Tag: Dematerialisation

UKSA Position Paper on Dematerialisation

UKSA has published a “Position Paper on Dematerialisation” – see https://www.uksa.org.uk/sites/default/files/2022-12/UKSA-position-on-dematerialisation-published-2022-12-24.pdf

It covers how the existing nominee and Crest systems operate which is an exceedingly complex topic, and what they would like to see if all shareholdings are dematerialised into the Crest system (and paper share certificates scrapped) as they must be soon.

I have been writing on this subject for over ten years for both UKSA and ShareSoc and the UKSA Paper provides a good explanation of the existing system. The ShareSoc campaign on the issue is described here: https://www.sharesoc.org/campaigns/shareholder-rights-campaign/

As one of the few remaining sponsored Crest members I am very keen to retain my rights that this provides such as being on the share register as a “Member” giving undisputed voting rights and clear communication rights.

But even this is proving problematic at present because companies and their registrars are now forcing payment of dividends via bank transfer rather than cheques. But if I buy a new shareholding they don’t know my bank details which creates a delay while they send me a form to register the details. Indeed the same difficulty arises with the few certificated holdings I have.

I am happy to give up receiving dividend cheques because my local bank is closing in May much to my disgust, but this is a system problem that needs resolving.

In the meantime the Digitisation Taskforce created last July needs to get a move on and come up with some recommended solutions before those of us on share registers all die of old age.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Austin Review of Capital Raising and Dematerialisation

It’s the mid-summer doldrums in the stock market and with investors having more time on their hands, what better time to issue a 265 page document entitled “UK Secondary Capital Raising Review” (see link below). This document covers a number of very important issues to investors after a review by Mark Austin as Chair of a committee that has looked at the way the UK stock market operates in certain areas. I will only cover some of the key points below because it is a long and complex technical document but Mr Austin has done a fine job in bringing out the key issues in his report to the Chancellor:

  • He spells it out early on in these sentences: “…….we as a market need to be bold and brave in our thinking. We need to look at our existing rules and practices with a fresh set of eyes and a blank sheet of paper, and ask ourselves with a bottom-up rather than top-down approach – what is the right regime for us as a market for the next decade and beyond? …….That requires bold thinking and potentially addressing vested interests that have organically (and understandably) grown up in the past couple of decades due to how the system currently operates – and that may have made our capital markets fit for purpose in the past couple of decades but will not necessarily make it fit for purpose in the coming two decades”.
  • Secondary capital raising is one area he looks at in detail. He says: “There are many – sometimes competing and overlapping – structures, views and guidelines that create a complex architecture. Practice has built up over many years. It is, for want of a better phrase, an area that is very ‘whack-a-mole’ in nature, in that when one issue is addressed, it often causes another that needs to be addressed to pop out elsewhere – usually for a different set of stakeholders”. Retail investors are ill-served by existing practices and have been missing out on placings for example. Mr Ausin says, and quite rightly, that “As much of a company’s existing shareholder register as possible – including, importantly, retail investors – should be able to participate in any capital raising in a timely way, whatever its structure. Again, technology and digitisation have a key role to play here”.
  • Pre-emption rights are important to shareholders to avoid dilution but the rules on what is allowable are not defined in law but are promoted by a “Pre-emption Group” – in essence a club of city grandees. The Austin Review suggests it should be put on a more formal basis which is surely sound policy. The Review also covers the use of “Cash Box” transactions to get around the current legal limits on share issuance which should surely be outlawed and is one option suggested in the Review.
  • One matter discussed is the complexity and delays that occur when a rights issue or open offer is chosen as the fund-raising method. This discourages their use and the reliance instead on placings to expedite matters and reduce costs which prejudice private shareholders and smaller institutions. The key problem is the lack of a complete digital register of shareholders (including beneficial owners who hold shares in nominee accounts). That frustrates rapid communication with investors. Where a general meeting to vote on a proposal is required this currently requires 14 or 21 days notice to shareholders but the proposal is to reduce that to 7 days – an impractical objective unless electronic communication is possible. That will certainly assist rapid fund raisings which are sometimes required but it might also obstruct the ability of shareholders to communicate their concerns to other shareholders in time to oppose a vote. I suggest this requires more consideration.
  • The Review spells out the key priority in this sentence: “Raise the priority of an ambitious ‘drive to digitisation’ to facilitate innovation, stewardship and improved market infrastructure, which is actioned by a Digitisation Task Force with an independent chair and a clear set of principles to be followed”.
  • That will include “the eradication of paper share certificates and that “– it should seek to ensure that rights attaching to shares flow to end investors quickly and clearly and that investors are able to exercise those rights efficiently”. That is currently obstructed by the prevalent nominee system and the obstruction of some nominee operators (stockbrokers and platforms).
  • I have of course written extensively on the issue of dematerialisation and the use of nominees extensively in the past – in fact for more than 15 years with little action on the issue being decided. It is well overdue! ShareSoc has run a campaign on this issue where you can see the issues explained – see https://www.sharesoc.org/campaigns/shareholder-rights-campaign/ . There needs to be a “bottom-up” reform of the ways share are held and transactions recorded as the Review suggests. The current system is way too complicated and needs reform to improve shareholder democracy and market efficiency. Dematerialisation of all shares in public companies is a given requirement and all shareholders should be on the share register so that issuers (public companies) know who their investors are and can communicate with them quickly and easily. That is also a requirement for improved shareholder democracy.  

In conclusion, the Austin Review is a well-researched report and is essential reading to anyone who invests in the stock market. It includes detail reviews of how other international markets such as Australia operate. Let us hope that its recommendations are followed through with some urgency.  For retail investors the proposals should be welcomed not feared.

Austin Review: https://www.gov.uk/government/publications/uk-secondary-capital-raising-review

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Scrapping Share Certificates and Clive Sinclair Obituary

The Government is to push ahead with the scrapping of paper share certificates. An announcement yesterday by Lord Frost included this in a bonfire of regulations which also included plans to scrap driving licences (i.e. making them digital only). The dematerialisation of shares was long ago committed to by an EU directive with no new paper certificates to be issued by 2023 and all existing ones replaced by 2025.

There are many share certificates still held by investors – for example I still hold a few, mainly for VCT companies which I have never bothered to dematerialise. A paper share certificate at least ensures you are on the share register of a company and hence are a “member” with full shareholder rights. A replacement system which ensures you retain those rights rather than shares being held in a stockbroker’s nominee system is required but plans for implementation of such a system have been slow in appearing.

See https://www.gov.uk/government/publications/brexit-opportunities-regulatory-reforms for the announcement.

Inventor and businessman Sir Clive Sinclair has died at the age of 81. He developed early calculators, digital watches and the ZX81 and Spectrum personal computers. The latter were the first popular home computers in the UK sold at a price almost everyone could afford (less than £100). I fondly remember playing video games on a Spectrum but they were not much use for anything else. The keyboard was a single sheet of rubber and not fit for much at all.

Despite these short-lived commercial impacts, he never developed these businesses into long-term successes and even proceeded to destroy his reputation with the Sinclair C5 electric vehicle.

He provided a very good example of how in Britain we have good technology innovators but not good businessmen who can develop a company and conquer the world with superior sales and marketing.

Sir Clive seemed to always want to move on to new inventions rather than concentrating on making money from existing ones and doing the boring work involved in developing existing products and markets. Therefore in essence a flawed personality in many ways.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Law Commission Review of Intermediated Securities

The Law Commission has published a “scoping paper” on Intermediated Securities (See Reference 1 below). This might sound a pretty dry technical subject but the subtitle of the report asks the important question – it covers “Who Owns Your Shares?”

I have written about the problem of the growth in the use of nominee accounts as on-line platforms have replaced share certificates many times in the past. ShareSoc has a web page with voluminous information on this subject including reports written by me (see Reference 2). It is certainly an area well overdue for reform.

I also submitted a personal response on the subject to the Law Commission (See Reference 3) – the Commission did quote from it in their report, but they did not get that many submissions from investors.

The Law Commission has actually done a good job of explaining most of the problems inherent in the current system of “intermediated securities”, otherwise known as the use of “nominee accounts”. I can do no better than to repeat their summary of the issues: “The system of holding investments through a chain of financial institutions (“intermediated securities”) stops investors being able to exercise shareholder rights and can lead to legal uncertainty”.

The Commission identifies these advantages and disadvantages of the current use of intermediated securities:

Advantages

The Commission found a number of strengths of the intermediated securities system, including increased efficiency and economies of scale, and convenience for ultimate investors, who may hold a diverse, cross-border portfolio of investments through a single intermediary.

 Disadvantages

On the other hand, there are well-founded concerns relating to corporate governance and transparency, and uncertainty as to the legal rights and remedies available to an ultimate investor. An ultimate investor is not a “member” or shareholder of the company under the Companies Act 2006, and it is therefore unlikely that they will receive information from companies, have voting rights (for example at AGMs) or be able to attend meetings. Even where an ultimate investor is able to vote, they may find it difficult to confirm that their vote was received and counted by the company.

There is also legal uncertainty around a number of scenarios that could play out, including what happens when an intermediary in the chain becomes insolvent, and the legal position when intermediated securities are wrongly sold.

The fact that most retail investors do not own the shares they think they do is spelled out in this paragraph in the report summary: “As an ultimate investor, your name will not appear on the register of members and you are not a member of the company. You will not automatically have a direct relationship with the company. Instead, the financial institution (the “CREST member”) at the top of the intermediated securities chain will be the legal owner of the investments and the legal shareholder or member of the company. They will receive information and correspondence from the company, be able to attend company meetings and vote in relation to the shares”.

This is a good quotation from the full report: “When people have money saved, they may wish to invest it. But not all investments are straightforward to own. If you buy a gold bar, you own the gold bar. If you buy a piece of art, you own the painting or sculpture. If you decide to buy securities, such as shares or bonds issued by a company, the position is more complicated”. In essence, way too complicated!

The Scoping Paper explains all the above in a lot of detail, and they conclude by suggesting how the system could be improved, with a number of options covered.

They point out that the prospect of “dematerialisation” gives the opportunity to either remove intermediation altogether or introduce a genuine alternative for investors so that they could hold their shares directly if they wished. They favour the latter because they consider it more “proportionate”. But also suggest the Government should consider the long-term systemic advantages of removing intermediation altogether by the use of a “name on register” system.

The Law Commission’s report is very comprehensive (at 200 pages) and well covers the legal complexities. It also provides some useful information on the way shares are held and voting turn-outs.

One area which they do not cover well is the issue of the engagement with investors by companies and by other shareholders. Companies cannot communicate with their ultimate investors if they hold their shares in intermediated form. This can be very important when takeover bids arise or there are corporate governance issues (see pages 40-41 of the report). This is also very important when shareholders wish to communicate with other “members” (i.e. shareholders) which they have rights to do under the Companies Act. But this is thwarted when most shareholders are in nominee accounts (theoretically they can but practically it is almost impossible to do so in most cases – see pages 63 to 66 of the report where some solutions are suggested). But the Commission does not go into these issues because apparently this policy issue was not included in their terms of reference from BEIS. That is most unfortunate.

The failure to have all shareholders on the share register fatally undermines shareholder democracy. But even if the use of intermediaries was retained it is still possible to have all shareholders (including beneficial owners) on the share register. Technically that is not difficult to achieve (I speak as an former IT system designer). That would solve many of the problems associated with voting and shareholder democracy.

Chapter 3 of the Report on “Voting” gives you a good picture, if not understanding as it is horribly complex, of how shareholders can vote at General Meetings. This is normally possible, if your broker (nominee operator) agrees but perhaps at some cost. But it typically does not allow someone in a nominee account to appoint someone else as a proxy – you can only appoint your nominee operator. This is a big defect as it makes it difficult for any person or organisation to collect proxy votes.

Unfortunately the Commission only proposes minor improvements in the voting system, not a wholesale reform. But they do discuss extending the Shareholder Rights Directive to cover beneficial (ultimate) owners which it certainly should have done anyway, but did not as implemented in the UK.

Chapter 4 of the Commission’s report covers the problems related to Schemes of Arrangement. The “headcount” test can result in bizarre consequences when such schemes are voted upon as only Members are counted, not beneficial owners. Or it can result in exploitation of the anomalies by clever persons. The Commission recommends the headcount test be removed which I consider makes sense but other provisions to protect small minority investors should preferably be added (relying on a court’s discretion to protect minorities does not in my experience work).

The Commission’s discussion of the “No Look Through” Principle in Chapter 5 makes for interesting reading. This principle in contract and trust law prevents any beneficial owner in a nominee account from pursuing the share issuer (company) in law as they only have a contract with their nominee operator. The Commission suggests some improvements that might assist in this area and which appear to be sensible.

In Chapter 6 the insolvency of an intermediary is discussed, i.e. what happens if your stockbroker or platform operator goes bust. This is big concern for investors as the use of intermediaries undermines your legal rights of ownership to shares, and there have been a number of examples of where ultimate owners were prejudiced, or lost money, as a result. The use of “omnibus” or “pooled” nominee accounts is particularly dangerous.

The position of investors was improved when the Special Administration Regime was introduced but it has not resolved all the problems. The Commission proposes some improvements that might help but also suggests more research and consideration is required in this area. This area could justify a 200-page report alone and the solutions are not at all obvious.

Chapter 7 of the report covers the legal problems associated with the sale and purchase of intermediated securities. It may be of more interest to lawyers than casual readers.

Chapter 8 covers dematerialisation (scrapping paper share certificates) and the opportunities for reform it creates. It covers the proposals developed by the Demateralisation Working Group and Registrars Group to create a replacement electronic system. That would support a “name on register” system and hence preserve voting and information rights to certificated shareholders. But extending such a system to cover intermediated securities might be a very big and costly task it is suggested. It would also create some legal issues apparently.

The Commission recommends, in Chapter 9, that a new set of best practice principles be developed in regard to intermediated securities. The report explains how that might assist. The discussion makes it clear that a lot more work would be required in this area to develop a code of practice that was both clear and understandable by retail investors.

The report concludes by covering the areas where further work is required, which is clearly very extensive. It is does however provide a very comprehensive review of the legal and technical aspects of this subject and I could not find any inaccuracies therein.

It is good that they have clearly read, reported and understood the submissions not only by several individual investors like me, but also of ShareSoc and UKSA. I am hopeful the report will lead to some improvements in due course, but regrettably the pace of change is low.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

Reference 1: Law Commission – Intermediated Securities Scoping Paper: https://www.lawcom.gov.uk/project/intermediated-securities/

Reference 2: ShareSoc Shareholder Rights Campaign: https://www.sharesoc.org/campaigns/shareholder-rights-campaign/

Reference 3: Roliscon Submission to Law Commission: https://www.roliscon.com/Intermediated-Securities-Consultation.pdf

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Sophos, Interquest and the Government

Yesterday I missed the Sophos (SOPH) AGM due to having a clashing engagement, but I noticed that in the announcement of the voting results that there were substantial votes against the Remuneration Report (29.8% against) and also high votes against most of the directors. One only needs to glance at the Remuneration Policy to see why.

The maximum bonus opportunity is 200% of salary, and the maximum LTIP award is 500% of salary in normal circumstances and up to 750% in exceptional circumstances. So total incentive payments can reach nearly 10 times normal salary. That’s the kind of scheme I always vote against.

For what is actually a relatively small company that has never reported an annual profit, the actual pay figures are way too high – CEO got a base salary of $695,000 last year and total single figure remuneration of $2.32 million. Other directors, even the non-execs, have similar generous pay figures. It might be a rapidly growing company in a hot sector (IT security) but I am beginning to regret my purchase of a few shares.

Although I missed the AGM, I did “attend” the previous days Capital Markets Day. I was refused physical access but anyone could log into the web cast of the event. Not quite the same thing but it was exceedingly boring with a lot of the time spent on the wonders of their technology rather than important business questions. Is it not despicable though that companies and their PR advisors try to keep such events solely to institutional investors?

Interquest (ITQ) is an AIM listed company that received an offer for the company from some of the directors but they only got 58% committed support. That’s not enough to delist the company under the AIM Rules which requires 75% so the offer was abandoned. What did the directors do then? They notified their Nomad of termination of their contract and subsequently said they would be unlikely to appoint another Nomad within the one month period allowed. This means the shares will automatically be suspended from AIM and subsequently delisted if no Nomad is appointed.

The moral is that if directors or anyone else control 58% of the company then minority shareholders are in a very difficult position because they will have the ability to do lots of things that prejudice the minority shareholders – for example pay themselves enormous salaries. A legal action for prejudice of a minority is available but as my lawyer said yesterday, these are complex cases, as I well know from having run one myself in the past, and successfully (we were discussing my past legal cases). It’s difficult enough in a private company, and even more so in a public one. In summary, having an AIM Rule about delistings may not help if one cannot win a vote of shareholders on other matters that require just 50%.

Having control of a public company in the effective hands of a concert party of a few people is something to be very wary about, and something all AIM company investors should look at.

Government policy on tackling excessive pay levels for the directors of public companies has taken a step backwards this week. Tougher measures which Theresa May threatened have been watered down, and the core of the problem – the fact that Remuneration Committees consist only of directors, whose appointment and pay is controlled by other directors, has not been tackled. In addition, the potential to control pay by votes at General Meetings has been undermined by the disenfranchisement of private shareholders as a result of the prevalence of the nominee system and the dominance of institutional voters who have little interest in controlling pay.

Another bit of news from Government sources this week is that the hope of some change in shareholder rights that might have improved private shareholder voting is fading away after a decision to postpone yet again the issue of “dematerialisation”. The staff involved in that project have been moved and expertise will be lost. This is likely to be the result of both lack of interest in tackling a difficult and complex problem, and the need to put in effort on Brexit matters at the BEIS Department.

Will we ever get a proper shareholder system where everybody is on the share register and automatically gets full rights, including voting rights? It remains to be seen but I will certainly continue to fight for that. Without it we will never get some control over public companies and their directors. I suggest readers write to their Members of Parliament about this issue.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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