The issue or whether a stock loan is a sale of a loan resurfaces periodically. Here is John Piccitto’s response to a flurry of interest on the subject that reached the European Commission. On the basis of this and similar testimony from industry professionals, it was decided (once again) that a loan was a loan, not a sale.
Ref: MARKT/ 16.09.2004
“Fostering an Appropriate Regime for Shareholders’ Rights”
European Commission – Internal Market Directorate General
Consultation Document of the Services of the Internal Market Directorate General
Dear Sirs,
I would like to offer the following response to one specific question posed in your document referenced above.
I am a consultant in the field of Global Equity Finance, a member of the Risk Management Association (“RMA”) in the United States, and I have contributed on occasion to the activities of the International Securities Lending Association (“ISLA”) in London. I also publish articles about the Equity Finance business in industry journals. Please visit my website at www.piccitto.com for further information.
Under the section titled “Main Issues” of your proposed document, I would like to respond to Question 5.2, Stock Lending, as follows:
5.2) The practice of securities lending NEED NOT create problems for the exercise of voting rights even though the legal documentation in place prior to any business being transacted indicates that since title passes with the loan of a security, voting rights do as well. Lenders and Borrowers in the profession operate under a “best practices” understanding of the implications of this aspect of the business, and have done so since the inception of the practice of lending international securities (ex-US and ex-UK) in London in 1982.
It is incorrect to say that since title passes from the lender to the borrower in a securities lending transaction, the deal represents a sale and not a loan. The legal documentation that accompanies a securities loan transaction requires the transaction to be terminated at the wish of either the Borrower or the Lender at any time during the process, through the return of “like kind” instruments. This issue of the “loan” as opposed to the “sale” of securities was discussed and agreed by London industry participants, the UK Inland Revenue, and the Bank of England in 1983, when it was decided that a securities lending transaction was to be treated as a loan and NOT a sale. This has been settled practice ever since.
From the beginning, securities lending transactions have been terminated when stocks are recalled by the owner to cover fails. Similarly, and increasingly as the Corporate Governance movement gains impact, shares have been recalled for voting, in apparent contravention of the rigid notion that the right to vote “travels with” the change of title to the shares with the loan of the securities. The possibility that the shares may be recalled for voting can be indicated verbally or in writing by the lender to the borrower before the transaction, increasingly it is just assumed. Thus through incremental evolution, “best market practice” now insures the right to vote at GM’s or EGM’s. Further assurance – if any is deemed necessary – should be addressed through changes to the appropriate wording in standard practice documents or standard legal agreements, GMSLA for example, or within the codes of guidance of individual countries.
For the same reason, that a securities lending transaction is a loan and not a sale, the practice of borrowing securities in order to affect the outcome of a GM should be eliminated. Voting borrowed securities constitutes market abuse, because it arrogates the power to decide corporate issues to people (borrowers) who, since they do not in fact own the shares they have voted, do not have the same economic interest in the outcome of those issues as the owner (lender) has. (See April, 2002 news reports of British Land PLC and Laxey Partners Ltd. and 1993/4 media reports of Mr. Martin Ebner and Credit Suisse, Zurich)
Clearly at issue in both these examples of appropriate exercise of voting rights is how to be sure that the owner of shares is duly notified that an occasion to vote has arisen, in order to enable him to act accordingly, either by voting his shares, or by appointing an agent to vote for him or by deciding not to vote his shares. Regarding the ability of the owner of the shares to vote them if he so wishes, this problem has already been resolved by current industry practice. When shares are loaned out, either the owner (for example, a pension fund manager) or else his custodian, retains some of the shares – a buffer – to insure receipt of notification of corporate actions. Upon notification, a decision can be taken to vote just the retained shares, or to recall shares on loan for voting purposes, or not to vote and to leave loaned shares out, earning fee income. As these arrangements are already in place, there is no need to add legislation or to revise codes of practice on this matter at any level.
The corresponding problem of preventing borrowers of shares from voting them might begin from this point: the owner of the shares almost always knows that the shares are going to be voted. What is needed here may very well be a development of existing industry practice, rather than a change of legislation at some level, or a revision of current codes of best practice.
Thank you for this opportunity to reply to this proposed directive as an interested party.
