06 May 2011

Fact, fiction and securities lending

by Geoff Hoffman

Two recent ASIC changes will affect substantial holding notices and borrowing rights under prime broking and securities lending programs.

ASIC has created a legal fiction for substantial holding notices by securities lenders.

Essentially, the fiction is that lenders continue to have notifiable relevant interests in lent shares – even when they don’t.

The relevant interest chain

To understand how this is intended to make life easier, consider this scenario.

Person A owns 5% of a company and has lodged a substantial notice in relation to that holding. He lends those shares to Person B. Person A continues to have a relevant interest, because he can demand that B return the shares. Person B has a relevant interest in the shares because he’s now the registered owner of them. Person B is required to lodge a substantial holding notice.

Person B then lends the shares to Person C. Person C joins A and B in having a relevant interest in the shares and has to lodge a substantial holding notice.

Person C then lends the shares to Person D. Person D sells the shares. That extinguishes the relevant interest that A, B and C have in the shares.

This may affect the substantial holding notification obligations of A, B and C. The Corporations Act requires a person to lodge a notice when it acquires or loses a substantial holding. However, that notice only has to be lodged once the person becomes aware of the change. A, B and C may not know that D has sold the shares.

Until recently, ASIC advised shareholders in this situation simply to assume that they continued to retain their relevant interests (Consultation Paper 107). Now it has acted to give legal effect to that advice.

It has done this by making a class order which says that, as long as the securities lending agreement remains in place, a lender of shares retains a relevant interest in those shares, regardless of whether the shares are sold off down the chain. In fact, the lender keeps the relevant interest even if it knows that the shares have been sold.

This only relates to the need to lodge and update substantial holding notices. It does not affect other obligations and restrictions applying to relevant interests.

Prime broking and securities lending programs

Another recent ASIC change relates to borrowing rights under prime broking and securities lending programs.

A prime broker or custodian may have a right to borrow a client’s shares. That right gives the broker or custodian a relevant interest in the client’s shares, even if it is never exercised.

ASIC has modified the application of the Act to allow the broker or custodian to disregard that relevant interest unless and until it actually borrows the shares. Again, this relief only applies for the purposes of the substantial holding notice requirements.

It is important to note that this relief only applies to borrowing rights acquired in the ordinary course of the broker’s or custodian’s prime broking or custodial business, and it will not apply where the client is subject to restrictions on how it deals with the shares, other than:

  • a mortgage, charge or security taken over the shares in the ordinary course of carrying on a prime broking business or custodial business and on ordinary commercial terms; or
  • any restrictions of a “procedural or administrative nature in relation to giving instructions to the service provider for dealing in the securities”.

This is intended to exempt standard industry restrictions.

Substantial holding documentation

Along with these changes, ASIC has modified the documentation requirements for substantial holding notices related from securities lending.

A substantial holding notice of a relevant interest arising out of a securities lending agreement does not have to:

  • disclose the securities lending fees; or
  • include any relevant master lending agreement, provided a summary is provided).

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.