The Future of
Money Market
Instruments
A Consultation
November 1999
CONSULTATION ON THE FUTURE OF MONEY MARKET INSTRUMENTS (MMIs)
PAGE
A.
INTRODUCTION
3
B.
TERMS OF REFERENCE
5
C.
SUMMARY OF THE PROPOSALS AND RECOMMENDATIONS FOR
FURTHER WORK
6
D.
DEMATERIALISATION OF MMIs
10
E.
PROVISIONS FOR DEMATERIALISED TREASURY BILLS
15
F.
SIMPLIFICATION OF BILLS OF EXCHANGE
17
G.
ISSUANCE AND SETTLEMENT OF DEMATERIALISED MMIs
19
H.
INTEGRATION OF MMIs INTO CREST AND NEXT STEPS
22
APPENDIX I
SECTION 207 OF THE COMPANIES ACT 1989
APPENDIX II
NEGOTIABILITY
25
A. Introduction
27
B. Note of a consultation with Mr Richard Sykes QC
31
APPENDIX III
TAKING SECURITY OVER DEMATERIALISED MMIs
33
APPENDIX IV
ENDORSEMENT
35
APPENDIX V
REOPENING ISSUES OF MMIs: EXAMPLES
37
APPENDIX VI
ASSIGNING ISINs TO MMIs
38
APPENDIX VII
TRANSITIONAL ISSUES
41
APPENDIX VIII
ABBREVIATIONS AND ACRONYMS
45
2
A.
INTRODUCTION
This consultative paper seeks the views of market participants and their representative bodies,
and of other interested parties, about the future of money market instruments.
The findings of the September 1998 Securities Settlement Priorities Review indicated strong
support for the integration of the settlement arrangements for money market instruments
(MMIs) into the CREST settlement system.( 1) Against this background, the Bank of
England’s Sterling Money Market Liaison Group (MMLG) asked a Working Group to
prepare a report on the future of MMIs.
The Working Group comprised representatives of the Bank of England, CRESTCo, the
Association of Corporate Treasurers, APACS, the London Money Market Association
(LMMA), and the UK Debt Management Office (DMO), and experts from Bank of Scotland,
Bank One, Barclays Bank, Dresdner Bank, Gerrard & King, HSBC Bank, and Halifax. The
London Stock Exchange, the Financial Services Authority, and Freshfields also took part in
some of the discussions; and the Bank also had contact with Treasury Solicitors. HM Treasury
was kept informed. The Working Group terms of reference are set out in Section B below.
This consultative paper reflects the findings and proposals of the Working Group, as
amended in the light of subsequent comments and discussions at the MMLG. The MMLG
decided that the proposals should be submitted for wider market consultation before
implementation. The main proposals are set out in Sections D-H, and Section C provides a
summary. The Appendices provide some legal and other background, and also include more
detail on some of the proposals and options.
The Bank would be grateful for comments on the proposals in this paper, and on any points
arising, including suggestions for further work, by 17 December. These should be addressed
to:
Peter Andrews
Head of Gilt-Edged & Money Markets Division
Bank of England
Tel: 020 7601-5394
Threadneedle Street
Fax: 020 7601-5810
London EC2R 8AH
E-mail: peter.andrews@bankofengland.co.uk
In addition, this paper includes a consultation from the UK Debt Management Office on the
dematerialisation of Treasury Bills (see Section E). Any comments on the issues raised with
respect to Treasury Bills should be addressed to:
Allison Holland
UK Debt Management Office
Cheapside House
138 Cheapside
London EC2V 6BB
(1)
Tel: 020 7862-6534
Fax: 020 7862-6509
E-mail: allison.holland@dmo.gov.uk
Since the Review, CRESTCo has taken over the management of both the CGO and the CMO.
3
If readers have any questions on the details of the CREST arrangements, they should contact:
Toby Davies
CRESTCo Ltd
33 Cannon Street
London
EC4M 5SB
Tel: 020 7849-0051
Fax: 020 7849-0132
E-mail: toby.davies@crestco.co.uk
This paper is also available on the Bank’s website at: www.bankofengland.co.uk/mmfuture.htm
4
B.
TERMS OF REFERENCE
The Working Group considered the future of Money Market Instruments and the possibility of
their dematerialisation and integration into CREST. The Working Group focused on the four
main types of MMIs in the Central Moneymarkets Office (CMO): certificates of deposit (CDs),
Treasury Bills, bills of exchange, and commercial paper (CP).
The terms of reference were:
•
To consider the future of MMIs and the options for their integration into CREST.
•
To consider what changes to existing MMIs may be necessary in order to enable their
integration into CREST.
•
To make recommendations on these issues to the Sterling Money Market Liaison
Group, identifying any further work required.
The Working Group considered the main differences between MMIs in CMO and the securities
currently settled in CREST that would need to be addressed in order to enable the integration
of MMIs into CREST:
(i)
MMIs are currently in paper form,( 2) whereas securities in CREST are dematerialised.
(ii)
MMIs are bearer instruments, whereas securities in CREST are registered.
(iii)
MMIs are negotiable. Negotiability is a feature of bearer instruments which does not
apply to the registered instruments in CREST (see Appendix II).
(iv)
MMIs are not fungible ( 3) as each MMI in CMO is a separate bearer instrument, whereas
securities in CREST are fungible (holdings of the same issue can be interchanged).
(v)
MMIs are not settled in an assured payment system, whereas payments for securities in
CREST are assured by the CREST settlement banks.
(2)
CDs in CMO are dematerialised under contractual arrangements involving a deed of covenant executed by
the issuer of each instrument and an agreement entered into by all members of the CMO and CRESTCo.
(3)
A fungible instrument is easily divisible and interchangeable – like gilts which are divisible down to one
penny and are completely interchangeable within an issue. This means that delivery of any part of an issue (for
the correct amount) can fulfil an obligation to deliver some quantity of the issue - so all deliveries of an issue are
fully interchangeable. In this paper fungibility always refers to fungibility within an issue (ie between
instruments with the same characteristics – issuer, maturity date, etc).
5
C.
SUMMARY OF THE PROPOSALS AND RECOMMENDATIONS FOR
FURTHER WORK
Proposals
(i)
MMIs should be integrated into CREST. A single system would enable market
participants to treat MMIs on the same operational basis in settlement as gilts and
equities. A single system could bring also economies of scale and efficiency in back
office systems, thereby facilitating straight-through processing.
(ii)
Existing forms of MMIs should be issued in dematerialised form. The
dematerialisation of MMIs would bring cost savings (no need to print on security
paper). The dematerialisation of existing forms of MMIs should not impede the
development of new types of MMIs (in either dematerialised or physical form). The
DMO is seeking views on the dematerialisation of Treasury Bills (see Section E).
(iii)
Issues of MMIs should be fully dematerialised. Issuers could continue to issue
MMIs in physical form, but such issues would be wholly separate from dematerialised
MMIs in CREST. The Working Group considered that there was little demand for an
interface between paper and dematerialised forms of MMIs.
(iv)
CREST records should serve as the definitive record of ownership of
dematerialised MMIs. The records of holdings in CREST are updated in real time
and could provide the record of the holder of, and transfer of title to, dematerialised
MMIs.
(v)
The same legal structure should apply to holders of dematerialised MMIs as
applies to holders of other dematerialised securities in CREST. There is no
obvious policy case for recommending specific provisions designed to replicate
negotiability for dematerialised MMIs. Although it would be undesirable for the
strength of title to an MMI to be materially affected by dematerialisation, this should
not be the case if MMIs are treated on the same basis as holders of dematerialised
securities under the Uncertificated Securities Regulations, particularly once Electronic
Transfer of Title is in place.
(vi)
There should be further discussions to take forward the objective that assured
payment arrangements (and full Delivery Versus Payment in due course) should
be introduced for MMIs. The dematerialisation (and in some cases simplification) of
MMIs should create a settlement environment in which settlement banks could take an
adequate charge over MMIs and could assure payments on MMIs.
(vii)
The following simplifications to bills of exchange are proposed:
6
-
The abolition of the Bank of England’s underlying transaction requirements for
eligible bills;
-
The abolition of the Bank of England’s clausing requirements; and
-
The abolition of endorsement (as evidenced in use of the “e-field” in CMO) for
dematerialised MMIs (this would not preclude bilateral arrangements between market
participants). This form of endorsement is almost never used for bills in CMO.
Without extra distinguishing features, like endorsement, bills with identical economic
characteristics (the same drawer, acceptor, and maturity date) could be grouped into
fungible issues. The abolition of endorsement would have little impact on current
market practice and would assist the integration of bills into CREST.
(viii)
MMIs should be issued as “issues” (rather than as separate physical instruments).
An issue would represent all instruments with the same features. For discount
instruments an issue would include all instruments with the same issuer and maturity
date. For coupon bearing instruments an issue would include all instruments by the
same issuer possessing the same coupon, coupon payment dates, and maturity
(including accrued interest as necessary).
(ix)
Issues of MMIs should be identified by ISINs. The Working Group considered
ISINs to be the most appropriate identifier for MMIs as they are the internationally
recognised standard numbering system for securities, and are used for all securities in
CREST. In addition, identifying MMIs by ISIN should assist greater efficiency in
back office systems (most of which are based on ISINs).
(x)
Issuers (or their issuing agents) should be able to input new issues of MMIs
directly into CREST. This should enable new issues to be input into CREST quickly,
thus making them available for rapid distribution to the market.
(xi)
Issues of dematerialised MMIs should be fungible. This would allow holdings of
the same issue to be interchanged and divided into smaller holdings. Fungible MMIs
could also bring benefits for the wider market including:
-
A deeper and more liquid market, which in turn could bring cheaper issuance, and better
prices; and
-
A reduction in the number of identifiers which settlement banks would need to track
collateral. This could thereby help to facilitate the introduction of assured payment.
(xii)
Dematerialised MMIs should be denominated in units of one penny, as small
multiples provide maximum flexibility. This would not affect market practices or
conventions dealing with minimum transaction sizes.
(xiii)
These changes should be implemented, as far as practicable, using section 207 of
the Companies Act 1989. This will, of course, be subject to the views of HM
Treasury, and of Treasury Solicitors.
7
Recommendations for further work
•
The method of valuation of MMIs in CREST requires further discussion. This will be a
key issue for settlement banks and for assured payment arrangements (if this is
implemented before full DVP). What reference prices should be used – a price source, a
simple discount to maturity, or an accrued interest approach with a “haircut”?
•
How should MMIs in CREST be grouped for collateral purposes, specifically for the
categories used for DBVs and floating charges? There is a trade-off between the desire
for numerous categories in order to assign appropriate haircuts to different instruments,
and the need to keep the approach to categories for MMI collateral relatively simple.
•
Issuing MMIs directly into CREST would be a significant change from current practice
for CREST. This would have systems implications for CREST, and require an agreed
contractual and legal underpinning. CRESTCo and market participants (issuers and their
issuing agents) need to consider this further.
•
If MMIs are integrated into CREST, how should the transition work? The period of
transition could involve some MMIs being issued under the proposals outlined in this
paper whilst other (existing) MMIs continued as physical, bearer instruments within
CMO. The Working Group considered that transitional issues should be considered
further, but suggested a few preliminary recommendations:
•
All MMIs should be covered by the same transitional arrangements (rather than a
series of separate transitions for different types of MMIs).
•
It may be best to have a period of transition, followed by a “big bang” when remaining
physical MMIs are dematerialised at the same time (or preceded by a big bang for
MMIs with an outstanding maturity longer than the transitional period). This would
allow a large number of MMIs to mature, and any outstanding MMIs could be dealt
with in a big bang which should be more manageable for a smaller number of MMIs.
There would be a number of issues concerning a big bang that would require further
consideration (for example, should dematerialisation be automatic, or should it involve
prior consent).
•
Many legal and legislative issue s will require further detailed work. Treasury Solicitors
need to consider the legislative changes. CRESTCo and its members and settlement banks
would also need to consider their relationships; for example, on the exact legal provisions
for the transfer of title to MMIs in CREST. The Working Group considered that such
detailed questions should be taken forward at a later stage.
•
CRESTCo and market participants will need to consider their preferred timetable for the
integration of MMIs into CREST. This will depend on the legislative timetable, but will
also relate to other priorities and available resources.
•
There are also some general tax points that will need to be agreed with the Inland
Revenue in due course. The Working Group proposed that, as a matter of policy, the tax
treatment of dematerialised MMIs should be the same as for physical MMIs.
8
•
Progress towards the dematerialisation of MMIs may also prompt moves to dematerialise
other instruments. Some members of the Working Group considered that euro CP could
be a candidate for dematerialisation. Members of the Stock Lending and Repo Committee
suggested that, as some stock lenders take Letters of Credit as collateral, it could be useful
for them to be dematerialised as well.( 4) Given its focus on MMIs in CMO, these
questions were not a priority for the Working Group but they were flagged for future
consideration.
(4)
Letters of Credit can be described as an arrangement whereby one bank, acting on instructions from a
customer (the “applicant”), authorises another bank to pay or accept bills of exchange drawn by a beneficiary.
They fall into two categories: “commercial” where the applicant is usually an importer and the beneficiary an
exporter, and “standby” which provides a similar function to a guarantee. Letters of Credit are not negotiable
instruments. The International Chamber of Commerce (ICC) oversees Letters of Credit (or Documentary
Credits) and the Electronic Trade Practices Working Group of the ICC Electronic Commerce Project has held
separate discussions to consider their dematerialisation.
9
D.
DEMATERIALISATION OF MMIs
1
The Working Group recommended the dematerialisation of existing forms of
MMIs. Dematerialisation would bring cost savings as there would be no more need to
administer costly bearer instruments. It should also bring efficiency gains as MMIs could be
combined into issues, rather than being traded as separate instruments. Dematerialising
MMIs, along with some simplification of MMIs, could provide greater liquidity in the money
markets. The following recommendations for dematerialisation apply to Treasury Bills as
well as to CDs, CP and bills of exchange; Treasury Bills are also considered separately in
Section E.
2
One option for achieving dematerialised MMIs under existing legislation would be to
use section 207 of the Companies Act 1989 as amended by the Bank of England Act 1998
(see Appendix I).(5) Section 207 covers the transfer of securities without a written instrument
and specifically provides for the dematerialisation of bearer securities (see subsection 10).
Section 207 empowers HM Treasury to make secondary legislation changes enabling the
dematerialisation of securities (and associated changes) that modify and exclude provisions of
other legislation. The proposed changes to MMIs under the provisions of section 207 are
subject to the views of HM Treasury and Treasury Solicitors.
3
The Working Group considered that the main MMIs in CMO - CDs, Treasury Bills, bills
of exchange, and CP – would all be “securities” for the purpose of section 207. Preliminary
contact with Treasury Solicitors confirms the view that section 207 can probably deliver the
dematerialisation of MMIs and can achieve other objectives relating to the characteristics of
MMIs.( 6) Section 207 effectively requires that the rights and obligations relating to
dematerialised instruments should be as similar to those relating to physical instruments as
practicable, so that some changes to MMIs could be made to enable their dematerialisation and
settlement in CREST. Dematerialised MMIs in CREST would be different from paper bearer
MMIs (for example, they may not have bilateral endorsement – see Section F), but MMIs in
CREST would have those features that market participants considered important.
4
While the Working Group’s focus was on MMIs currently held in CMO, it saw no
obstacles to integrating CDs with a maturity of greater than one year into CREST (these
cannot be held in CMO as CMO does not provide a functionality for dividend processing). As
CREST does support coupon-bearing securities, longer dated CDs could be integrated into
CREST along with other CDs. In addition, CREST could support CDs (and indeed other
MMIs) denominated in currencies other than sterling; CREST currently supports euro and
dollar securities, and other currencies may be added over time. In principle other bearer
instruments with a maturity of over one year (for example, MTNs) could also be
dematerialised and settled in CREST.
(5)
Recently the Bank of England Act 1998 included changes to section 207 of the Companies Act 1989
broadening its scope; the new subsection (10) stipulates that “the reference to transfer without a written
instrument includes, in relation to bearer securities, transfer without delivery.”
(6)
Treasury Solicitors have confirmed that section 207 should be sufficient to deliver the dematerialisation of
MMIs and to achieve the Group’s other objectives relating to the characteristics of MMIs. Treasury Solicitors
stressed that this view was subject to further scrutiny of all the proposals.
10
5
The option of issuing MMIs in dematerialised form would not preclude issuers from
issuing paper bearer MMIs. Some members felt that there would be ongoing demand for
MMIs in bearer form. If there were investor demand for paper bearer MMIs, issuers could
issue paper MMIs in addition to dematerialised MMIs. While issuers and investors would be
free to issue MMIs in paper bearer form, the safe keeping and settlement arrangements for
paper bearer MMIs could be costly if the majority of MMIs were issued in dematerialised
form.
Paper interface
6
Providing an interface between dematerialised and bearer instruments would be costly
and difficult; therefore it would be preferable not to have an interface between dematerialised
MMIs in CREST and paper bearer MMIs outside CREST. The wholesale market could
therefore be wholly dematerialised. This paper therefore proposes wholly dematerialised
issues. As MMIs are rarely withdrawn from CMO or lodged in CMO other than at the time
they are issued, there is apparently no practical need for an interface between dematerialised
instruments in CREST and bearer instruments outside CREST, but the Bank would welcome
views on this. The DMO would like views on the implications for Treasury Bills, see Section
E.
7
The issuance of bearer MMIs could continue alongside the issuance of dematerialised
MMIs into CREST, but bearer MMIs could not be added into CREST, nor could
dematerialised MMIs be withdrawn as bearer instruments.( 7) Any customer demand for
physical bearer instruments could be met by issuing separate physical issues, without
requiring an interface. If there were separate markets for paper MMIs outside CREST, would
it be helpful to continue to have guidelines for such a market (from the Bank or the FSA)?
8
Separate markets for MMIs inside and outside the securities settlement system would
not represent a significant change from current practice as MMIs are rarely moved into and
out of CMO, and as there are already separate markets for dematerialised and paper CDs.(8)
The markets for these different MMIs are already priced differently.
9
An interface with bearer instruments would be difficult to implement and would
reduce the cost savings associated with dematerialisation. Several difficult questions would
arise. How would bearer MMIs be input into CREST? Who would lodge them? How would
records of the securities held in bearer and dematerialised form be reconciled? How would
ISINs be assigned? There could also be difficulties if the legal characteristics of paper
instruments were materially different from dematerialised instruments. Accommodating an
interface could delay the inputting of new issues into CREST which would present a problem
for issuers and investors of MMIs who rely on a quick turnaround for new issues.( 9)
(7)
While CREST and CGO do provide an interface between dematerialised securities and certificated securities,
such certificates are registered, not bearer securities.
(8)
CDs are dematerialised by deed of covenant and contractual agreement in CMO, but a smaller segment of the
CD market is issued in physical form outside CMO.
(9)
The Working Group also considered the option of a one-way interface that enabled members to transfer paper
bearer MMIs into dematerialised form in CREST, but not to take dematerialised MMIs out of CREST. It
concluded that, as with a two way interface, there did not appear to be enough demand to justify the costs this
would entail.
11
10
By contrast, not providing an interface for dematerialised MMIs and bearer MMIs
would provide a number of benefits:
•
A simpler operational structure.
•
A clearer and simpler legal and contractual position.
There are already precedents for fully dematerialised instruments (for example, gilt strips, and
Floating Rate Treasury Stock 2001).
Record of ownership of dematerialised MMIs
11
The Working Group considered that, in addition to dematerialising MMIs, secondary
legislation under section 207 should provide for the transfer of title to dematerialised MMIs
(see subsection 5); Treasury Solicitors’ preliminary view was that this should be possible. It
is proposed that CREST records serve as the definitive record of ownership of
dematerialised MMIs. This would bear some resemblance to plans for Electronic Transfer
of Title of securities in CREST.(10)
12
Certainty of transfer is an important issue for market participants and in particular the
settlement banks. Such certainty of title would enable owners of dematerialised MMIs to
give a charge over such MMIs to their settlement banks, which in turn would be a
precondition for settlement banks to provide assured payment. Detailed discussion on the
exact legal provisions for the transfer of title to MMIs in CREST involving settlement banks
and CRESTCo would need to be taken forward at a later stage.
13
The ability to take security over dematerialised MMIs is also an important issue (see
Appendix III). A key question is whether there is a need to include legislative provisions for
pledging dematerialised MMIs along with other provisions for the dematerialisation of
MMIs.( 11) Members of the Working Group preferred to retain flexibility and to be able to
continue to use existing agreements, including those used for secured lending. It was not
evident that it would be necessary to replicate pledging for this purpose. Charges (fixed and
floating) are generally used, and there appears to be no market demand for pledging.
Negotiability
14
Existing MMIs are negotiable bearer instruments. Negotiable instruments have four
main legal features: they can be transferred solely by physical delivery, they provide the holder
with unchallengeable title, they provide certain benefits in the event of a court action, and they
may include rights against two or more parties (for example, “two-name paper”); see Appendix
II. The position of a holder of a negotiable MMI is different in law from the holder of a gilt or
(10)
CRESTCo and HM Treasury have plans to make CREST records part of the register– CREST records would
serve as evidence of legal title to dematerialised securities, while registrars’ would continue with other
functions. It is hoped that the new arrangements will come into force for UK corporate securities in CREST
during 2000.
(11)
Pledging does not apply to other securities in CREST as they are registered, whereas pledging only applies to
securities where title passes by delivery. For dematerialised MMIs to be subject to pledge, there would need to
be a provision for “deemed delivery” to take place.
12
equity in CREST. This raises questions as to what features of negotiability market
participants find most important, and what provisions should be made for dematerialised
MMIs.( 12)
15
The Working Group considered that the two most important features of negotiability
are strength of claim to title, and the feature of two (or more) name paper (see points 1(b) and
1(d) in Appendix II). Members agreed that, although they did not want the strength of title to
an MMI to be materially affected by dematerialisation, it seemed that this would not be the
case if they were treated on the same basis as holders of dematerialised securities under the
Uncertificated Securities Regulations, particularly once Electronic Transfer of Title was in
place (see below and Part B of Appendix II). The Working Group considered that there was
no obvious policy case for specific provisions to replicate negotiability.
16
The same legal structure should apply to holders of dematerialised MMIs as
applies to holders of other dematerialised securities in CREST. While holders of
dematerialised MMIs would then theoretically be in a different position from holders of bearer
MMIs, members of the Working Group were not able to construct an example in which a
practical difference in a holder’s claim to title to a dematerialised security in CREST and a
paper MMI would arise. The rights of a holder of a dematerialised MMI would in principle
be different from those of a holder of a paper MMI, but the Working Group considered it was
not apparent that in practice there would be any disadvantage to the holder in dematerialised
MMIs being treated on the same basis as registered instruments in CREST, like equities.(13)
17
These views were confirmed by Richard Sykes, QC, when the Bank and CRESTCo
sought his advice on the questions regarding the benefits of negotiability (see Appendix II).
Mr Sykes’ advice supported the view that there is no reason to replicate negotiability for
dematerialised MMIs. In his opinion there is no respect in which a holder of a security in
CREST is worse off than a holder of a negotiable instrument. He considered that a transferee
in CREST has slightly better protection than a transferee of a negotiable instrument against
challenges to the validity of his title based on alleged forgery, defective authority or competing
interests.
Tax
18
There are several issues concerning dematerialised MMIs that will need to be considered
with the Inland Revenue. The Working Group considered that dematerialised MMIs should not
be subject to stamp duty or Stamp Duty Reserve Tax (SDRT). (14) Provided no physical
instrument is created, stamp duty should not be payable on the issue of an MMI. Similarly,
(12)
The question of what elements of negotiability should be retained for dematerialised MMIs involves a vires
question on what changes would be possible using section 207, as subsection (4) requires that “rights and
obligations in relation to securities dealt with under the new procedures correspond, so far as practicable, with
those that would arise apart from any regulations under this section.”
(13)
The Working Group considered that one particular feature of “two name” paper could be retained for
dematerialised MMIs by specific legislative provision. This feature is that a holder in due course may be treated
as having good title to an instrument under which the drawer’s signature has been forged (at least as against the
acceptor and any endorser of that instrument).
(14)
Stamp duty attaches to certain types of written instrument, whereas SDRT applies to agreements to transfer
certain types of securities.
13
transfers of MMIs within CREST should fall outside the scope of stamp duty on the basis that
no physical instrument is created. SDRT should not apply to the issue of dematerialised MMIs
as it normally only applies to the purchase of securities, not to their issue. On transfer,
dematerialised MMIs should not be subject to SDRT because each of the main categories of
MMIs should qualify for an exemption from stamp duty.( 15) As these arrangements would
depend to a certain extent on exactly how the proposed arrangements are implemented, the
Bank will keep these initial views under review with the Inland Revenue.
19
There are various special stamp duty and SDRT charges which can apply when
securities are issued or transferred into a clearing system. However, these types of charges are
not expected to apply to dematerialised MMIs.
20
As a matter of policy, the tax treatment of dematerialised MMIs could be the same as
for physical MMIs. The Inland Revenue’s initial response indicated that where the paper
bearer MMI is of a type that is exempt from stamp duty, there would be no SDRT on the
dematerialised instrument either. The Inland Revenue will be consulted further about the
application of all the tax provisions in due course.
(15)
SDRT is not payable on the purchase of securities where the transfer of those securities is exempt from all
stamp duties. The main MMIs should be exempt: CP and CDs should be exempt as instruments relating to loan
capital; bills of exchange should be exempt as they would fall within a repealed head of charge (in accordance
with the generally accepted stamp duty principle that instruments falling within a repealed head will not be
chargeable under another head); Treasury Bills should be exempt because they fall within a general exemption
from stamp duties contained in Schedule I to the Stamp Act 1891.
14
E.
PROVISIONS FOR DEMATERIALISED TREASURY BILLS
21
Treasury Bills are a specific category of MMI which represent a liability of
HM Government. They are currently issued as individual physical bearer instruments; for
each £1bn nominal of Treasury Bills in issue there are on average 625 separate securities.( 16)
The costs associated with the production of the physical bills, including the cost of secure
printing, safe-keeping and other necessary security arrangements, are significant. HM
Government currently bears these initial costs.
22
The majority of Treasury Bills are held in “immobilised” form in CMO; investors’
interests are evidenced by entries in CMO’s electronic records but the physical bills
underlying these interests are held in the depository provided by the Bank of England.
Immobilisation allows settlement of trades in a secure environment and provides an electronic
record of title. However, immobilisation does not offer all the benefits of dematerialisation.
For example, it does not allow fungibility of issues or provide an assured payments facility.
23
In keeping with the recommendations in this paper, the intention is that, in the
future, the DMO would issue Treasury Bills in dematerialised form, on behalf of HM
Government. Thus Treasury Bills would be issued in accordance with the proposals outlined
herein, and it is intended that Electronic Transfer of Title would apply. This will bring all the
benefits associated with dematerialisation referred to in Section D above, including reduced
costs, operational efficiencies, fungibility, development of an assured payments system, etc.
24
However, as suggested in paragraph 5 above, if respondents felt it was necessary,
holders could have the option to receive bearer Treasury Bills on issue. If Treasury Bills were
available in physical as well as dematerialised form, holders of physical Bills would need to
make their own arrangements for the safe-keeping of their securities and they would need to
bear the costs associated with supplying them with these physical assets. These costs are likely
to be higher than the costs they face today as they will be shared amongst fewer investors(17)
and because it is unlikely that HM Government will contribute to such costs. In addition, the
physical Bills would not be fungible with the dematerialised Bills and would trade in a separate
market. This market is likely to be considerably less liquid than the market for dematerialised
Bills. Respondents’ views are sought on the possibility of retaining the option to receive
physical Treasury Bills.
25
It is not envisaged that CREST will provide any interface between physical and
dematerialised securities. If an interface was to be provided for Treasury Bills, then it is
likely that HM Government would provide it. Any interface would complicate settlement
and, as outlined in paragraph 9, would reduce the benefits of dematerialisation. Any change
in the type of Treasury Bill (physical to dematerialised or vice versa) would require the
(16)
Treasury Bills are issued in a range of denominations and must be traded as separate securities. Successful
bidders at Treasury Bill tenders currently choose which denominations they receive on issue. The available
denominations are £5k, £10k, £25k, £50k, £100k, £250k, £500k, £1mn, £5mn and £10mn nominal value.
(17)
The majority of the market is likely to prefer the dematerialised form.
15
original Bill to be cancelled and then to be reissued in the alternative form. This would take a
number of days and, consequently, would give rise to a non-standard settlement cycle where
investors wanted to hold the securities in the alternative format. This would add to
uncertainty in the market as the amount of Treasury Bills held in each form would change day
to day and might reduce liquidity in the overall market. Additionally, those holders who
chose to change the form of the Bills they held would need to meet the costs associated with
administering that change; these would be considerably larger than the transaction costs they
face today.
26
Consequently, HM Government is not actively considering providing such an
interface. Respondents’ views are sought on the recommendation that there should be no
interface between physical and dematerialised Treasury Bills.
27
The DMO would also welcome views on the proposals for the dematerialisation of
Treasury Bills outlined above.
16
F.
SIMPLIFICATION OF BILLS OF EXCHANGE
28
Bills are issued under the Bills of Exchange Act 1882, and their issuance details
typically reflect the requirements for eligibility in the Bank of England’s open market
operations (OMOs).(18) Bills differ from most other MMIs in that they have at least “two
names” – that of the drawer and acceptor. In addition, unlike other MMIs, a bill may be
unique due to its history of endorsement.(19)
29
HM Treasury should be able to use section 207 to make changes to the Bills of
Exchange Act to dematerialise bills of exchange. Section 207 effectively requires that the
rights and obligations relating to dematerialised instruments should be as similar to those
relating to physical instruments as far as practicable. The Working Group considered
therefore that section 207 would provide HM Treasury with the vires to simplify bills of
exchange where such changes enabled the integration of MMIs into CREST and facilitated the
achievement of fungibility.
30
As the specific features of bills of exchange raise problems for their integration into
CREST, the Working Group recommended several simplifications. Without extra
distinguishing features like endorsement, bills with identical economic characteristics (the
same drawer, acceptor, and maturity date) could be grouped into fungible issues. If bills were
fungible, identical bills in the same issue would be interchangeable (it is not envisaged to
group securities with different characteristics). It is estimated that the approximately 7,000
bills currently held in CMO could be consolidated into less than half that number of issues if
bills were fungible (see Table in Section G).
Underlying transaction and clausing requirements
31
The Working Group recommended that the underlying transaction and clausing
requirements for bills of exchange to be eligible in the Bank of England’s operations be
dropped. These changes to bills of exchange would not require legislative changes. The
Bank could continue its other requirements for bills of exchange to be eligible in its
operations. The Bank will consider whether to drop its clausing and underlying transaction
requirements in advance of taking forward other changes to MMIs.
32
The underlying transaction requirement stipulates that the bill should be drawn against
a short term, self liquidating transaction. So, for example, a bill could not be drawn for capital
purposes. Market feedback indicated that this requirement is not credit enhancing in the
absence of a collateral relationship between the bill and the transaction. The proposed
change would mean that drawers would be able to draw bills for whatever purpose they liked,
(18)
The Bank’s eligibility requirements are set out in the Bank’s Notices of 4 August 1981 and 17 November
1981; and in a letter to market participants of 13 August 1981. They are also summarised in the Bank’s
Operational Notice of June 1999.
(19)
Endorsement can be spelled with either an “e” or “i”. While the Bills of Exchange Act 1882 uses
“indorsement”, this paper uses the more common spelling of “endorsement”.
17
with the proviso that the accepting bank would, as now, have to be satisfied with the
creditworthiness of the drawer before agreeing to accept a bill.
33
The clausing requirement stipulates that the bill should describe the underlying
transactions thus evidencing compliance with the underlying transaction requirement. In
practice implementation of the clausing requirement is administratively cumbersome, and
increases the risk of a bill being rejected for trivial reasons. If the underlying transaction
requirement were dropped, the need for clausing would fall away.
Endorsement
34
Endorsement is the process in which a person accepts liability on a bill to holders in
due course of a bill by signing the bill.(20) The CMO system currently provides an “e-field”
for bills that shows the endorsement status for any particular instrument; however this field is
very rarely used. Some market participants may use bilateral undertakings to endorse outside
the CMO. There is a difference between endorsement on the e-field (or in the traditional paper
form) which apply to all subsequent purchasers of a bill, on the one hand, and, on the other,
undertakings to endorse which are purely bilateral and cannot be relied upon by a subsequent
purchaser of a bill.
35
The Working Group considered that, in practice, endorsement was not widely used or
considered important. Many members felt that the accepting bank was the most important
feature of a bill and that market participants rarely look at the drawer of a bill; nor do they rely
on endorsement. On this basis, the Working Group considered that endorsement could be
dropped (see also Appendix IV). The Working Group had no wish to see the adoption of
multilateral endorsement agreements, or any other replacement for traditional endorsement.
36
Abolishing endorsement would simplify bills of exchange. In addition, bills would
continue to be eligible in the Bank’s operations and for sterling stock liquidity, and should
continue to provide a useful source of funding for issuers. The Working Group noted that the
Bank would continue to require bilateral endorsements from its counterparties on bills sold to
it, but that its position could be distinguished from the generality of market participants.( 21)
(20)
Endorsement is used here in the special sense referred to in section 56 of the Bills of Exchange Act 1882.
Since all bills which qualify as money market instruments are bearer instruments, negotiation does not involve
endorsement in the strict sense; section 56 provides that when a person signs a bill otherwise than as drawer or
acceptor, he thereby incurs the liabilities of an endorser to a holder in due course. Such an “endorsement” does
not arise automatically on negotiation of a bearer instrument.
(21)
The Bank effectively seeks a “third name” on bills of exchange as – unlike other market participants – the
Bank does not have limits by acceptor on the bills it takes in its operations and can thereby incur large exposures
to accepting banks (although the Bank does set the overall limits on the quantity of bills a bank can accept). The
additional comfort provided by the counterparty’s name is therefore required.
18
G.
ISSUANCE AND SETTLEMENT OF DEMATERIALISED MMIs
37
The following reforms are proposed in order to provide for efficient issuance and
settlement of MMIs.
Issuing MMIs as fungible issues
38
MMIs should be issued as issues (rather than as separate physical instruments).
An issue would represent all instruments with the same features including that they are issued
on the same day (although this is not a necessary condition, see discussion on re-opening of
issues below), by the same issuer, with the same price (reflecting either the coupon rate or rate
of discount), and with the same maturity. This would significantly reduce the number of
instruments that market participants and CREST would have to track (see Table). For
example, 3,000 separate Treasury Bills could be consolidated into 30 issues. This should be
more convenient and efficient.
39
This need not involve any changes to current issuance practice; it would simply
involve grouping identical instruments into a single issue. Issuers could issue in exactly the
same way as they do now, but their issues could be represented by a single pool of securities
rather than by several pieces of paper with identical characteristics.
Table: Estimate for the consolidation of MMIs into issues
Type of instrument
Separate instruments in CMO
Separate issues in CMO
Treasury Bills
3,000
30
Eligible Bank Bills
6,500
3,200
20
10
Bank CDs
50,000
6,700
Building Society CDs
2,000
500
Ineligible Bank Bills
40
Issues of dematerialised MMIs should be fungible so that holdings of the same
issue can be interchanged and divided into smaller holdings. Fungible MMIs could also
bring benefits for the wider market including:
- Enabling MMIs to be identified by ISINs which would assist greater efficiency in back
office systems (most of which are based on ISINs) and could help in the development
of straight-through processing – see below;
- A deeper and more liquid market; and
- Fungibility could facilitate the introduction of assured payment (as it would reduce the
number of identifiers which settlement banks would need to track as collateral).
41
Discussions within the Working Group suggested that MMIs issued at different times
could be fungible, provided they have the same issuer and cash flows (like tranches of gilts
when an issue is re-opened). This would provide issuers with additional options, but would
not require any change to current practice. Some issuers may want to avoid having too many
19
securities maturing on any single day. The DMO would want to have the option of reopening issues of Treasury Bills.
42
Re-opening an issue of a discount instrument would be simpler than re-opening a
coupon-bearing instrument, but issuers should have the option to re-open issues as they
choose (for example, see Appendix V). Some issuers of CDs may, for example, wish to
issue discount CDs. It was noted that in London CDs had been issued on a discount basis in
the early stages of the market. The Working Group considered that some issuers could
consider issuing further CDs to add to an existing issue – in a similar fashion to tapping a
gilt, and that some issuers may want to issue “benchmark” CDs. Some members felt that a
mixed market of discount and coupon-bearing CDs could be confusing, but others considered
that it would not be confusing as they could trade on a yield basis.
43
Dematerialised MMIs should be denominated in units of one penny as small
multiples provide maximum flexibility. This would not affect market practice (for
example, pricing in fractions of a penny) or conventions dealing with minimum transaction
sizes.
Inputting new issues of MMIs into CREST
44
Issuers (or their issuing agents) should be able to input new issues of MMIs
directly into CREST (rather than having CRESTCo administer new issues centrally). This
would follow from current practice in CMO and should enable issuers to issue at short notice
with a quick turnaround (rather than going through central administration in CREST which
would be time-consuming). This would constitute a significant change from current practice
for CREST and would have systems implications. It would also entail new contractual
responsibilities for issuers and their agents.
45
Issues of dematerialised MMIs should be identified by ISINs. The Working
Group concluded, after discussions between CRESTCo, the Bank, and the London Stock
Exchange, that ISINs were the appropriate identifier for dematerialised MMIs.
46
Market feedback suggested that issuers’ requirements for numbering MMIs would be:
- High speed and frequency
- Ability to cope with large volumes
- Immediate / same day issuance - this process should take only a matter of minutes.
47
These requirements could be met by CREST assigning an ISIN to a new issue as part of
the new issues input process (see Appendix VI). As noted, using ISINs (rather than some other
identifier) to identify MMIs in CREST would provide harmonised settlement practice for all
securities in CREST, which could in turn lead to greater settlement efficiency and a higher
degree of automation and efficiency in back office systems (most of which are based on ISINs).
ISINs would also be needed as practical identifiers: for example, in order for a settlement bank
to identify exactly what MMIs a customer has charged to it. In addition, ISINs are the
internationally recognised standard numbering system for securities, and are used for all
securities in CREST. ISINs are already used to identify MMIs in France and Italy.
20
Information on ISINs
48
Members of the Working Group agreed that full information on issues of MMIs
identified by ISIN should not be publicly available from CRESTCo. When market
participants make an enquiry citing the relevant ISIN, they should have access to some
information on the issue (for example, the issuer’s name), but not the full details of the issue.
It could be detrimental to the market if issuance information (for example, the size of issues of
MMIs) were widely available in all cases and issuers’ particular borrowing positions were
evident. Providing access to limited information on ISINs for MMIs would be consistent with
current CREST and Stock Exchange arrangements for ISIN queries for other securities.
49
Under current arrangements, members of CREST can make enquiries of CREST about
details of securities in CREST (a Security Full Details Request). When members of CREST
make an enquiry citing an ISIN, they have access to a range of information, but only a limited
number of information fields are always provided (these include the security abbreviation,
security start date, and security category ID fields). What information has to be provided will
depend on the characteristics of the relevant security (for details see Appendix VI). All
CREST members receive the same set of security details in response to a Security Full Details
Request (regardless of whether or not they hold the security). This same approach to
information disclosure could apply to the ISINs for MMIs.
50
In addition, the Stock Exchange (as the UK numbering agency responsible for assigning
ISINs) would have information on ISINs for MMIs provided by CRESTCo and would make
such information available in response to ISIN queries. (Any queries with regard to ISINs
allocated to MMIs should be directed initially to CRESTCo.) Under the Stock Exchange’s
current arrangements for ISIN queries (for bonds and equities) only the main security details
(issuer, description, payment and maturity dates) are made available in response to an ISIN
query. Many details including the issue size are not available from an ISIN query. Thus the
Stock Exchange’s current arrangements for providing information on ISINs should also be
appropriate for MMIs.
51
The same arrangements as already apply to bonds and equities should be applied
to MMIs – providing certain key information while allowing issuers discretion as to
whether or not to include other details. The Bank would welcome further views on this issue.
21
H.
INTEGRATION OF MMIs INTO CREST AND NEXT STEPS
52
Provided that market participants are broadly content with the above proposals for the
integration of MMIs into CREST, the following areas for further work should be taken
forward.
Transitional issues
53
If MMIs are integrated into CREST, how should the transition work? A number of
transitional issues are set out in Appendix VII which will need to be considered further.
Treasury Solicitors would need to consider any necessary transitional legislative provisions
for the dematerialisation of MMIs.
54
The Working Group made some preliminary recommendations:
(i)
All MMIs should be covered by the same transitional arrangements (rather than a
series of separate transitions for different types of MMIs).
(ii)
It may be best to have a period of transition, followed by a “big bang” when
remaining physical MMIs are dematerialised at the same time (or preceded by a
big bang for MMIs with an outstanding maturity longer than the transitional
period). A period of around six months parallel running of CMO and CREST
would allow many existing MMIs to mature (Treasury Bills, many CDs, and most
bills as they have a maturity of under 187 days), while new issues could be issued
directly into CREST. After the transition period any outstanding bearer securities
with longer maturities (up to five years in the case of some CDs), could be
dematerialised under a legislative provision for the transformation of bearer
securities to dematerialised form.
(iii)
A big bang should be more manageable for a smaller number of paper MMIs;
hence it would be easiest if it only applied to those (relatively few) MMIs with
longer outstanding maturities.
55
Issues requir ing further consideration include:
(i)
The length of the notice period.
(ii)
The length of the transition period of parallel running and the costs involved.
(iii)
The transitional regulations would need to recognise two types of MMIs and
would need to provide a legislative framework for the transfer of MMIs to CREST
(for example, using Properly Authenticated Dematerialised Instructions).
(iv)
How the rights of holders of MMIs and provisions covering mandatory or
consensual dematerialisation would be included in the regulations for transition.
56
In addition, CRESTCo and market participants would need to consider their preferred
timetable for the integration of MMIs into CREST. This would depend on the legislative
timetable, but would also relate to other priorities and available resources.
22
Valuations and reference prices
57
One outstanding issue concerns the valuation of MMIs in CREST. What reference
price would apply to MMIs? And how would MMIs be grouped?
58
How should MMIs in CREST be grouped for collateral purposes (for example,
assembling DBVs and settlement bank floating charges over collateral)? The Working Group
recognised the trade-off between the desire for numerous categories in order to assign
appropriate haircuts to different instruments, and the need to keep the approach to categories
for MMI collateral relatively simple. Currently CREST divide their securities into three
baskets: FTSE 100 securities, FTSE 250 securities, and all other securities (and additional
categories will be added for additional types of securities in CREST). These baskets are
based on the FTSE indices. But who would assess and group MMIs? There would clearly be
sensitivities for issuers on their issues’ credit rating and status. Settlement banks would need
to find a solution that provided for simplicity of process as well as allowing adequate
differentiation between instruments.
59
What reference price should be used? The alternatives include a price source, a
simple discount to maturity or an accrued interest approach? Grouping all bills in a single
basket with a single reference price may be an option (this would be comparable to the Bank
of England’s policy, in its open market operations, of buying all outrights with the same
maturity at the same price). An alternative could be to use a simple accrued interest or
discount to maturity calculation to value MMIs. The Bank of England, for example, buys
bills outright based on a simple discount formula using the repo rate and days until maturity.
There could be scope for similar simple arrangements for the valuation of MMIs. But
achieving this simplicity might necessitate a larger standard “haircut” for credit risk.
New issues
60
Issuing MMIs directly into CREST would be a significant change from current
practice for CREST. This would have systems implications, and would require an agreed
contractual and legal underpinning. CRESTCo and market participants (issuers and their
issuing agents) would need to consider this further.
Dematerialisation of other instruments
61
Progress towards the dematerialisation of MMIs may also prompt moves to
dematerialise other instruments. Some members of the Working Group suggested that euro
CP could be a candidate for dematerialisation. The Stock Lending and Repo Committee
suggested that, as some stock lenders take Letters of Credit as collateral, it could be useful for
them to be dematerialised as well. The Bank would welcome further views on these points.
Market structure issues
62
The dematerialisation of MMIs raises new opportunities for money market participants,
particularly for the future of the secured lending market. There could be new market structure
23
issues such as looking into the possibility of introducing a repo market for MMIs which would
be compatible with same day settlement – for example, introducing DBVs for MMIs in CREST.
Legislative and tax issues
63
Many legal and legislative issue s will require further detailed work. Treasury Solicitors
would need to consider the necessary legislative changes. CREST and its members and
settlement banks would also need to consider their relationships; for example, on the exact legal
provisions for the transfer of title to MMIs in CREST. These points will be taken forward at a
later stage.( 22)
64
As noted above, there are also some general tax points that will need to be agreed
with the Inland Revenue.
(22)
For example, the Uncertificated Securities Regulations currently contain several provisions placing statutory
duties on participating issuers. Many of these are parallels of the requirements in the Companies Acts relating
to the keeping of registers etc by companies. It will be for discussion as to whether any, and if so how many, of
these provisions should apply to issues of money market instruments.
24
APPENDIX I
SECTION 207 OF THE COMPANIES ACT 1989
(AS AMENDED BY THE BANK OF ENGLAND ACT 1998)
COMPANIES ACT 1989
Part IX
Transfer of Securities
Section 207 Transfer of securities
“(1)
The Secretary of State( 23) may make provision by regulations for enabling title to
securities to be evidenced and transferred without a written instrument.
In this section –
(2)
(a)
“securities” means shares, stock, debentures, debentures stock, loan stock,
bonds, units of a collective investment scheme within the meaning of the
Financial Services Act 1986 and other securities of any description;
(b)
references to title to securities include any legal or equitable interest in
securities; and
(c)
references to a transfer of title include a transfer by way of security.
The regulations may make provision –
(a)
for procedures for recording and transferring title to securities, and
(b)
for the regulation of those procedures and the persons responsible for or
involved in their operation.
(3)
The regulations shall contain such safeguards as appear to the Secretary of State
appropriate for the protection of investors and for ensuring that competition is not
restricted, distorted or prevented.
(4)
The regulations may for the purpose of enabling or facilitating the operation of the
new procedures make provision with respect to the rights and obligations of persons
in relation to securities dealt with under the procedures.
But the regulations shall be framed so as to secure that the rights and obligations in
relation to securities dealt with under the new procedures correspond, so far as
practicable, with those which would arise apart from any regulations under this
section.
(23)
The Transfer of Functions (Financial Services) Order 1992, SI 1992 No 1315 transferred these functions
from the Secretary of State for Trade and Industry to the Treasury.
25
(5)
The regulations may include such supplementary, incidental and transitional
provisions as appear to the Secretary of State to be necessary or expedient.
In particular, provision may be made for the purpose of giving effect to –
(6)
(7)
(a)
the transmission of title to securities by operation of law;
(b)
any restriction on the transfer of title to securities arising by virtue of the
provisions of any enactment or instrument, court order or agreement;
(c)
any power conferred by any such provision on a person to deal with securities
on behalf of the person entitled.
The regulations may make provision with respect to the persons responsible for the
operation of the new procedures –
(a)
as to the consequences of their insolvency or incapacity, or
(b)
as to the transfer from them to other persons of their functions in relation to
the new procedures.
The regulations may for the purposes mentioned above –
(a)
modify or exclude any provision of any enactment or instrument, or any rule
of law;
(b)
apply, with such modifications as may be appropriate, the provisions of any
enactment or instrument (including provisions creating criminal offences);
(c)
require the payment of fees, or enable persons to require the payment of fees,
or such amounts as may be specified in the regulations or determined in
accordance with them;
(d)
empower the Secretary of State to delegate to any person willing and able to
discharge them any functions of his under the regulations.
(8)
The regulations may make different provision for different cases.
(9)
Regulations under this section shall be made by statutory instrument; and no such
regulations shall be made unless a draft of the instrument has been laid before and
approved by resolution of each House of Parliament.
(10)
In subsection (1), the reference to transfer without a written instrument includes, in
relation to bearer securities, transfer without delivery.”
26
APPENDIX II
NEGOTIABILITY
A. Introduction
Features of negotiability
1
Negotiable instruments have the characteristics described below. These characteristics
confer certain advantages over instruments which are not negotiable.
(a)
A negotiable instrument may be transferred by physical delivery (or in the case of an
instrument payable to order by endorsement and delivery of the instrument) without
the need for a separate written document of transfer or notice to the original debtor.
This is in contrast to the general requirement of English law that assignments (of debts and
other contractual rights) must be in writing and signed by the transferor and notice must be
given to the debtor.( 24) In the absence of such notice, the original debtor may acquire
rights against the original creditor which can be set off against both the original creditor
and any subsequent assignees (until notice is given). In addition, the original creditor may
assign the same right to another person who, if he is unaware of the earlier assignment and
gives notice to the original debtor, will have priority over the first assignee.
(b)
A negotiable instrument is transferable so as to confer upon its holder an
unchallengeable title, i.e. free of any defects in the title of his transferor or of prior
transferors.
A transfer of a non-negotiable instrument is “subject to equities”. This means that a
transferee has no guarantee that his transferor has a good title to give him. Thus, for
example, a transferor who has obtained an instrument by fraud from a previous holder
may not have a good title to transfer. The transferee of a negotiable instrument will,
nevertheless, receive good title irrespective of any defect in title of the transferor
provided that the transferee has taken the instrument in good faith for value and without
notice( 25) of any previous defect in the transferor’s title. Such a transferee is known as
the “holder in due course” of the instrument. It is this feature which makes an
instrument “negotiable”.
(c)
A negotiable instrument benefits from a number of evidential and procedural
advantages in the event of a court action.
These include the avoidance of counterclaims and a presumption of consideration.
Thus it is not necessary for the holder of a negotiable instrument to introduce
evidence of the transaction in respect of which the instrument was originally issued,
nor can any matters in dispute in relation to that transaction be raised as a ground for
resisting payment on the instrument.
(d)
The rights created and transferred by a negotiable instrument may include rights
against two or more parties.
The simplest form of negotiable instrument represents an obligation of a single party.
MMIs of this kind include Treasury Bills and CDs. A negotiable instrument may also
represent obligations of two or more parties, and further parties may be added while it
(24)
See sections 53(1)(c) and 136 of the Law of Property Act 1925 (which are disapplied for CREST by
regulation 32(5) of the Uncertificated Securities Regulations 1995).
(25)
Notice for this purpose means actual notice or a means of notice wilfully disregarded or imputed notice
(which might arise where it is acquired by an agent of the holder with actual or apparent authority to receive
such notice).
27
is current. Thus a bill of exchange represents a primary liability of the acceptor (in
the case of MMIs, this will be the accepting bank) and also a liability, comparable to
that of a guarantor, of the drawer. Anyone who subsequently endorses( 26) the bill will
also assume a liability comparable to that of a guarantor. In addition, a transferor by
delivery who negotiates a bill thereby warrants to his immediate transferee who is a
holder for value of the bill that (i) the bill is what it purports to be, (ii) the transferor
has a right to transfer the bill, and (iii) at the time of the transfer the transferor is not
aware of any fact which renders it valueless.( 27)
The fact that bills constitute “two name” paper has hitherto been regarded as
important. It was also formerly common practice in the discount market for bills to be
transferred with the endorsement of the transferor, and the CMO system includes a
procedure which permits this feature to be replicated under the immobilised structure.
Effect of dematerialisation
2
In its pure form, “dematerialisation” involves dispensing with any form of written
instrument so that the relevant obligation is evidenced solely by entry on an electronic
record.(28)
3
Because delivery of a physical instrument is a key element of the traditional concept of
negotiability, absent special provision in legislation or contract (for example, under the CMO
agreements for dematerialised CDs), an instrument must exist in physical form if it is to be
negotiable. Without specific legislative provision retaining some or all of the attributes of
negotiability for dematerialised instruments,(29) dematerialisation of MMIs would result in the
loss of negotiability.
4
In assessing the impact of the loss of negotiability, it should be noted that the inherent
features of a dematerialised instrument to some extent reproduce characteristics of negotiability.
5
Of the characteristics discussed above, (a) and (b) are the most important.
(a)
By definition, a dematerialised system will involve transfer without the need for a
written instrument. Accordingly, holders of dematerialised MMIs would in this
respect be in the same position as holders of negotiable instruments.
(b)
The question of whether a transferee under a dematerialised system would be
significantly more exposed to claims based on alleged prior defects in title in the
absence of provisions expressly treating him as the equivalent of a holder in due
course is more complex and depends on the effect of the Uncertificated Securities
Regulations 1995, which govern the operation of the CREST system. The issue is
(26)
Since an MMI is a bearer instrument, a transferor does not need to endorse it in order to negotiate it, but if he
does so he assumes the liabilities of an endorser to a holder in due course (see section 56 of the Bills of
Exchange Act 1882).
(27)
Bills of Exchange Act 1882, section 58(3).
(28)
This is to be contrasted with “immobilisation”, an intermediate form of dematerialisation, under which the
relevant obligations are represented by physical instruments which are lodged with a depository and investors’
interests are evidenced by entries on electronic records of the depository. With the exception of CDs, MMIs
currently held in the CMO are in immobilised form, the underlying physical instrument being held by the Bank
of England as depository. CDs are issued in dematerialised form under contractual arrangements involving a
deed of covenant executed by the issuer of each instrument and an agreement entered into by all the members of
the CMO and CRESTCo.
(29)
It is expected that such provision could be made in the form of regulations under section 207 of the
Companies Act 1989.
28
most likely to arise where there has been a defective issue by the drawer or a forged
transfer of an instrument or where there have been conflicting dispositions by the
owner of an instrument.
Theft/forged transfer
6
In a fully paper-based system, a person may be a holder in due course of, and
therefore be treated as having title to, a negotiable instrument which has previously been lost
or stolen. This is because the holder of a bearer instrument is the person in actual possession
of it. A holder in due course may also be treated as having title to an instrument under which
the drawer’s signature has been forged, at least as against the acceptor and any endorser of
that instrument.( 30)
7
Under an immobilised system, the question arises whether a forged computerised
instruction which causes the records of the system to be altered so as to show a different
person as holder is effective. This depends on the terms of the contract between the
depository and the members. In the case of the CMO, the Membership Agreement makes it
clear that it is the person to whose account a CMO instrument is in fact credited who is
treated as the holder.( 31) This matches the relatively favourable treatment of transferees and
actual holders under the general law.
8
Under a fully dematerialised system governed by the 1995 Regulations, the position
depends on the effect of regulation 29 of those regulations, which contains provisions
protecting the system operator and other addressees of a “properly authenticated
dematerialised instruction” from liability for acting on such an instruction which proves to
have been defective and prevents the system-member from denying the correctness of the
information contained in the instruction or that the instruction has been sent by him or with
his authority.
9
The Working Group consulted Counsel on the difference between the position of a
holder of instruments in the CMO (or in paper form) and the position under the 1995
Regulations (in particular regulation 29). A note of Counsel’s advice is reproduced at
Section B of this Appendix. Counsel concluded that a transferee under the CREST system is
in at least as good a position as a person to whom a paper instrument is negotiated.
Competing claims
10
In relation to a dispute about title stemming from other adverse claims such as claims
arising from conflicting dispositions by the owner of the instruments (e.g. where the owner
purports to charge the instruments to more than one party), the priority of claims by different
third parties are likely to depend on whether a subsequent transferee of the instrument took
delivery of the instrument in good faith without notice of any competing claim. This is
broadly the test both in relation to negotiable instruments and under the general law
governing equitable interests (which would be relevant in the case of other securities such as
shares). The tendency of the courts in recent years has been to adopt a common approach to
what is treated as “notice” for this purpose both in the context of negotiable instruments and
under the general law.
11 Counsel considered this issue also and concluded that a person taking a transfer of a
security through the CREST system is in at least as good a position as regards notice of
(30)
By virtue of sections 54(2)(a) and 55(2)(b) of the Bills of Exchange Act 1982.
(31)
This does not, however, necessarily constitute the transferee a holder in due course, since this status depends
on the transferee’s notice (actual or implied) of any prior defect in title of the relevant instrument.
29
defects in title as a person to whom a paper instrument is negotiated (and indeed that his
position is if anything slightly better). This conclusion resulted partly from regulation 29 and
partly from the effect of the “escrow” functionality in the CREST system, as a result of which
the risk of a transferor creating an equitable interest in a dematerialised instrument in a
manner which could be regarded as putting a CREST transferee on inquiry is minimal.
30
B. Note of a consultation with Mr Richard Sykes QC
SECTION 207 OF THE COMPANIES ACT 1989 AND DEMATERIALISATION
OF MONEY MARKET INSTRUMENTS
NOTE of a consultation with Mr Richard Sykes QC at Erskine Chambers, Lincoln’s Inn on
20 July 1999.
Present were Mr John Rippon and Mrs Caroline Pitt of the Bank of England, Mr Toby Davies
of CRESTCo, Mr Mark Evans of Travers Smith Braithwaite and Messrs Guy Morton and
Michael Raffan of Freshfields.
Counsel gave his opinion on the two specific questions identified below.
1.
The effect of regulation 29 of the Uncertificated Securities Regulations 1995: are
there any circumstances in which a transfer effected as result of a properly
authenticated dematerialised instruction which is shown to be forged or
unauthorised may be reversed as against (i) the transferee or (ii) a person who
has become the holder of the relevant securities as a result of a subsequent
transfer the validity of which is not in question?
In Counsel’s view, the answer to this question was “no”.
Counsel considered that regulation 29 was clear and that there was no doubt that a forged
properly authenticated dematerialised instruction would fall within it; this was apparent, in
particular, from the phrase “expressed to have been sent”. Regulation 30 was also relevant in
providing a limited remedy against the system operator (which did not include reversal of the
transfer); in Counsel’s view, this provided further support for the conclusion that a transfer
which was made as a result of a forged properly authenticated dematerialised instruction
could not be reversed. Counsel did not consider that this conclusion was affected by the fact
that regulation 30 referred to a “forged dematerialised instruction” rather than a “forged
properly authenticated dematerialised instruction”.
Counsel agreed with instructing solicitors’ view that a transferee under the CREST system is
in at least as good a position as a person to whom a paper negotiable instrument is negotiated,
since under the CREST system the time for determining whether the transferee has notice of
any defect in the title of the transferor is earlier than the actual credit of the instrument to the
transferee’s member account. In addition, regulation 29(5) requires actual notice.
2.
Whether, how and to what extent would the absence of provisions replicating
negotiability in any regulations providing for the dematerialised transfer of money
market instruments through the CREST system affect the circumstances in which the
title of a transferee of such instruments could be challenged on the basis of prior
dispositions of, or interests in, the relevant instruments?
In Counsel’s view, there was no separate test of notice for negotiable instruments. Counsel
preferred to avoid the use of the term “constructive notice”; except in the context of title to
land, where the term “constructive notice” had a specific meaning, he regarded the labels of
“actual” or “constructive” notice as unhelpful, since their precise meaning was often unclear.
31
In Macmillan Inc. -v- Bishopsgate Investment Trust plc [1995] 3 All ER 747, Millett J
described constructive notice as including notice of such facts as a person would have
discovered if he had taken proper measures to investigate them. The key question was
therefore: what “proper measures” of investigation could a transferee (whether of a
negotiable instrument or of a security transferable through the CREST system) be expected to
take?
In the context of negotiable instruments, the answer to the question was in Counsel’s view
“none”, unless the transferee was actually aware of facts which put him on inquiry by
indicating that the position was not as it should be. If there were such indications, the
position remained as laid down in London Joint Stock Bank -v- Simmons [1892] AC 201,
where Lord Herschell stated that a transferee of an instrument must have regard to the facts of
which he had notice and must act in good faith, and that he would not be acting in good faith
if he shut his eyes to obviously suspicious circumstances.
In Counsel’s view, the answer to the question was the same in the context of transfers
through the CREST system. A person taking a transfer of a security through the CREST
system was therefore in at least as good a position as regards notice of defects in title as a
person to whom a paper negotiable instrument was negotiated; indeed his position was if
anything slightly better. This was not only because of the requirement for actual notice in
regulation 29(5), but because the risk of a transferor creating an equitable interest in an
instrument in a manner which could be regarded as putting a CREST transferee on inquiry
was minimal as a result of the “escrow” and related functionality available in CREST.
This functionality allows a member to transfer securities to an “escrow sub-account” (which
is a sub-account of his member account). Although the securities so credited remain in the
name of the member, the legal title to the securities may only subsequently be transferred in
response to a properly authenticated dematerialised instruction received by the system from
the escrow agent’s CREST Gateway. The “escrow agent” for this purpose will be a CREST
member and will be the person who is intended to have an equitable interest in the securities
credited to the escrow sub-account (or the nominee of such a person). Securities which are
freely at the disposal of a CREST member are credited to that member’s “available balance”
in his member account. In this way, the CREST system minimises the risk that a transfer of
legal title to CREST securities will be effected otherwise than on or with the instruction,
authority or consent of the person who has the right to effect such a transfer free from any
prior equitable interest.
The availability of similar functionality in the system for dematerialised money market
instruments makes it likely that, where instruments are not required to be transferred to an
escrow balance under the control of the person claiming an equitable interest in them, such a
person would not be able to claim successfully that a subsequent transferee of such an
instrument was put on inquiry as to his equitable interest so as to take title subject to it.
Approved
Richard Sykes
Erskine Chambers
Lincoln’s Inn
29 July 1999
32
APPENDIX III
TAKING SECURITY OVER DEMATERIALISED MMIs
1
It is envisaged that provision would be made under English law for the creation,
holding and transfer of money market instruments in dematerialised form. Such MMIs would
be held and settled in the CREST system, subject to regulations made under section 207 of
the Companies Act 1989 (referred to in this Appendix as the MMI Regulations), and the
CREST records would constitute evidence of entitlement. It is further envisaged that the
system would incorporate an assured payment mechanism similar to that which currently
operates in CREST for dematerialised shares. Against this background, a question had been
raised about the ability to take security over MMIs held in CREST.
2
This Appendix discusses the principal issues arising from taking security over
dematerialised MMIs under the proposed structure. It should be noted that until the
legislative framework for dematerialised MMIs has been developed further, it is not possible
to determine or assess all issues in detail or with any certainty.
3
It seems likely that the incorporation of dematerialised MMIs into CREST will result
in an account structure and procedures which will be closely aligned to those which currently
exist in CREST. In particular, it seems unlikely that procedures for taking security over
instruments held in CREST will differ significantly from existing arrangements. On the
basis, therefore, that CREST settlement banks are content with existing arrangements, there is
no reason to suspect that the position of settlement banks in a system for dematerialised
MMIs will be substantially different and therefore that the level of comfort and certainty
which the banks will be able to draw should be reduced.
4
The position with regard to methods for the transfer and recording of title of
dematerialised MMIs will be determined by the MMI Regulations. However, there is no
reason to believe that the position will be any less certain than that under the Uncertificated
Securities Regulations 1995 which govern the position in relation to dematerialised shares.
5
One principal distinction between materialised money market instruments and shares
is negotiability. It is not yet clear whether, even if it is desired by the market, it will be
possible to replicate negotiability in relation to dematerialised MMIs.
6
If negotiability is not perpetuated, the position of members and settlement banks will
be substantially similar to that which applies in respect of instruments already transferable
under the CREST structure. If negotiability is replicated, a question has been raised whether
this feature will enhance a customer’s ability to confer on third parties unauthorised rights in
relation to MMIs held in a CREST account, in breach of existing contractual restrictions.
This will depend on the provisions of the MMI Regulations, but it seems unlikely that the
continuation of negotiability would have this effect. Under existing law, negotiation requires
delivery of the instrument. It therefore seems likely that negotiability under a dematerialised
system will depend upon a transfer of the instrument across accounts within CREST (this
being the equivalent of delivery under a dematerialised system). Accordingly, any security
33
involving a legal mortgage or a pledged-out account will not give rise to any concerns for the
secured settlement bank in view of its ability to control dispositions of the instruments.
7
In the case of a floating charge, the position as regards priorities, and therefore the
risk to a chargee, should be no different from that which exists at present where the borrower
is left in possession of the instruments. In particular, the tendency of the courts in recent
years has been to adopt a common approach as to what is treated as notice both in relation to
negotiable instruments and under the general law governing equitable interests and therefore
registration of particulars of a charge over an account containing dematerialised MMIs,
including, where appropriate, particulars of a negative pledge, should offer a settlement bank
the same level of protection as in the case of an existing CREST account.
8
In the current CMO system, security can be created by way of pledge, a concept
which relies on delivery of the instrument pledged. In the CMO, delivery is achieved through
constructive delivery and attornment. It should be possible to provide for a pledge structure
for dematerialised MMIs through the MMI Regulations; this would involve providing for
deemed delivery of MMIs, for example upon updating of the record of title by CREST, in the
same manner as the rules of the CMO.
9
It seems unlikely that the EU Settlement Finality Directive ( 32) can be used to change
the rules of priorities in relation to floating charges. The directive relates to matters of
insolvency law and conflicts of laws and the vires derived from the directive do not appear
broad enough to enable amendments to be made to the general law rules of priorities of
charges.
(32)
Directive 98/26/EC of the European Parliament and the Council of 19 May 1998 on settlement finality in
payment and securities settlement systems.
34
APPENDIX IV
ENDORSEMENT
Background on endorsement
1 The Working Group agreed that, under the Bills of Exchange Act, anyone who negotiated
a bill did not thereby endorse it. The contrary view is mistaken and is no longer prevalent in
the market.
2 The previous mis-interpretation related to section 31 (4) of the Bills of Exchange Act,
which states:
“Where the holder of a bill payable to his order transfers it for value
without endorsing it, the transfer gives the transferee such title as
the transferor had in the bill, and the transferee in addition acquires
the right to have the endorsement of the transferor.”
3 However, this reading of section 31(4) of the Act was misguided; this is because that
subsection only applies to instruments payable to order. Money market instruments are, in
contrast, bearer instruments.( 33)
4
It is worth also noting the contrasting terms of subsections (2) and (3) of section 31:
“(2) A bill payable to bearer is negotiated by delivery.
(3) A bill payable to order is negotiated by the endorsement of
the holder completed by delivery.”
5
Section 58 is also relevant:
“(1) Where the holder of a bill payable to bearer negotiates it by
delivery without endorsing it he is called a “transferor by delivery”.
(2) A transferor by delivery is not liable on the instrument.”
Alternatives to dropping endorsement
6 The Working Group considered the alternatives to abolishing endorsement, but did not
find them attractive. The Working Group considered that there could be four main options for
future settlement arrangements for bills of exchange.
(i)
Keep bills in a “rump” CMO (while other MMIs are integrated into CREST). If
other MMIs were integrated into CREST, maintaining such settlement
arrangements for bills would, however, be likely to become prohibitively expensive.
(33)
Some instruments are payable to order on original execution or during the process of lodgement with the
CMO. However, by the time lodgement is completed all such instruments will have been endorsed “in blank” (ie
without a named endorsee being specified), thereby becoming bearer instruments (see section 34(1) of the Act).
35
(ii)
Integrate bills into CREST in their current form – this would involve each
instrument being separately identified, and may require considerable CREST
systems changes to replicate the e-field in the CREST system. This would not
allow the efficiency gains that consolidating MMIs into issues could bring.
(iii)
Although endorsement would limit fungibility, it may be possible to preserve some
form of endorsement for fungible bills of exchange – but this would require that
undertakings to endorse include provisions for the treatment of co-mingled
holdings, and for the treatment of holdings when some bills have been on-sold. (34)
The endorsers would want to know in order to be able to track their contingent
liabilities; and the owners would want to know by whom their holdings have been
endorsed. Any undertakings to endorse dealing with co-mingling and on-selling
may require multilateral agreements which could be complex to arrange. One
option would be that all members could agree on a pro rata approach to their
contingent liabilities; however as the CREST membership encompasses a range of
market participants, they may not agree to such arrangements.
(iv)
Another possible option would be the development of a central clearing house for
bills. However some members questioned whether market participants would be
willing to enter into such risk-sharing arrangements.
7 Having considered the above options, the Working Group recommended that
endorsements are not preserved for dematerialised MMIs.
(34)
As an example of why such provisions would be needed if bills were fungible, consider the following: Bank
X buys £100 mn of a bill endorsed by Bank A and £100 mn of the same bill endorsed by Bank B. If Bank X
sold a portion of its total co-mingled holding of that bill to Bank Y, how would one determine which holdings
contain the bills endorsed by Bank A and which the bills endorsed by Bank B, and in what proportion?
36
APPENDIX V
REOPENING ISSUES OF MMIs: EXAMPLES
(a) Discount instruments. Like gilt strips, discount instruments such as CP and bills with
the same issuer (and, in the case of bills, acceptor) and maturity could be fungible if
issuers chose to issue them under the same ISIN.
When bills are traded at a rate of discount, the price per cent (consideration) is derived
thus:
Price = £100 - discount
where
discount = £100 (nominal) x (discount rate) x (days to maturity)
100
365
Assume there are 91 days to maturity of a bill and that the discount rate on the bill is
5.25%. This implies that the discount is £1.31 and that the resultant price of the bill is
£98.69.
The “days” used in the calculation, 91 here, are those from trade date (or issue date) to
maturity. The length of time a discount instrument may previously have existed prior
to the trade date has no bearing on the calculation. The price increases linearly with
the time to maturity.
If, therefore, £100 nominal of bills were issued, others with the same maturity date
could be added to them and treated as identical (issued under the same ISIN) because
the cash flow on maturity is the same, £100 per cent. If they were sold during their
remaining life to achieve a given discount/yield the price per cent would be common
to any part of that issue.
(b) CDs and other coupon bearing instruments. Like gilts, issues of coupon bearing
instruments can only be re-opened if a new tranche is fungible with an existing issue.
In order to be fungible, the second issue must have the same cash flows as the existing
issue; in other words it must be issued so that the accrued interest is the same on both.
If issuers choose to re-open issues in this way, then the issues are fungible and can
share a single ISIN.
Consider (1) a CD for £100 with a life of one-year and a coupon rate of 10%, which
was issued 6 months ago and; (2) a second CD of the same issuer issued today also
with an annual coupon rate of 10% and maturing on the same day as the CD described
in (1) above. (Money market yields have conveniently been unchanged at 10% for the
last six months.)
6 months ago
Today
In three months’ time
In six months’ time
(1) £100 CD, Coupon
10% issued at par
Buy today at a yield of
10%. Price = £104.76
(110/105)*.
Sell at a yield of 10%.
Proceeds = £107.32
(110/102.5).*
Redemption proceeds
£110.
(2) Buy today with
£4.76 accrued interest.
Consideration £104.76.
Sell at a yield of 10%.
Proceeds = £107.32
(110/102.5).*
Redemption proceeds
£110.
* based on 100+ r (rate) x t (fraction of years to maturity)
37
APPENDIX VI
ASSIGNING ISINs TO MMIs
Background
ISINs are 12 digit identifiers (11 digits plus 1 last check digit). In the United Kingdom ISINs
begin GB (followed by 9 places and the check digit).
The Working Group considered that issuers’ requirements for numbering MMIs would be:
-
High speed and frequency
Ability to cope with large volumes (35)
Immediate / same day issuance.
ISINs for MMIs
The Working Group agreed the following points:
1
ISINs are the appropriate identifier for UK MMIs.
2
The Stock Exchange could allocate a set of ISIN numbers to CREST, and CREST could
provide ISINs to MMIs as part of the process of inputting new issues of MMIs into
CREST. Issuers or their issuing agents could send CREST a message containing the
details of a new issue; in response CREST could confirm that the issue had been input and
would provide an ISIN for that issue.(36)
3
This process should take only a matter of minutes and could be done using electronic
messages with the information provided on a standardised template. Thus issuers could
inform their counterparties of the ISIN for a new issue very quickly. The cost of obtaining
ISINs for MMIs would be minimal.
4
In some cases issuers may want to obtain ISINs in advance (for example, the DMO may
want to obtain ISINs for Treasury Bills in advance); this should be possible provided the
main details of the new issue were also know in advance.
5
ISINs for MMIs would not be based on a SEDOL number, but would be assigned by
CREST sequentially as new issues were input into CREST.( 37) ISINs for MMIs could be
distinguished from ISINs for other securities (for example, by beginning with GBM). The
ISIN would identify the main features of an MMI issue; the issue could be re-opened
under the same ISIN just as bonds are.
(35)
On average, 250 issues are lodged daily in CMO. This number is quite consistently in the 230-270 range.
The highest ever record of lodgements on a single day was in 1991 when 870 issues were lodged on a single
day. In total there are around 10,000 issues of MMIs in CMO at any given time (based on current volumes).
(36)
The new issue input-process would probably also require a contractual underpinning as the issuer or their
agent would need to confirm that obligations represented by the issue were genuine; this process would
therefore probably be restricted to those issuers or issuing agents with whom appropriate legal steps had been
taken.
(37)
The Working Group considered whether assigning ISINs that provided standardised information (eg fields
showing issuer, maturity date etc.) would be possible. However, assigning ISINs reflecting information on the
issue would be difficult to implement; such a system would be time-consuming – which could be inconvenient for
market participants as quick turn-around during the issuance process is important for MMIs. In addition such a
system would waste a large number of available ISINs.
38
6
ISINs could expire and be reused at some point after the maturity of the instrument –
perhaps 10 years after maturity. This would be subject to any regulatory or other
requirements.
7
Full information on the MMIs in CREST should not automatically be available to all
members of CREST through a request identifying the MMI by ISINs. It was felt that it
would be detrimental to the market if issuance information were always widely available
and issuers’ detailed borrowing positions were evident. As current arrangements for
bonds and equities provide for limited information disclosure, following existing CREST
and Stock Exchange arrangements for ISIN queries should also be appropriate to the
MMIs.
Information on ISINs
8
Under current arrangements for securities in CREST, the information available on enquiry
through the system will depend on the nature of the security involved, as some information
will not be relevant to certain securities. In response to a Security Full Details Request, all
CREST members access the same set of security details (as provided by the issuer). This
same approach to information disclosure could apply to the ISINs for MMIs.
9
In addition the Stock Exchange (as the numbering agency responsible for assigning ISINs
in the UK) would also have information on ISINs for MMIs. Under the Stock Exchange’s
current arrangements for ISIN queries (for bonds and equities) only the main security
details (issuer, description, payment and maturity dates) are made available – the issue size
is not provided when they respond to an ISIN query.( 38) These same disclosure
arrangements could apply to MMIs.
(38)
The Stock Exchange also have additional information for listed securities – but the information disclosure
requirements for listing are separate from the security details that are publicly available on particular ISINs. As
MMIs are not listed, this would not apply for MMIs.
39
Information provided in response to a Security Full Details Request in CREST
Mandatory ( 39)
Optional( 40)
ISIN
Security Abbreviation
Nationality Declaration Req'd
Security Start Date
Settlement Allowed
DBV Allowed
RUR Required
Security Category ID
Security Status
Security Stamp Exempt
Balance Decimal Places
Registrar ID
Security Description
Security End Date
Security Bid Price
Security Offer Price
Security Bid Price Timestamp
Security Offer Price Timestamp
Security Reconciliation Date
Full Reconciliation Timestamp
Balance Reconciliation Timestamp
Account Reconciliation Timestamp
Stamp Country
Security Margin Currency
Security Disable Reason
Security Holiday Group
Strip Indicator
Dividend Rate Type
Maturity Date
Principal Interest Indicator
Fungibility Indicator
Strip Multiple
Minimum Strip Quantity
Total Stripped
Total Reconstituted
Base RPI
Cap Margin Category ID
Withdrawable Indicator
Electronic Sub Registration
Security Type
Last Date for Stock Deposits
Units of Transfer
Issuer CSD
Dividend Rate
Units or Nominal Value
International ISIN
Issuer Country
Nominal Amount of Issue
Nominal Amount per unit
Price at Issue
Date of Issue
First Payment Date
Payment Frequency
Maturity Call Date
Depositable Indicator
Security Withholding Tax Exempt
Certificates Issued
Settlement Period
(39)
Mandatory applies to all securities.
“Optional” in this context means the information will be only available where it is relevant to the particular
security.
40
(40)
APPENDIX VII
TRANSITIONAL ISSUES
TRANSITIONAL PROVISIONS FOR THE INTEGRATION OF MMIs INTO CREST
1
This Appendix sets out a few issues which will arise in the transition of MMIs from
CMO to CREST. Once the necessary legislative provisions for dematerialised MMIs are in
place, then issuers should be able to issue new issues of MMIs directly into CREST. But what
should happen to existing paper MMIs? How should the transition period be handled? While
none of the options seems perfect, it appears that allowing existing MMIs to mature during
a transition period, combined with a big bang for MMIs with longer maturities may be the
best approach.
2
Section 207 appears to allow for a variety of transitional arrangements. The Working
Group considered which approach to the treatment of any outstanding paper MMIs in CMO
members would prefer. A number of questions are considered below. Transitional
arrangements would be subject to the findings of Treasury Solicitors and their plans for
legislative provisions for dematerialised MMIs.
(i)
Transitional approach. Should outstanding paper MMIs simply continue in paper
form until maturity?
(ii)
Big bang. Or should there be a legislative provision to transform paper MMIs in
CMO into dematerialised MMIs in CREST?( 41)
(Options (i) and (ii) can be combined)
(iii)
Phased approach. In either case, should there be separate transitions for different types
of MMIs, or should the same transitional arrangements apply for all MMIs?
3
Transitional approach. Question (i): Should outstanding paper MMIs simply continue in
paper form until maturity? New issues of MMIs could be issued into CREST, while existing MMIs
remain in CMO until maturity. This would mean that CMO and CREST would run concurrently –
but for a maximum period of one year as the maximum maturity of MMIs in CMO is one year.
This would result in some degree of division of the market for a period of time. The average
maturity of MMIs is around 4 months; about half of the MMIs in CMO would mature within a
period of 1- 4 months.
4
The impact of such a transition could be minimised if a long notice period were given.
The intention to dematerialise MMIs should be publicised well in advance, and the legislation
for dematerialised MMIs could include a provision to come into effect on any date chosen (as
long as it was long enough after being laid before Parliament to give time for the debates in
both Houses). Issuers may not want to risk having a large number of issues maturing in a
short period, but if sufficient lead-time were given, issuers could plan their funding so as to
reduce the number of MMIs that would remain outstanding in paper form for more than a few
months after the go-live for issuing dematerialised MMIs into CREST. This approach should
(41)
Section 207(5) allows the regulations to cover transitional arrangements.
41
be relatively straightforward (though it could result in an unusually large volume of issuance
in the first few months after dematerialised issuance were possible).
5
It is instructive to compare the transitional approach taken when CREST was introduced,
even though the position of equities is materially different from that of short-term, repayable
instrument s.(42) Corporate securities went into CREST one at a time over a period between 15
July 1996 and 7 April 1997 (when TALISMAN was switched off). The dates were set by
arrangement between CREST and issuers – for example, to avoid dividend dates etc. Volumes
built up gradually, which was helpful with a new system. As a contrast to the big bang approach
(see below), the CREST precedent is of interest as MMIs too could be integrated into CREST
over time (as outstanding paper MMIs mature).
6
Some members of the Working Group favoured this approach and estimated that about
70-80% of their holdings of MMIs would mature within 4 months. A transitional approach
could help reduce the operational risks associated with market participants adapting to a new
settlement system. The transitional period would give the market some time to adapt as
volumes built up gradually.
7
During the transitional period some MMIs would be held in CMO, whereas others
would be held in CREST. This should not be a problem for market participants as MMIs in
CREST would be identified by ISINs, whereas paper bearer MMIs would not. Market
participants should be able to easily distinguish between MMIs in the two systems. MMIs in
CMO and CREST would also have different payment arrangements in place (there would be
assured payment (or full DVP) arrangements in place for securities in CREST). This should
not be a change for the market which is familiar with the arrangements for MMIs in CMO, and
with the assured payment arrangements in CREST.
8
Market feedback suggested that the lead time given in advance of the transition would
have little influence on market participants’ preferred method of transition for MMIs. The
market would carry on as usual; the Working Group did not expect settlement considerations to
influence market behaviour as issuers’ funding needs and their directional views on interest
rates would remain the overriding considerations.
9
The Working Group considered that the length of the transition period should also take
cost factors into account. As MMIs matured and there were few outstanding MMIs in CMO, at
some stage it would become uneconomical to continue to operate the CMO. These cost factors
could influence the length of the transition period, but further work would need to be done on
costs.
10
Big bang. Question (ii): Should there be a legislative provision to transform paper
MMIs in CMO into dematerialised MMIs in CREST? An alternative to the transitional
approach indicated above would be to recommend that a legislative provision should be made
using section 207 to provide for the transition of paper MMIs from CMO into dematerialised
(42)
In order to dematerialise equities, companies had to pass a directors’ resolution and inform their
shareholders. In addition, after each security became CREST-eligible (a “participating security” as defined in
the regulations), holders had to dematerialise their own holdings by delivering their certificates to the registrar
for cancellation.
42
form in CREST (a big bang approach). While this would avoid having MMIs in two systems
for some period, this option raises a number of practical difficulties.
11
If MMIs were fully dematerialised from one date (with no paper interface), a
transitional legislative provision would be needed to dematerialise paper MMIs.( 43) However
providing a transfer mechanism raises practical difficulties which mirror the various problems
associated with a paper interface more generally. Market participants and CREST would need
to consider the treatment of outstanding bearer MMIs – presumably these would have to be
cancelled somehow and replaced by a book entry MMI. It may be difficult to transfer
individual bearer MMIs into CREST as they would not be “new issues”. How would they be
input into CREST? Who would lodge them? How would ISINs be assigned? There could
also be difficulties if the legal characteristics of paper instruments were materially different
from dematerialised instruments. Furthermore the Working Group could not rule out a paper
MMI market remaining, albeit with no interface with dematerialised MMIs in CREST.
12
The Working Group considered that a big bang approach for all MMIs at one time
would be difficult as the volumes of MMIs would be very large. However combining this
with a transitional approach would allow a large volume of MMIs to mature, after which the
smaller number of outstanding MMIs could be integrated into CREST in a later big bang.
13
The FSA pointed out that provisions for a big bang would need to include a legislative
basis for the record of title to move to CREST. The enabling legislation for any transition
would need to include some form of recognition in law that the record of title to MMIs would
move from CMO to CREST. The enabling legislation would need to include clear provisions
for the use of Properly Authenticated Dematerialised Instructions (PADIs), as stipulated under
the USRs.
14
Should the dematerialisation of outstanding MMIs in a big bang be compulsory or
optional? Would holders have to give their consent to dematerialisation? The Working Group
considered that it may be possible to include provisions along similar lines to redenomination
clauses in bond issues in legacy currencies before EMU. Alternatively issuers could redeem
MMIs and re-issue into CREST (the Working Group recognised that this approach could raise
accounting and tax issues).
15
The Working Group recognised that there would, however, be a number of issues
concerning the big bang that would require further consideration. These include:
(i)
The length of the notice period.
(ii)
The length of the transition period of parallel running and the cost issues involved.
(iii)
The transitional regulations would need to recognise two types of MMIs and
would need to provide a legislative framework for the transfer of MMIs to CREST
(for example, using PADIs).
(43)
Alternatively there could be arrangements to provide an interface with paper MMIs, in which case there
would need to be legislative provisions for the ongoing dematerialisation of paper MMIs; presumably these
provisions could apply for the transition of MMIs to CREST as well. However, this approach would also
present the practical problems associated with a paper-dematerialised interface. Hence this approach does not
seem desirable.
43
(iv)
The rights of holders of MMIs and provisions covering mandatory or consensual
dematerialisation would need to be included in the regulations for transition.
16
Phased approach. Question (iii): Should there be separate transitions for different
types of MMIs, or should the same transitional arrangements apply for all MMIs?
Whichever approach on questions (i) and (ii) is chosen, the transition could be divided into
phases by instrument (for example, one phase for CDs, one phase for Treasury Bills etc)
either as a series of transitional periods, or a series of mini-bangs. This option was mooted
as a possibility if the dematerialisation of some instruments (for example, bills of exchange)
proved difficult.
17
A phased approach would seem sensible if different legislative provisions were
required to dematerialise various types of MMIs and if these changes involved different lead
times. If this were the case, then such a phased approach would be sensible as the
dematerialisation of one type of MMI need not delay the dematerialisation of other types of
MMIs.
18
However, it appears as though the obstacles to the dematerialisation of MMIs are not
too great, and that similar legislative provisions could apply across different types of MMIs.
Provided that the dematerialisation of various MMIs can proceed on a uniform timetable,
then there is no obvious rationale for a phased approach.
19
It is envisaged that all MMIs should be covered by the same transitional arrangements.
Preliminary recommendation
20
The Working Group considered that further work should be done on the details of a
big bang for the dematerialisation of MMIs, and how this could be combined with a
transitional period. It may be best to have a period of transition, followed by a “big bang” in
which existing MMIs are dematerialised at the same time (or preceded by a big bang for
MMIs with an outstanding maturity longer than the transitional period). A period of around
six months parallel running of CMO and CREST would allow many existing MMIs to mature
(Treasury Bills, many CDs, and most bills have a maturity of under 187 days), while new
issues could be issued directly into CREST. After the transition period any outstanding
bearer securities with longer maturities (up to five years in the case of some CDs), could be
dematerialised under a legislative provision for the transformation of bearer securities to
dematerialised form.
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APPENDIX VIII
ABBREVIATIONS AND ACRONYMS
APACS
Association for Payment Clearing Services
CD
Certificate of Deposit
CGO
Central Gilts Office
CMO
Central Moneymarkets Office
CP
Commercial Paper
DMO
United Kingdom Debt Management Office
DVP
Delivery Versus Payment
ETT
Electronic Transfer of Title
FSA
Financial Services Authority
ICC
International Chamber of Commerce
ISIN
International Securities Identification Number
LMMA
London Money Market Association
MMI
Money Market Instrument
MMLG
Sterling Money Market Liaison Group
MTN
Medium Term Note
PADI
Properly Authenticated Dematerialised Instruction
SDRT
Stamp Duty Reserve Tax
SEDOL
Stock Exchange Daily Official List
USRs
Uncertificated Securities Regulations
45