Legal Issues and Implications of UNIDROIT Convention

1. Legal Issues and Implications of UNIDROIT Convention Yeon-Wook Kang Lawyer of Risk Management Team E-mail : ywkang@ksd.or.kr

2. Introduction of UNIDROIT Background of UNIDROIT Convention on Substantive Rules regarding Intermediated Securities Progress of UNIDROIT Convention Main Contents of the Convention Implications for Korean legislation Activities of the KSD The need for cooperation Contents

3. International Institute for the Unification of Private Law (Institut International Pour L’Unification du Droit Prive) Independent intergovernmental Organization Purpose Modernising, harmonizing and co-ordinating private and in particular commercial law as between States and groups of States Membership : 63 Members States Achievements UNIDROIT has drew up 11 Conventions, 2 Principles and 2 Model Laws 11 Conventions admitted into municipal law via ratification 2 Principles adopted by an arbitrator and contracting parties freely 2 Model Laws Introduction of UNIDROIT

4. Backgrounds Expansion of cross-border securities transactions Enlarging complexity of the intermediation chain Structure of cross-border securities transactions Multi-tier holding system with a chain of intermediaries ultimately connected to the CSD Background of UNIDROIT Convention • Convention on Substantive Rules regarding Intermediated Securities Increasing awareness of the legal risks from different legal frameworks in many countries

5. Solution (1) : Hague Convention Hague Convention on the law applicable to certain rights in respect of Securities held with an intermediary Final version : December 2002 Basic Purpose : update and unify conflict of laws principles Solution (2) : UNIDROIT Convention (2002~) UNIDROIT Convention on Substantive Rules regarding Intermediated Securities Modenising and harmonizing substantive rules regarding cross-border intermediated securities holding and transaction Framework and issues of substantive law at global market are comprehensively addressed Backgroundof UNIDROIT Convention Issues of substantive law are not addressed Limited Solution? Reduction of Legal Risk

6. Progress of UNIDROIT Convention September 2002 ~December 2004 • First Meeting of UNIDROIT Study Group • Preliminary Draft Convention May 2005 First Session of the Committee of Governmental Experts March 2006 Second Session of the Committee of Governmental Experts November 2006 Third Session of the Committee of Governmental Experts May 2007 Fourth Session of the Committee of Governmental Experts September 2008 First Session of the Diplomatic Conference to adopt a Convention October 2009 Final Session of the Diplomatic Conference to adopt a Convention

7. Features The basic rules for different types of systems for intermediated securities The effects of non-Convention law of Contracting States retain Structures Main Contents of the Convention Chapter I Definition, scope of application and interpretation Chapter II Rights of account holder Chapter III Transfer of intermediated securities Chapter IV Integrity of intermediated holding system Chapter V Special provisions with respect to collateral transactions Chapter VI Transitional Provisions Chapter VII Final Provisions

8. Rights of an account holder (Article 9) The credit of securities to a securities account confers the right to receive and exercise the rights attached to the securities (dividends, other distribution, voting right, etc) Enforceable against third parties Acquisition and disposition by debit and credit (Article 11, 12) An account holder can acquire/dispose intermediated securities by way of a credit/debit No further steps are necessary under the non-Convention law to ensure the effectiveness against third parties Parties are able to create a security or other limited interest in respect of intermediated securities by way of a debit and credit Other methods to create a security : designating entry, Control agreement Main Contents of the Convention

9. Acquisition by an innocent person (Article 18) Purpose : Protection to innocent acquirers of intermediated securities Unless an acquirer actually know or ought to know of an earlier defective entry, the credit is valid, effective against third parties Unless an acquirer actually know or ought to know that another person has an interest in securities or intermediated securities and that the credit to the securities account of the acquirer violates the rights of that other person, the credit is valid, effective against third parties This protection does not apply in respect of acquisitions of securities made by way of gift or otherwise gratuitously Main Contents of the Convention • Adoption of principle of public confidence

10. Integrity of the intermediated holding system (Article 21 to 30) Effectiveness of rights in insolvency proceeding Rights that have become effective against third parties are effective against the insolvency administrator and creditors in any insolvency proceeding in respect of the relevant intermediary Prohibition of upper-tier attachment (No-look-through Principle) A creditor cannot attach positions held for its debtor at any level in the chain above its debtor’s immediate intermediary Loss sharing in case of insolvency of the intermediary Where securities have been allocated to single account holder, the loss is borne by that account holder In all other cases, the loss is shared among the account holders to whom the securities concerned have been allocated in proportion to the respective number or amount of such securities credited to their securities accounts Main Contents of the Convention

11. Main Contents of the Convention • Insolvency of system operator or participant • Instructions for making book entries and of resulting debits, credits and designating entries are irrevocable in case of insolvency of system operator or participant

12. Special provisions with respect to collateral transaction (Article 31 to 38, Chapter V) Recognition of title transfer agreement The law of a Contracting State shall permit a title transfer collateral agreement Right to use collateral securities If and to the extent that the terms of a security collateral agreement, the collateral taker shall have the right to use collateral securities In order to enhance liquidity Top-up or substitution of collateral For protecting top-up and substitution against certain provision of insolvency law, They may not be treated as invalid, reversed or declared void solely in respect of insolvency proceeding Main Contents of the Convention • A Contracting State may declare Chapter V shall not apply

13. UNIDROIT Convention Korean legislation Effects of statement of account book Credit/Debit to a securities account is considered to acquire/dispose intermediated securities (Article 9, 11, etc) Statement to a securities account is considered to hold respective securities (FSCMA Article 311) Protection to the innocent acquirer of securities Approval of Innocent (good faith) acquisition by transfer of securities between accounts (Article 18) Innocent (good faith) acquisition by transfer of securities between accounts is not yet stipulated expressly Implications for Korean legislation Various ways of establishing a security right • The way of • transfer of securities between accounts • or control agreement* • is also accepted (Article 12) • control agreement is the agreement • that pledgorgrant “control” (authority • of management and disposition) • of the account to secured party • for the purpose of a establishing • a security right The way of transfer of securities between accounts or control agreement is not accepted [For the present, a security right is established in the way of statement to be pledged in account books (FSCMA Article 311)]

14. Implications for Korean legislation UNIDROIT Convention Korean legislation Prohibition of upper-tier attachment A Creditor cannot attach positions held for its debtor at any level in the chain above its debtor’s immediate intermediary (Article 22) Direct provision doesn’t exist, however upper-tier attachment isn’t performed materially Right to use collateral securities Collateral taker have the right to use collateral securities under collateral agreement (Article 34) None Top-up or substitution of collateral Top-up or substitution of collateral may not be declared void in respect of insolvency proceeding (Article 36) Direct provision doesn’t exist, however top-up or substitution of collateral could be declared void, as the case may be, in respect of insolvency proceeding (Debtor Rehabilitation And Bankruptcy Act Article 100, 120, etc)

15. An individual An organization Scope of Knowledge Article 14. 4 (b) describes the test of innocence applied to an individual and requests “a significant probability that the interest or fact exists and deliberately avoids information,” which means gross negligence.  Article 14. 4 (c) asks an organization for “ought reasonably to have been brought to the attention of the individual responsible,” which means simple negligence. Activities of the KSD • KSD to attend the Committee of Governmental Experts • KSD submitted comments concerning acquisition by an innocent person • Scope of Innocence • Difference between an individual and a an organization (2008 draft)

16. KSD’s opinion is reflected in the draft 2009 Activities of the KSD • there is no ground for the different treatment between an individual and an organization • the standard of an individual should be applied to an organization in the same way •  Effect of Innocence Acquisition • Regarding Article 14.2 (2008 draft), it seemed to be possible that the issuer is included in the third parties and the innocent acquirer contends his/her rights to the issuer For the effect against the third parties, Article 14.2 (2008 draft) describes: "(a) the credit of interest is not rendered invalid, ineffective against third parties or liable to be reversed as a result of that defective entry; and (b) the account holder, or the person to whom the interest is granted, is not liable to anyone who would benefit from the invalidity or reversal of that defective entry."

17. KSD’s opinion is expected to be reflected in the Official Commentary Activities of the KSD • the purpose of the innocent acquisition is to protect the trade aspect of the securities • Effect to the issuer is desirable to be regulated by the non-Convention law

18. The need for productive cooperation in the Asian finance sector • Preparation for the change of business environment • The necessity for the analysis on the effects on the CSD • Preparation for the basis of competitive CSD • The necessity for the separate group for study of UNIDROIT • Convention at Asian level The need for cooperation • UNIDROIT Convention is expected to be operated as Global Standard of clearing and depository legislation • Commitment to the UNIDROIT Convention implies for the law revisions

19. For more information http://www.unidroit.org/english/workprogramme/study078/item1/main.htm

20. Thank You