2Insolvency 1 CDC Pakistan

							                       A Presentation on
“Key impacts of participant insolvency on the Central
Depository System of the Central Depository Company
                of Pakistan Limited ”
  Presented by: Rasool Hooda, Manager Legal & Compliance




          11th ACG Cross Training Seminar
           2-5 July 2009 Dhaka, Bangladesh



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    Key Background Points

 The Central Depository System (CDS), maintained and
  operated by the Central Depository Company of Pakistan
  Limited (CDC), is recognised and supported by specific
  legislation, namely, the Central Depositories Act, 1997
  (CD Act)

 The CD Act sets out certain basic principles dealing with
  ownership of securities entered in the CDS [SECTION 4]

 Account Holders open Accounts with CDC in the name of
  the Account Holders [SECTION 4]

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     Key Background Points

 Some Account Holders, named as Participants (usually
  members of stock exchanges), open Sub Accounts with
  CDC in the name of Sub Account Holders, who are the
  clients of the Participants

 Securities are held in the CDS in electronic form in either
  Accounts or Sub Accounts

 The CD Act provides that the title to securities entered in
  Accounts vests in the respective Account Holders and that
  the title to securities entered in Sub Accounts vests in the
  respective Sub Account Holders [SECTION 4]

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      Key Background Points

 In this manner, the relevant Sub Account Holders are protected in case
  any Account Holder/Participant becomes insolvent as the securities
  entered in the Sub Accounts of the Sub Account Holders will not be
  mixed with the securities entered in the Account of the insolvent
  Participant

 The CDC Regulations add to this protection by requiring Participant to
  segregate their beneficially owned securities from the securities of
  their Sub Account Holders

 Further protection for Sub Account Holders is also provided by a
  specific provision of the CD Act which forbids Participants from
  transferring, pledging or withdrawing from the CDS any securities
  entered in the Sub Accounts of their Sub Account Holders without the
  consent of the concerned Sub Account Holders [SECTION24]

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     Key Background Points

 However, if a Sub Account Holder complains that they did
  not consent to the transfer from their Sub Account of any
  securities entered in their Sub Account, the CD Act forbids
  the record of CDC from being rectified, but the aggrieved
  person can obtain damages against the defaulting party
  [SECTION 11]

 Furthermore, CDC is expressly exonerated by the CD Act
  if CDC acts in good faith and without negligence on
  transfer instructions given to it by Account Holders and
  Participants [SECTION 8]



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     Legal impact of Participant
     insolvency

 In the above background, there is no immediate legal
  impact of Participant insolvency on both CDC and the Sub
  Account Holders of the Participant. In other words, both
  CDC and the Sub Account Holders of a Participant, as
  well as the other Elements of the CDS, are remote from the
  insolvency of a Participant




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      Procedural implications of
      Participant insolvency

 Certain procedures, however, begin to operate in the event of
  Participant insolvency

 Insolvency of a Participant triggers an Event of Non-compliance
  having certain consequences under the CDC Regulations, which have
  the force of delegated legislation as they are made under and pursuant
  to the CD Act
 In the event of Participant insolvency, the CDC Regulations empower
  the CDC to: [REGULATION 15.2.1]

    Impose full or partial restrictions on the Participant
    Suspend a Participant for a limited time
    Terminate the admission of the Participant in the CDS



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     Procedural implications of
     Participant insolvency
 The appropriate action from the above range of actions will
  be determined by the CDC having regard to the finality of the
  insolvency proceedings against the Participant

 If the Participant is a member of a stock exchange, notice of
  the action taken against the Participant will also be given to
  the stock exchange
 In case the admission to the CDS of the insolvent Participant
  is terminated, CDC may make consequential arrangements
  with the liquidator/administrator of the insolvent Participant
  for withdrawal from the CDS, or removal from control of the
  Participant, of the securities entered in the Accounts and Sub
  Accounts of the Participant

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     Procedural implications of
     Participant insolvency
 While taking withdrawal or removal from control action,
  CDC must take into account the wishes of the pledgees in
  whose favour the Participant has pledged any securities and
  of the Sub Account Holders who have any securities entered
  in any Sub Accounts controlled by the Participant




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     DOES CDC REQUIRE SPECIAL LEGAL
     PROTECTION IN CASE OF
     PARTICIPANT INSOLVENCY?

 Yes

 In the absence of special legal provision for CDC to deal
  with Participant insolvency, the general insolvency laws
  would have applied and the process would have come
  under control of the courts, which could have caused delay
  and attendant systemic risk to the functioning of the
  securities market

 If the securities of the insolvent Participant were not held
  in an insolvency remote manner from the securities of its
  clients, the clients would have been exposed to the
  insolvency of their Participant, in the same position as
  unsecured creditors of the Participant

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     DOES CDC REQUIRE SPECIAL LEGAL
     PROTECTION IN CASE OF
     PARTICIPANT INSOLVENCY?

 The insolvency procedures stipulated in the CD Act and the
  CDC Regulations as described above, are enforceable against
  bankruptcy laws in Pakistan because, being special laws,
  they override the general laws of bankruptcy

 Such special laws also have the advantage of giving
  expeditious access to their securities to the pledgees and Sub
  Account Holders of the insolvent Participant, who would
  otherwise have to wait for the courts and the liquidators to
  deal with their securities, causing delay and possible
  systemic risk to the securities market.




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     STIPULATIONS OF PRINCIPLES ON
     DEALING WITH PARTICIPANT
     INSOLVENCY

 Procedures for dealing with Participant’s insolvency vis-à-
  vis disposal of their securities controlled by Participants
  are set out in the CD Act and the CDC Regulations, as
  described above

 The general law of insolvency is set in the Insolvency
  (Karachi Division) Act, 1909 and the Provincial
  Insolvency Act, 1920. In case of company insolvency, the
  Companies Ordinance, 1984 provides that the rules
  contained in applicable insolvency law will apply to the
  wind up of such company



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     CDC’S EXPERIENCE IN THE RECENT
     TURBULENT MARKET CONDITIONS

 Relatively few cases of member default were observed in the
  recent market turbulence

 Of these, most were handled efficiently and in a consensual
  manner by the administrations of the Stock Exchanges

 Moreover, Pakistan does not have a culture of institution of
  insolvency/liquidation proceedings against defaulters

 Therefore, it is an open question how Pakistan insolvency
  laws will deal with Participant insolvency when such cases
  do come before the courts


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     CDC’S EXPERIENCE IN THE RECENT
     TURBULENT MARKET CONDITIONS

 Our understanding is that the procedures discussed above
  will be upheld by the courts in the event of Participant
  insolvency

 Other issues to be tested are:
   One specific issue which needs to be tested, and on which the
    CD Act and the CDC Regulations are both silent, is how the
    courts will deal with allegations of fraudulent preferences

   The claw back period for fraudulent preferences in the case of
    insolvent companies is 6 months before the insolvency strikes,
    and 3 months in the case of individual bankruptcy


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  CDC’S EXPERIENCE IN THE RECENT
  TURBULENT MARKET CONDITIONS


Furthermore, whilst the law exempts bona fide transactions
 from fraudulent preference, the limit to which and the manner
 in which this exemption will be applied by the courts in relation
 to securities transactions is to be tested

It is also to be tested to what extent will the CD Act’s bar
 against rectification of the CDC’s records for unwinding
 securities transactions recorded by it will be enforced by the
 courts against fraudulent preference claims

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