New rules for settling securities transactions
A bill to amend the Act on Trading in Financial Instruments was adopted on 28 June 2012. The main purpose of the amendment is to prepare the Polish capital market for entry into force of the European Market Infrastructure Regulation soon to be enacted by the European Union.
The need to adopt the European Market Infrastructure Regulation, or “EMIR” as it is popularly known, was agreed by the G20 countries after the 2008 collapse of Lehman Brothers. EMIR will change the manner in which transactions in financial instruments are settled, in order to shore up the security of transactions in “over-the-counter” derivatives outside of organised trading (e.g. via the stock exchange). A draft of EMIR was adopted by the European Council on 4 July 2012, and the final wording of the regulation is still being worked out. When enacted, EMIR will apply directly in Poland as a member state of the European Union.
So far, transactions in OTC derivatives have been settled directly between the parties. Upon sale of an OTC security, the seller is required to deliver the financial instrument to the buyer and the buyer is required to pay the price to the seller. After entry into force of EMIR, most such transactions would be required to be settled through a clearinghouse acting as a “central counterparty”. The key to the operation of the central counterparty is that upon accepting a transaction for clearance, it assumes the rights of the parties to the transaction, becoming liable to the seller to perform the buyer’s obligation (to pay the price) and liable to the buyer to perform the seller’s obligation (to deliver the instrument to the buyer’s securities account). In the words of the proposed regulation, the central counterparty will become “the buyer to every seller and the seller to every buyer”, a structure referred to in Polish legal terms as a “clearance novation”.
The clearinghouse should be a more secure counterparty, among other reasons, because it will maintain a fund to secure proper settlement of transactions in the event of insolvency of one of the parties. The fund will operate as a mutual guarantee fund, and the amount of the fees paid by the participants in the fund will depend on the risk inherent in the type of trades they conduct.
Another new feature is an obligation for the clearinghouse to report on OTC derivatives transactions and maintain a repository of such trades.
The recently adopted bill to amend the Act on Trading in Financial Instruments would enable the clearinghouse operating in Poland, KDPW CCP SA (a subsidiary of the National Depository for Securities, KDPW SA) to operate as a central counterparty. Under the bill, the clearinghouse would specify in its rules the types of transactions subject to clearing through the central counterparty using the novation mechanism described above. Ultimately, this issue will be determined primarily by EMIR.
Introduction of clearing novation may also have a beneficial impact on trading on the stock exchange. Under current law, conclusion of a contract of sale of shares on the stock exchange does not automatically result in transfer of rights to the shares to the buyer. The transfer also requires entry of the shares in the securities account of the buyer. Performance of this action does not depend on the parties to the transaction, but on the entities operating the depository and clearance system for transactions on the Warsaw Stock Exchange, namely the National Depository for Securities (KDPW SA) and its subsidiary KDPW CCP SA. This approach has caused certain difficulties in enforcing claims between counterparties to transactions on the stock exchange. When the seller does not have the power to deliver the securities to the buyer, the buyer cannot seek an order requiring the seller to do so. The new provisions would clarify the positions of the counterparties and the scope of their obligations, and hence the scope of any claims they may have.
The liability of the central counterparty assuming the rights of the parties to the transaction will not be absolute, however. Its rules would specify the scope of liability for non-performance or improper performance of its obligations in clearing a transaction. The clearinghouse would also be entitled to withhold from the clearance consideration of the same type payable for the parties’ participation in the system guaranteeing proper clearance of the transaction.
Danuta Pajewska & Jakub Koziński, Capital Markets and Financial Institutions practices, Wardyński & Partners