enact a statute referring expressly to the rule and provide, prospectively, for its own law to apply regardless of any difference from the SEC rule.414 Moreover, the SEC was also required to establish, within ninety days after enactment of the Market Reform Act, an advisory committee under the Federal Advisory Committee

408 15 U.S.C. § 78q-1(f)(1) (2000). Under this provision, the SEC was allowed to preempt state commercial laws, including the Uniform Commercial Code. *See* also Charles W. Mooney, Jr. (*supra* n 383) 567.

409 1934 Act § 17A(a)(2), 15 U.S.C.A. § 78q-1(a)(1)(A).

410 1934 Act § 17A(f)(2)(A)(i), 15 U.S.C.A. § 78q-1(f)(2)(A)(i).

411 1934 Act § 17A(f)(2)(A)(ii), 15 U.S.C.A. § 78q-1(f)(2)(A)(ii).

412 1934 Act § 17A(f)(2)(A)(iii), 15 U.S.C.A. § 78q-1(f)(2)(A)(iii).

413 1934 Act § 17A(f)(2)(B), 15 U.S.C.A. § 78q-1(f)(2)(B).

414 1934 Act § 17A(f)(3), 15 U.S.C.A. § 78q-1(f)(3). The state statute had to specifically refer to the Securities Exchange Act of 1934 (1934 Act) subsection and to the SEC rule promulgated thereunder.

Act.415 This development did not disrupt the work of the ABA Advisory Committee. Rather, the establishment and appointment of the fifteen members of the Market Transaction Advisory Committee (MTAC), along with the SEC, the Board of Governors of the Federal Reserve System (the Fed), and the Department of Treasury (Treasury), reasonably ensured cooperation and coordination; several active participants in the ABA Advisory Committee were appointed to the MTAC.416 With the first formal meeting of the MTAC on 29 October 1991, the work of the ABA Advisory Committee was complete.

And another project was well underway: Given the crisis caused by the October 1987 stock market crash and in the wake of several studies on that market crash,417 the National Conference of Commissioners on Uniform State Law and the American Law Institute418 established a draft committee in 1991 with Professor Curtis Reitz as its chair and Professor James Rogers as the reporter. Its purpose was to continue with the revision of UCC Article 8 and to efficiently address the issues raised by the studies and eliminate systemic risk during periods of market stress.419 The first (largely organisational) meeting of the Drafting Committee was held in August 1991during the NCCUSL annual meeting. In 1994, after three years of study and discussion, the NCCUSL and ALI approved the revised version of UCC Article 8 alongside related amendments to UCC Article 9 and to other relevant Articles.420

#### *c) The 1994 Version of UCC Article 8*

The 1994 revision of UCC Article 8 was aimed at tailoring a set of intelligible legal rules to govern contemporary securities holding practices.421 It sets

417 *See* for instance Charles W. Mooney, Jr., Sandra M. Rocks & Robert S. Schwartz, 'An Introduction to the Revised U.C.C. Article 8 and Review of Other Recent Developments with Investment Securities' (1994) 49 Business Lawyer 1892; James Steven Rogers (*supra* n 373) 1445–1447.

418 These two institutions are the sponsors of the Uniform Commercial Code.

419 Financial Markets Law Committee, *Issue3-Property Interests in Investment Securities: Report on the Research into the 1994 Revision of Article 8 of Uniform Commercial Code* (London 2005) 5–6; James Steven Rogers (*supra* n 373) 1446–1447; Charles W. Mooney, Jr. (*supra* n 366) 559–576.

420 *See* Charles W. Mooney, Jr., Sandra M. Rocks & Robert S. Schwartz (*supra* n 417) 1891; James Steven Rogers (*supra* n 373) 1432. *See* also Charles W. Mooney, Jr. (*supra* n 383) 559 et seq for a personal sketch of the revisions of UCC Article 8.

421 On 24 February 1995, Arkansas became the first state in the U.S. to adopt the 1994 Revised UCC Article 8.

415 15 U.S.C. § 78q-1(f)(4) (2000).

416 Pursuant to Subsection (f)(4)(B), the SEC was to appoint eleven members, the Federal government two members, and Treasury two members. Active MTAC members in the ABA Advisory Committee were Charles W. Mooney, Jr., Robert Mendelson (MTAC Chair), Martin J. Aronstein, Richard B. Nesson, Sandra M. Rocks, and Robert J. Woldow. In addition, there was one member who was past president of NCCUSL, Carlyle C. Ring, Jr.

ground rules for implementing transfers and resolves disputes that may arise in respect of interests in securities.422 Whereas the 1962 and the 1977 versions of UCC Article 8 were in principle based on physical securities certificates, the 1994 version establishes a distinction between the direct and the indirect holding systems.423 The drafters of the 1994 revision reasoned that it is "by no means clear whether the long-term evolution will be toward decreased or increased use of direct holdings," that developments will be determined by market and regulatory forces, and that the UCC Article 8 rules should not seek to influence that development in any specific direction. Therefore, the revised text took a "neutral position on the evolution of securities holding practices."424 Accordingly, UCC Article 8 generally retains the former Article 8 provisions on the direct holding system425 but contains a new Part 5 which determines rules for the intermediated system; and it rendered unnecessary the complicated provisions of the 1977 text embodied in former UCC § 8-313.426

In respect of the indirect holding system, Part 5 of UCC Article 8 is not based on traditional property law but rather creates a new intermediated system which is, from a legal perspective, comparable to the payment system.427 It also introduces several new definitions and concepts, such as "securities account" and "securities entitlement". Indeed, the old terms contained in the former versions of UCC Articles 8 and 9 were inadequate to describe paper-

424 Learning from the mistakes of the past, the revision process aimed nevertheless to encourage market development while limiting any unforeseen constraint on the evolutionary process of the direct and indirect holding systems (U.C.C. Series (Hawkland) Special Release, Revised Article 8 Code Text & Official Comments, pt. 2, 7–8 (1995); Everette L. Martin (*supra* n 367) 9, fn 22).

425 UCC Series (Hawkland) Special Release, Revised Article 8 Code Text & Official Comments, pt. 2, 9–10 (1995).

426 It is also worth noting that the scope of UCC Article 8 includes not just securities but also financial assets; it also covers money market funds, repurchase agreements, securities lending agreements, US government securities (to the extent not preempted by federal treasury and related government agency regulations), interests in limited partnerships (if the partnership agreement opts into revised UCC Article 8 or the partnership interests are publicly traded), and other financial assets. However, it does not apply to normal bank accounts.

427 Charles W. Mooney, Jr. & Atsushi Kinami, 'Transfer, Pledge, Clearance and Settlement in the Japanese and United States Government Securities Market' (1991) 12 4 University of Pennsylvania Journal of International Business Law 517, 518–519; Charles W. Mooney (*supra* n 366) 403–405. For more details on the difference between the intermediated system and the payment system, *see* Jeanne L. Schroeder (*supra* n 379) 371–375.

422 Most states have adopted the 1994 revision of UCC Article 8 along with related amendments to UCC Article 9. The Department of the Treasury has also adopted Revised UCC Article 8 for the market in Treasury securities, preempting certain provisions of the laws of any state that has not adopted Revised UCC Article 8.

423 Ruth Olson, 'Review of Recent Developments with Revised U.C.C. Article 8 and Investment Securities' (1995) 50 Business Lawyer 1542.

less transactions within the intermediated system. Hence, the drafters had to develop novel terms and concepts. Moreover, the revision suppresses the necessity of transferring or physically delivering securities into the possession or control of the secured party in order to create an effective security interest. The only necessary elements are UCC § 9-203 (agreement, signature, the debtor's interest in the collateral, and a debt to be secured).428 With respect to the direct holding system, the 1994 version of UCC Article 8 largely maintains the previous 1977 version but with simplified rules.

§ 8-501 of the UCC determines what a securities account is429 and how security entitlements are acquired from the relevant intermediary. § 8-502 contains a limitation on adverse claims in the indirect holding system. § 8-503 it governs the property aspects of entitlements and the innocent acquisition rule. §§ 8-504 through 8-509 specify duties of the intermediary. The rights of a purchaser of a security entitlement from an entitlement holder are set forth in § 8-510, which also determines the relevant priority rules. § 8-511 addresses the priority rules among secured creditors and entitlement holders. UCC Article 8 Part 1 also sets out definitions and general rules that are essential to a proper understanding of the provisions in UCC Article 8 Part 5. § 8-110 contains choice of law rules.430

#### *2. Brief History of UCC Article 9*

#### *a) Pre-Article 9 Law applying to Security in Personal Property*

*Gilmore*431 notes that UCC Article 9 is not so much a new start or a fresh approach as it is a reflection of work long since accomplished. A detail histo-

430 For a discussion of the conflict of laws problems that the 1994 version of UCC Article 8 attempts to solve, *see* James Steven Rogers (*supra* n 373) 1457–1460.

428 The 1994 version of UCC Article 8 does however introduce the concept of "control" to obtain a perfected security interest; the creditor must be in a position to sell the collateral without the cooperation of the debtor and apply the proceeds to the debt. This may be accomplished either by having the securities transferred into an account in its own name or by having the debtor and the securities intermediary sign an agreement that acknowledges right of the creditor to control and order the disposition of the securities (*see* UCC § 8- 106). It is important to note that perfection by filing an ordinary Article 9 financing statement is an alternative to control. Perfection by filing is subordinate to perfection by control (*see* UCC § 9-328(1)). *See* section C of this chapter.

429 A "securities account" under Revised UCC Article 8 is: "An account to which a financial asset is or may be credited in accordance with an agreement under which the person maintaining the account undertakes to treat the person for whom the account is maintained as entitled to exercise the rights that comprise the financial asset." The following relationships are clearly covered by the definition of a securities account: (1) between a clearing corporation and its participants; (2) between a broker and customers who leave their securities with the broker; and (3) between a bank acting as securities custodian and its customers (*see* Arkansas Code Annoted § 4-8-501(a)).

ry of the law governing security interests before UCC Article 9 is beyond the scope of this study. However, to put UCC Article 9 in its proper perspective, it is important to present a summary of that history. The evolution of the law relating to security in personal property reflects the development of increasingly sophisticated commercial transactions. Until the early 1980s, the pledge was the only recognised personal property security device. Attempts to create non-possessory security interests in personal property were viewed by courts as tantamount to fraud.432 Following the Industrial Revolution, however, there was an increased need for credit. This forced lenders to seek recourse to personal and real property as security for loans. With the increasing use of nonpossessory security interests in personal property, courts progressively recognised the validity of both possessory and nonpossessory security interests in most types of personal property. Courts notably recognised:

– The pledge;

In addition, variouslaws were enacted to apply to varioustypes ofsecurity interestsin personal property. Some of these statutes were modelled on acts proposed and drafted by the NCCUSL.433 In the late 1930s, many lawyers, judges, business people, and academics were concerned about a lack of uniformity in the state statutory law that governed security interests in personal property, with much uncertainty for persons involved in interstate business. Thus, efforts were put into a comprehensive re-examination of state laws applying to commercial transactionsin general and to security interestsin particular.434

# *b) The 1962 Version of UCC Article 9*

Although several states adopted the UCC between 1957 and 1961,435 many were still adopting numerous non-uniform amendments to it. To discourage

431 Grant Gilmore, *Security Interests in Personal Property* (Little, Brown & Company, Boston 1965) 290.

432 Richard F. Duncan, William H. Lyons & Catherine Lee Wilson, *The Law and Practice of Secured Transactions: Working with Article 9* (Law Journal Press, New York 2004) 1–4.

433 Such as: (i) the Uniform Trust Receipts Act; (ii) the Uniform Conditional Sales Act; (iii) the Uniform Negotiable Instruments Law; (iv) the Uniform Warehouse Receipts Act; (v) the Uniform Sales Act; and (vi) the Uniform Bill of Lading Act. However, other statutes were not modelled on any uniform model (such as the chattel mortgage acts and the factors lien acts).

434 Richard F. Duncan, William H. Lyons & Catherine Lee Wilson (*supra* n 432) 1–5.

non-uniform amendments, the ALI and the NCCUSL established the Permanent Editorial Board. Its purpose was to review the UCC on an ongoing basis and draft suggested amendments to ensure that the UCC was adapted to changing commercial practices. The first substantive action of the Permanent Editorial Board was to recommend that its proposed 1962 Official Text of the UCC be adopted.436

Article 9 as it appeared in the 1962 Official Text was a major simplification of pre-UCC personal property security law; it replaced many pre-UCC security devices with a unitary security device called a "security interest"437 and established a uniform body of law with a single filing system and a single terminology. Article 9 moreover departed from the past in de-linking the creation and perfection of security interests from the mere form of the transaction; instead, distinctions in that area were based on the nature of the collateral and the nature of the transaction.

#### *c) The Pre-1972 Official Text and the 1977 Amendments*

The 1962 version of UCC Article 9 constituted a major simplification of personal property law. Yet there were still issues it did not address. To resolve them, individual states turned once again to non-uniform amendments. In 1966, the Permanent Editorial Board launched a full review of UCC Article 9 and in 1971 presented a report recommending revisions.438 Though the suggested revisions did not alter the fundamental approach of UCC Article 9, they were substantial and required a complete redrafting of entire sections of Article 9.439 The 1972 Official Text, which was adopted by all states, was largely based on the report of the Permanent Editorial Board. In 1977, UCC

435 Massachusetts (in 1957); Kentucky (in 1958); Connecticut, New Hampshire, Rhode Island, Wyoming, Arkansas, Ohio, New Mexico, Illinois, Oklahoma, Georgia, New Jersey, Alaska, Michigan, and New York (in 1958). Pennsylvania substituted the 1958 Code for the 1952 Code in 1959.

436 The 1962 Official Text is available at <http://www.legislature.mi.gov/(S(kidfh1 nkkbu0ctnkrs4nepqj))/documents/mcl/pdf/mcl-Act-174-of-1962.pdf> (accessed 4 January 2021). *See* also The American Law Institute, *Uniform Commercial Code – 1962 Official Text with Comments* (1963). The 1962 Official Text was eventually adopted in all the states, except Louisiana.

437 Richard F. Duncan, William H. Lyons & Catherine Lee Wilson (*supra* n 432) 1–6.

438 *See* Permanent Editorial Board for the Uniform Commercial Code, Review Committee for Article 9 of the Uniform Commercial Code, Final Report, *Proposals for changes in Article 9 of the Uniform Commercial Code and Related Changes in Other Articles with Reasons Therefor and Comments* (25 April 1971, Philadelphia). The report is available at <http://heinonline.org/HOL/LandingPage?handle=hein.ali/alicc0140&div=1&src=home> (accessed 4 January 2021).

439 For instance, UCC § 9-103(1962), which governs the perfection of security interests in multiple state transactions, was completely redrafted in the 1972 Code.

Article 9 was amended in response to problems with negotiable stock certificates. Certain amendments were also made to UCC Article 8's provisions on the creation and perfection of security interests in uncertificated securities. Following the 1977 amendments, UCC Article 9 no longer governed those issues; but the 1994 revision of UCC Articles 8 and 9 reversed this action.440

# *d) The 1994 Amendments to UCC Article 9*

In 1994, several provisions of UCC Article 9 were amended in connection with the revisions to UCC Article 8. As mentioned above, the 1977 version of UCC Article 8 applied to property interests in investment securities. The 1994 revisions now returned the provisions in respect of the creation and the perfection of security interests in investment securities to UCC Article 9, thereby re-establishing the structure which existed before the 1977 amendments to UCC Article 9. More particularly, § 9-106 governs the control of investment property. § 9-206 applies to security interests arising in purchase, while § 9-309 applies to security interest perfected upon attachment. § 9-312 sets out rules on perfection. §§ 9-314 and 9-328 govern perfection by control and priority, respectively.441 It is important to note, however, that an account agreement concluded between an investor (or entitlement holder)442 and its intermediary plays a significant role in practice. Indeed, UCC Article 8 gives priority to an account agreement over some provisions of UCC Article 8 regarding the intermediaries' duties.

# *e) The 1999 Official Text*

In 1990, the Permanent Editorial Board created a committee to analyse UCC Article 9 and prepare the substance of any revision to its provisions. On 1 December 1992, the study committee issued a report which recommended several changes to UCC Article 9.443 In 1993, the ALI and the NCCUSL established a drafting committee which commenced its work based on the rec-

440 For a critical analysis of the 1977 amendments of UCC Article 9, *see* Peter F. Coogan, 'Security Interests in Investment Securities Under Revised Article 8 of the Uniform Commercial Code' (1980) 93 Harvard Law Review 889.

441 Edward J. Janger, 'Predicting when the Uniform Law Process Will Fail: Article 9, Capture, and the Race to the Bottom' (1998) 83 Iowa Law Review 569, 617–625, who addresses the possible role of industry capture in the revision process.

442 Under UCC Article 8, there is a difference between the concepts of entitlement holders and investors. In the US intermediated system, there are security entitlements at each tier of the indirect holding chain. Hence, intermediaries at various levels of the intermediated system are entitlement holders though not investors. For more details on this question, *see* section B of this chapter.

443 *See* Permanent Editorial Board for the Uniform Commercial Code, *PEB Study Group Uniform Commercial Code Article 9* (December 1992).

ommendation of the study committee. It completed and submitted its work to the American Law Institute and the NCCUSL during their 1998 annual meetings, whereupon the NCCUSL and ALI approved the revisions to UCC Article 9. The revised version of UCC Article 9 (Revised Article 9) has been adopted in all states, the District of Columbia, and the US Virgin Islands. It called for a uniform effective date of 1 July 2001.444 The drafting committee inserted a provision delaying the effective date of the revision until 1 July 2001; this was intended to eliminate as many conflict of laws issues as possible.445 Revised Article 9 substantially reorganises the 1972 version: First, its scope is expanded to include many situations and issues that were previously not subject to its rules concerning attachment, perfection, and enforcement. Second, the revised version changes the provisions on filing. Third, it changes the choice of law provisions applying to perfection, the effects of perfection or non-perfection, and priority. And fourth, as an alternative to signing a piece of paper, the revised version of UCC Article 9 provides for the authentication of a record.446

#### *B. Key Features of the Intermediated System in the US*

### *I. Basic Structure of the Intermediated System in the US*

The indirect holding system in the United States is composed of investors, intermediated securities, intermediaries, and a CSD. In this regard, the US intermediated system is similar to that of Germany and to that of the OHADA region. Nevertheless, the underlying legal framework of the indirect holding system in the US is entirely different.447 Indeed, an investor in the US indirect holding system does not hold the securities themselves but rather a new, intermediary-centred right, one that is *sui generis*, called a "security entitlement".448 A security entitlement is not an interest in any particular security.

444 Most states adopted Revised Article 9 with its 1 July 2001 effective date. However, a tiny minority of jurisdictions had a later effective date. For instance, Connecticut had an effective date of 1 October 2001. Alabama, Florida, and Mississippi had an effective date of 1 January 2002. For an in-depth analysis of the conflict of laws issues that arose from the non-uniform effective dates, *see* Bradley Y. Smith, 'New Article 9 Transition Rules' (1999) 74 Chicago-Kent Law Review 1339, 1351–1355.

445 Richard F. Duncan, William H. Lyons & Catherine Lee Wilson (*supra* n 432) 1–9.

446 For more details on the revised version of UCC Article 9, *see* Darrell W. Pierce, 'Revised Article 9 of the Uniform Commercial Code: Filing System Improvements and their Rationale' (1998) 31 Uniform Commercial Code Law Journal 16.

447 Changmin Chun (*supra* n 143) 203.

448 Bradley Crawford 'The Hague Prima Convention: Choice of Law to Govern Recognition of Dispositions of Book-Based Securities in Cross Border Transactions' (2003) 38 Canadian Business Law Journal 157, 166; Richard Potok, 'Legal Certainty for Securities Held as Collateral' (1999) 18 International Financial Law Review 12, 13; Stephan Saager,

Rather, section 8-102(a)(17) defines a "security entitlement" as "the rights and property interest of an entitlement holder with respect to a financial asset specified in Part 5". A person acquires a security entitlement when financial assets are credited to the entitlement holder's account by its securities intermediary; such financial assets can be money-market funds, limited partnership interests, and other interests that might be held through a securities entitlement account. From an OHADA legal viewpoint, a security entitlement is a packaged aggregate composed of rights *in personam* with some aspects of rights *in rem*. Moreover, securities are not the underlying objects of security entitlements in the US intermediated system.

UCC Article 8's broad definition of the concept of "financial asset", found in § 8-102(a)(9), is:

(i) A security;449

The third test in § 8-102(a)(9) is significant: any property (including an interest in a partnership or limited liability company, a negotiable instrument under Article 3,452 or a document of title) becomes a financial asset in case an investor

*Effektengiroverkehr und internationales Privatrecht* (Dunker & Humblot, Berlin 2007) 158–159; Dorothee Einsele (*supra* n 361) 305.

449 § 8-102(a)(14) defines the term "security" as "an obligation of an issuer or a share, participation, or other interest in an issuer or in property or an enterprise of an issuer: (i) which is represented by a security certificate in bearer or registered form, or the transfer of which may be registered upon books maintained for that purpose by or on behalf of the issuer; (ii) which is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations; and (iii) which: (a) is, or is of a type, dealt in or traded on securities exchanges or securities markets; or (b) is a medium for investment and by its terms expressly provides that it is a security governed by this Article."

450 § 8-102(a)(14) defines the term "securities intermediary" as "(i) a clearing corporation; or (ii) a person, including a bank or broker, that in the ordinary course of its business maintains securities accounts for others and is acting in that capacity".

451 As context requires, the term means either the interest itself or the means by which a person's claim to it is evidenced, including a certificated or uncertificated security, a security certificate, or a security entitlement.

452 Under § 3-104(a), "negotiable instrument" means "an unconditional promise or order to pay a fixed amount of money, with or without interest or other charges described in the promise or order, if it: (1) is payable to bearer or to order at the time it is issued or first

(or more accurately, entitlement holder) and its intermediary enter into an agreement that expressly stipulatesthat the property isto be treated as a financial asset.453 This provision reflects the liberal approach characteristic of the US intermediated system, which rests on the agreement between the relevant parties. In line with this liberal approach, there is no list ofsecurities eligible for the intermediated system in UCC Article 8. And similarly, under the DTC rules, eligible securities are determined solely at the discretion of DTC (Rule 5(1)).

Because of the importance placed on the relationship between the intermediary and the account holder, securities accounts play a key role in the US intermediated system, and the rules regarding securities accounts are therefore positioned first in UCC Article 8 Part 5. § 8-501 defines a securities account as "an account to which a financial asset is or may be credited in accordance with an agreement under which the person maintaining the account undertakes to treat the person for whom the account is maintained as entitled to exercise the rights that comprise the financial asset." In light of this provision, the concept of "securities account" in the US intermediated system is composed of two elements. First, a securities account is created by a consensual agreement. Second, the agreement must entitle the account holder to exercise the right which the financial asset represents. As mentioned above, a security entitlement is in essence a claim vis-à-vis the specific intermediary of an entitlement holder, so the US indirect holding system is consequently constructed "account by account" or "stage by stage". Under § 8-501, an account holder acquires a security entitlement when a financial asset is or may be credited to its securities account; in other words, in the US intermediary system a securities entitlement regarding financial assets is created by a book-entry to a securities account.454

Moreover, the absence of a trust relationship in the definition of a securities account in UCC Article 8 is noteworthy. In the US intermediated system, a securities account is a consensual agreement that entitles the entitlement holder to exercise the rights comprising the financial asset; this definition precludes a trust relationship in which the trustee holds legal title and exercises the rights. Therefore, it is not an analysis of the nominal words of an agreement that determines whether an agreement constitutes a securities account; rather, it is

comes into possession of a holder; (2) is payable on demand or at a definite time; and (3) does not state any other undertaking or instruction by the person promising or ordering payment to do any act in addition to the payment of money, but the promise or order may contain (i) an undertaking or power to give, maintain, or protect collateral to secure payment, (ii) an authorisation or power to the holder to confess judgment or realise on or dispose of collateral, or (iii) a waiver of the benefit of any law intended for the advantage or protection of an obligor."

453 Note also that under § 8-103(e), an option or similar obligation issued by a clearing corporation to its participants is not a security, though it is a financial asset.

454 Changmin Chun (*supra* n 143) 204.

whether the application of Part 5 of UCC Article 8 is consistent with the expectations of the parties and with the objectives of UCC Article 8.455

As mentioned above, the US intermediary system makes a distinction between an "entitlement holder" and an "account holder".456 § 8-102(a)(7) defines the term "entitlement holder" as a person identified in the records of a securities intermediary as the person having a security entitlement against the securities intermediary. If a person acquires a security entitlement by virtue of § 8- 501(b)(2) or (3), that person is the entitlement holder. This means that an entitlement holder is any person whose interest in a financial asset is not registered on the books of the pertinent issuer.457 In other words, an entitlement holder is a party that holds a security entitlement created in the securities account through its intermediary. However, an entitlement holder is not necessarily an "ultimate investor"; accordingly, the relevant intermediary of the entitlement holder may be an entitlement holder vis-à-vis its upper-tier intermediary, which in turn can be an entitlement holder vis-à-vis a further upper-tier intermediary. The existence of different layersin the US indirect holding system is a result of the "securities account" and "security entitlement" concepts found in UCC Article 8 Part 5. The only situation where there can be a singular entitlement holder in the US indirect holding system is when a participant in the CSD, *i.e.*, the Depository Trust Company (DTC), isthe ultimate investor.

As noted above, in the US intermediated system the different tiers of an indirect holding chain are insulated from one another. An entitlement holder has a relationship solely with its intermediary; it has no relationship with other intermediaries or with the issuer of the asset. Consequently, a creditor can only lodge a claim against its debtor's intermediary. Under § 8-112(c), "the interest of a debtor in a security entitlement may be reached by a creditor only by legal process upon the securities intermediary with which the debtor's securities account is maintained, except as otherwise provided in subsection (d)458." Therefore, except for an extremely rare case in § 8-503(d),459 an upper-tier attachment is systematically prohibited in the US intermediated system.

459 § 8-503(d) provides: "An entitlement holder's property interest with respect to a particular financial asset under subsection (a) may be enforced against a purchaser of the

455 Russel A. Hakes (*supra* n 365) 680.

456 *See* Article 1(e) of the Geneva Securities Convention and Article 1(1)(d) of the Hague Securities Convention, which both use the concept of "account holder".

457 FrancisJ. Facciolo, 'Father Knows Best: Revised Article 8 and the Individual Investor' (2000) 27 Florida State University Law Review 615, 623. The 1994 version of UCC Article8 expressly abandons all tracing rules (*see* Jeanne L. Schroeder (*supra* n 377) 332–334 (describing netting oftrades asleading to impossibility oftracing, both asrelated to § 8-313(2)).

458 Under § 8-112(d), "[t]he interest of a debtor in a certificated security for which the certificate is in the possession of a secured party, or in an uncertificated security registered in the name of a secured party, or a security entitlement maintained in the name of a secured party, may be reached by a creditor by legal process upon the secured party."

The definition of a securities intermediary in § 8-102(a)(14) indicates that the US indirect holding system, unlike the German intermediated system, does not require an intermediary to be regulated or engaged in a banking or brokerage business. Whether an entity maintains a securities account for others and acts in that capacity is the most crucial element.460 As defined in § 3(a)(23) of the Securities Exchange Act (SEA), a clearing corporation is a clearing agency under the federal securities law registered with the Securities Exchange Commission (SEC). A clearing corporation can also be any other entity which provides clearance or settlement services as long as its activities as such are governed by a federal or state governmental authority (§ 8- 102(a)(5)).461 In the US intermediated system, the DTC462 is the CSD. For most securities traded in US securities markets, the National Securities Clearing Corporation (NSCC)463 is the central counterparty.

If an entity issues global certificates, all transfers are made through bookentry. If the securities are not issued in book-entry-only form, they can be registered or withdrawn on behalf of the intermediaries, investors, or others. The relationship between a transfer agent (issuer) and the DTC plays a key role in the registration and withdrawal process. Under the Fast Automated Securities Transfer (FAST)464 program, the DTC enters into agreements with transfer agents whereby securities are registered in the name of the nominee of the

financial asset or interest therein only if: (1) insolvency proceedings have been initiated by or against the securities intermediary; (2) the securities intermediary does not have sufficient interests in the financial asset to satisfy the security entitlements of all of its entitlement holders to that financial asset; (3) the securities intermediary violated its obligations under § 8-504 by transferring the financial asset or interest therein to the purchaser; and (4) the purchaser is not protected under subsection (e)."

460 Article 1(d) of the Geneva Securities Convention and Article 1(1)(c) of the Hague Securities Convention have a similar definition of an intermediary.

461 Unlike other intermediaries, clearing corporations are governed by two preferential clauses for clearing corporations under UCC Article 8. First, the rules of the clearing corporations are effective even if they contradict provisions of the UCC. These rules also affect other parties who did not agree to the rules (§ 8-111). Second, under § 8-511, if a creditor of a clearing corporation does not have sufficient financial assets, it has no priority over the entitlement holders' claims.

462 Established in 1973 as a successor to the business of the Central Certificate Service of the NYSE (which was established to address the paper crunch in the late 1960s), it is a limited purpose trust company which was created under New York law. In 1999, DTC became a subsidiary of DTCC with the NSCC.

463 Created in 1976, the NSCC provides settlement, clearing, CPP services, and a guarantee of completion for transactions for almost all broker-to-broker trades.

464 FAST was introduced in 1975. In 1976, it was approved by the SEC. *See* Securities and Exchange Commission, *Depository Trust Co.* (1976) 41 Fed. Reg. 17823, Release n° 34-12353.

DTC, *i.e.*, Cede & Co.465 Because of this relationship between the DTC and the transfer agents, the balance certificates of the securities maintained by both reflect the DTC's ownership interests. If DTC a participant requires the DTC to withdraw securities, the DTC debits the securities from that participant's account. Furthermore, the DTC instructs the relevant transfer agent to withdraw the requested securities, whereupon the transfer agent reduces the DTC's balance, issues certificates in the name of the requested person, and moreover delivers the certificates directly to that participant. The FAST program allows fast withdrawal of securities and diminishes the DTC's operational burden from maintaining securities certificates. Nevertheless, it is important to note that not all deposit-eligible registered securities come under the FAST program, which is in place only for securities designated by the DTC. Besides the FAST program, the DTC also provides the Direct Registration System (DRS) program, under which securities are registered directly in the names of the ultimate investors on the books of the shareholders managed by transfer agents.

The figure on the next page illustrates the basic structure of the US indirect holding system described above.

#### *II. Key Features of the US Indirect Holding System*

As indicated above, the relevant provisions of UCC Article 8 depart from previous rules that were based on securities certificates. First, UCC Article 8 sets forth new definitions and terms which apply only to the indirect holding system, such as security entitlement, securities account, entitlement order,466 entitlement holder, financial asset, etc. Second, the UCC provides specific rules for the indirect holding system, more particularly regarding (i) the protection of the innocent acquirer or of relevant parties such as collateral takers (§§ 8-502 & 8-510(a)), (ii) insolvency immunity as well as allocation and shortfalls (for instance in §§ 8-503(a) & (b)), and (iii) priority (for instance in §§ 8-510, 8-511 & 9-328).

465 Cede & Co. stands for "Certificate Depository and Company". It is a partnership between the DTC and employees of the DTC. This legal form was chosen to simplify the verification of signatures to the issuer. It was thought that the verification of the signature for a partnership is less difficult than a signature for a corporation: Jeanne L. Schroeder & David Gray Carlson (*supra* n 373) 561. The only purpose of Cede & Co. is the maintenance of registered ownership of securities which are deposited with the DTC (Charles W. Mooney, Jr. (*supra* n 366) 319).

466 Under § 8-102(a)(8), an entitlement order is a notification sent to an intermediary instructing transfer or redemption of a financial asset to which the entitlement holder has a security entitlement.

*Figure 12:* Basic Structure of the US Intermediated System467

Further, the US intermediary system is an intermediary-centred regime. Indeed, the relationship with the intermediary is at the centre of the US indirect holding system.468 In fact, almost all operations in that system are performed by intermediaries; consequently, the nature of a security entitlement is basically an *in personam* right, one between the account holder and the intermediary. As for attachment of the debtor's security entitlement, no upper-tier attachment is allowed in the US indirect holding system since a relationship is maintained only with the debtor's intermediary. Additionally, because of this relationshipbased system and the nature of a security entitlement, all indirect holding systems are analysed stage by stage under UCC Article 8 Part 5.