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Diplomacy in Action

90. U.S. explanation of joint signing, convention on securities held through intermediaries (September 15, 2006)


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September 15, 2006

Joyce Hansen
Deputy General Counsel
Federal Reserve Bank of New York
33 Liberty street, New York NY

Joint Signature of the Hague Convention by the United States and Switzerland July 5 at the Hague

We agree with your office and others that July 5 (the date of the recent US signature of the Convention) was an important occasion for PIL work, given all that went into bringing that about. I have attached the substance of the memorandum we circulated this week to inform our Bureaus on Economics and Business Affairs and Congressional Relations, amongst others, as to the background and import of the Convention.

US signature proceeded on the basis of interagency clearance which included support from Treasury, the NY Federal Reserve, SEC, and CFTC. Issues initially raised by some others were resolved, stemming from the fact that the Convention was a self-executing treaty, as was the Cape Town Convention ratified by the U.S. in 2004, i.e. that it required no legislation either by the federal government or the states to be effective as transactional law, and would be applied directly along with the provisions of UCC Article 8 (uniform state law in the United States).

The purpose of the joint signing was to have two important banking countries take action together, which was intended to, and did, send a strong signal to other countries. In the financial markets, being a signatory to this Convention has an effect even prior to ratification. That has in the Asian sector moved some forward in their consideration of whether to also sign the convention. It may take longer for a decision to be made within the European Union. The Union, and in particular the EC and the European Central Bank, are seeking avenues to rationalize their national markets, and not all EU states welcome the UCC approach. Some EU states have been concerned about the impact of the Convention on their regulatory capacity. We have informally advised the EU that we would include a formal understanding to accompany our instrument of ratification to the effect that the Convention does not affect national regulatory capacity, but determines certain issues of transactional law only.

The Convention in a nutshell provides tests to quickly and with predictability determine what law applies to securities interests which move easily across borders in seconds by computer. This allows expeditious determination of risk, value, pricing and in a shortfall or systemic risk situation, under what rules interests will be dealt with. That determination may need to be made ex ante or it may arise if there's a contest, for example, at a subsequent point as to priority of competing secured interests. The matter of applicable law may not be a fixed point, since securities interests may traverse a number of intermediaries and cross borders. The key is whether, when it is needed, the applicable law at the point at which it needs to be fixed can be done so expeditiously and without substantial due diligence. That is what the convention would do.

Based on financial industry meetings, the US financial community has seen this convention as serving two important objectives, one obvious, boosting the efficiency of global and national markets, and secondly, but no less importantly, reducing systemic risk concerns, one of the goals of US banking and securities regulators. This concern arises from modern market and transactional law developments since the 1980's including the growth in shear volume of transactions and movements of securities by computer, which travel through and are managed by entities known collectively as "intermediaries". The US securities system had systemic risk concerns in the late 1980's when bankruptcy issues of a major securities participant made obvious that "older" traditional laws that linked securities holdings to company property books could not work. There was no effective way to timely trace through and identify all the

trades and interests, and even if eventually one might be able to do that, by that time the interference with ongoing market functions could present a systemic risk.

That led to the urgent revision of UCC Art. 8. The Article 8 solutions were one of the two competing approaches on the table at the Hague. The direction the Convention text was to take went down to the wire, remaining an open issue until the start of the diplomatic conference. The UCC 8 solutions were agreed to as the convention's solution within the first hour of the diplomatic conference, when the EC, speaking for their member states, announced that they supported that approach as a means to enhance the efficiency of European securities markets.

As to the dating, the Convention follows the practice of the Hague Conference so, while negotiated at the Peace Palace of the Hague in November 2002, the date of the Convention is 2006, fixed at the time and place where the first signatures took place, i.e. the joint signing by the U.S. and Switzerland at the Hague on July 5.

This brings us to the current status. We are preparing a draft of a transmission “package” to the Senate for advice and consent to U.S. ratification. That will need to incorporate proposed declarations as permitted under the Convention and a section-by-section analysis that we will want to be fully reviewed by all key sectors within the financial community.

We will advise you of progress on that and look forward to working closely with the Federal Reserve on implementation of this Convention.

__________________________

Harold S. Burman

Office of Legal Adviser



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