South Africa: Uncertificated Securities as Collateral in South African Securities Lending Transactions

Last Updated: 12 January 2011
Article by Anthony Colegrave

The question how uncertificated securities can be provided as effective collateral in South African securities lending transactions has been such a hotly debated topic that, for many years, the majority of participants in the South African securities lending market only accepted cash as collateral for loaned securities. Therefore, the South African securities lending market called for an effective method to provide uncertificated securities as collateral in securities lending transactions.

Under South African law, a share in a company consists of a bundle of personal (incorporeal) rights entitling the holder of the share to an interest in the company, its assets and dividends. Similarly, debt securities consist of a bundle of personal rights against the issuer of such debt securities. Securities may have true (beneficial) owners and registered owners. The true owner of a security is the person to whom the security belongs, but it is only if the true owner has its name entered into the register of the company or the issuer that it is a registered owner of the security.

Securities are transferred by way of a cession. A cession is a bilateral act by which a personal right is transferred from a cedent to a cessionary. There are two types of securities cession namely:

  • an out-and-out cession in terms of which the rights are transferred completely by the cedent to the cessionary; and
  • a cession in securitatem debiti in terms of which the cedent retains a reversionary interest in the ceded right.

True ownership in securities is transferred by an out-and-out cession. In the certificated environment, an out-and-out cession was evidenced by the delivery of the share certificates together with a signed share transfer form or the delivery of the debt certificate together with the appropriate transfer form. In the uncertificated environment, such a transfer is effected by the parties agreeing to cede the securities fully on an out-and-out basis which is accompanied by the transfer of registered ownership in the uncertificated securities through the debiting and crediting of the respective securities accounts in accordance with section 91A(4) of the Companies Act, 1973 ("Companies Act").

The current state of the South African law is that a cession in securitatem debiti of an incorporeal right is akin to a pledge of a corporeal thing. This point was clearly made by the Supreme Court of Appeal in Millman N.O. v Twiggs and Another, 1995 (3) SA 674 (A). In Millman, a company called Continental Foods (Proprietary) Limited (of which Millman was the liquidator) ceded to Twiggs an amount of R500 000 in securitatem debiti for debts owed by Continental Foods to Twiggs. The nature of this cession to Twiggs was questioned by Millman. When dealing with the nature of a cession in securitatem debiti, the court stated that:
"When a right is ceded with the avowed object of securing a debt, the cession is regarded as a pledge of the right in question; dominium of the right remains with the cedent and vests upon his insolvency in his trustee, who is under the common law entitled to administer it 'in the interests of all the creditors, and with due regard to the special position of the pledgee'."

Recently in Grobler v Oosthuizen [2009] ZA SCA 51 the Supreme Court of Appeal had to consider whether or not the proceeds of certain ceded policies paid to Oosthuizen without the knowledge that the ceded claims had reverted back to Grobler were valid. The Supreme Court of Appeal in Grobler confirmed the position that a cession in securitatem debiti of an incorporeal right is equivalent to the pledge of a corporeal right.

The demands of commerce recognise and require that securities should be capable of being offered as security for a debt owed by the true owner of the securities to its creditor. This was given recognition by the legislature in section 43 of the Securities Services Act, 2004. Section 43 specifies that a cession of uncertificated securities to secure a debt "must be effected" by entering the details of the cession in the cedent's securities account to ensure that there can be no transfer of these uncertificated securities from the cedent's securities account without the knowledge and permission of the cessionary. This process is referred to as "statutory flagging".

Section 43 of the Securities Services Act therefore recognises and applies the common law in respect of a cession in securitatem debiti because the uncertificated securities are not transferred out of the cedent's securities account and thus "dominium" (ownership in the form of a reversionary right) of the uncertificated securities remains with the cedent. Indeed, section 43 presupposes that no transfer of registered ownership of the dominium occurs. Such transfer of registered ownership in uncertificated securities is dealt with in section 91A(4) of the Companies Act and the mirrored provisions in section 42 of the Securities Services Act.

There is, however, a problem with ceding uncertificated securities in securitatem debiti by way of statutory flagging. In the South African market, securities lending is largely conducted under the Global Master Securities Lending Agreement (GMSLA) published by the International Securities Lending Association with such securities lending facilitated by banks playing the role of intermediaries. In this capacity, a bank, on request from a client, will borrow securities from another market participant in order to lend those securities to its client. The bank will receive collateral from its client in connection with that loan, and the bank's own borrowing from the market participant will be accompanied by a collateral obligation. If uncertificated securities are provided to the bank as collateral by its client by way of statutory flagging, the bank will be unable to use such uncertificated securities as collateral and will rather have to use its own assets to collateralise its borrowing from the market participant. Consequently, statutory flagging introduces unnecessary costs and compromises liquidity. Furthermore, the point has been correctly made by market participants that the provision for netting in the GMSLA following a default of a party will not operate effectively unless title to the collateral given has passed to the counterparty.

Because of the problems with statutory flagging, and due to the demands of the South African securities lending market to allow for the provision of uncertificated securities as collateral in securities lending transactions, the South African Securities Lending Association (SASLA) has published an amended South African schedule to the GMSLA. Surprisingly the schedule allows for the cession in securitatem debiti of uncertificated securities without statutory flagging. This is achieved by:

  • a cession in securitatem debiti of the true ownership in the uncertificated securities; and
  • a transfer in the registered ownership of these uncertificated securities from the cedent to the cessionary in terms of section 91A(4) of the Companies Act.

The argument put forward by SASLA's advisers in relation to the validity of a cession in securitatem debiti of uncertificated securities without statutory flagging is that statutory flagging is not practically possible where a transfer of registered ownership in uncertificated securities is effected because these uncertificated securities will, following such transfer, be reflected in the securities account of the transferee (ie the cessionary) and will thus not be in the transferor's (cedent's) securities account to flag. This process of transferring registered ownership in the uncertificated securities and ceding in securitatem debiti the true ownership of the uncertificated securities is thus seen by SASLA as an effective alternative to statutory flagging which will avoid the liquidity and costing problems related to statutory flagging discussed above.

However, if a lender in a securities lending transaction in South Africa were to accept uncertificated securities as collateral without statutory flagging in terms of the schedule, that lender will be exposed to certain risks:

  • Firstly, section 43 of the Securities Services Act states that statutory flagging "must be effected" when ceding uncertificated securities to secure a debt. There is a risk, therefore, that the words "must be effected" will be interpreted by a court to mean that statutory flagging is the only method for parties to effectively provide uncertificated securities as security for a debt. In such circumstances, a court will likely regard the provision of uncertificated securities as collateral without statutory flagging as ineffective security. Such a finding could potentially have disastrous consequences for a borrower. For example, in the case of the insolvency of the lender, the ceded securities would fall into the insolvent estate of the lender and the borrower (because it has not provided these securities as collateral in terms of section 43) may be found by a court to only have a concurrent claim against the estate of the lender for the return of these uncertificated securities.
  • Secondly, uncertificated securities are fungible and according to the common law ownership in fungibles passes when such fungibles are transferred to a transferee and are co-mingled with fungibles of the same type held by the transferee. Accordingly, if the borrower transfers registered ownership of the uncertificated securities to be provided as collateral to the lender who holds similar uncertificated securities in its securities account, there is a risk that a court may recharacterise this transfer of registered ownership as an outright transfer which will result in the consequences of an outright transfer having to be performed. Such consequences include:
    the payment of securities transfer tax;
    • the payment of capital gains tax in certain circumstances;
    • in relation to banks registered in South Africa, holding the required capital in relation to the banks consequent contingent liabilities; and
    • making the appropriate book entries to reflect the outright transfer of the uncertificated securities.

This recharacterisation risk will be even greater if the parties to the schedule have agreed that the uncertificated securities may be transferred in title to a third party, as the nature of a cession in securitatem debiti is that the cessionary is not permitted to use the ceded rights for his or her own purposes.

Section 43 of the Securities Services Act has, however, not altered the common law position with regard to an out and out cession of incorporeal rights. Indeed, the court in Grobler did not reject the notion that parties to a cession to secure a debt can draft the cession as an out-and-out cession on an outright transfer basis on which is superimposed an undertaking that the cessionary will recede the security to the cedent on satisfaction of the secured debt.

As the courts in South Africa have a common law power to recharacterise a transaction where the transaction does not accord with the intention of the parties, in order for parties to a securities lending transaction in South Africa to cede out-and-out uncertificated securities on an outright transfer basis only as security for a debt, this intention would have to be clearly expressed and performed by the parties. An expressly intended out-and-out cession transferring full ownership of the uncertificated securities outright as collateral will have to be supported by the parties accepting the consequences of this outright transfer (as described above) and performing all obligations in respect of those consequences.

One of the most undesirable consequences of an outright transfer of uncertificated securities as collateral is the payment of securities transfer tax. Currently, the Securities Transfer Tax Act, 2007 provides for the payment of securities transfer tax in respect of every securities transfer unless the transfer is conducted by way of recognised exemptions. Under the Securities Transfer Tax Act, parties to a securities lending transaction are exempt from paying securities transfer tax in respect of loaned securities if the transaction falls within the definition of a "lending arrangement". However, the wording of this exemption makes it clear that this exemption does not extend to the provision of uncertificated securities as collateral on an outright transfer basis. The National Treasury has been approached in an effort to amend the Securities Transfer Tax Act to include under the securities lending exemption the provision of uncertificated securities as collateral where these uncertificated securities are transferred outright. However, as at September 2010 no such amendment appears forthcoming.

Therefore, parties to a securities lending transaction in South Africa are currently faced with a difficult decision in respect of the provision of uncertificated securities as collateral, namely whether or not to:

  • cede uncertificated securities in securitatem debiti as collateral by way of statutory flagging with its attendant consequences in relation to costing and liquidity;
  • cede in securitatem debiti true ownership in uncertificated securities coupled with a transfer of registered ownership in the uncertificated securities to the cessionary with its attendant risks as to effectiveness and to recharacterisation; or
  • cede uncertificated securities as collateral on an out-and-out basis transferring full ownership of the uncertificated securities outright with its attendant consequences including the payment of securities transfer tax.

None of the above methods of providing uncertificated securities as collateral is without negative or at least potentially negative consequences. Any party wishing to provide uncertificated securities as collateral under any one of the abovementioned methods must therefore accept the consequences or potential consequences which may flow from the selected method. Parties wishing to avoid such consequences or potential consequences should therefore rather elect for cash as the appropriate form of collateral in a securities lending transaction.

For further reading: UncertificatedSecuritiesasCollateralinSouthAfricanSecuritiesLendingTransactions.pdf

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions