Although Ontario’s new Securities Transfer Act covers only a narrow subject — namely, the settlement of securities trades — it’s “the most significant piece of commercial legislation ever done in Canadian history” because of its uniform application across the country, says John Mitsopulos, manager of the business law modernization section at Ontario’s Ministry of Government Services.

“It is the first commercial law that will be harmonized across the country,” says Mitsopulos. “In terms of our intergovernmental relations working group, the law is harmonized almost 100%. Ontario and Alberta were first out of the gate on Jan. 1. Saskatchewan has introduced the bill and is in second reading; it’s expected to pass in the spring. British Columbia, Quebec and Manitoba are planning to introduce their legislation in the spring, and the other provinces will follow. It’s just a matter of getting time on their legislatures.”

The new STA makes the laws dealing with transferring securities uniform across Canadian jurisdictions and with Section 8 of the Uniform Commercial Code in the U.S., which has been in place in all 50 U.S. states since 1991. In practice, the STA legislation will reduce transaction costs and facilitate cross-border transactions. (This is an important consideration because about 25% of securities trades are cross-border.)

“These legislative amendments to Ontario’s corporate and personal security laws will enhance cross-border commercial activity,” says Jane Davis, executive director of the Canadian Capital Markets Association, adding that the new act “modernizes the legal framework underpinning Ontario’s financial services sector, thus enhancing global competitiveness.”

The STA updates a system of securities transfer legislation that had become seriously outdated. In the past, the law was based on actual possession of physical securities certificates. Although the marketplace began to change some two decades ago to a system in which most trades are settled through an indirect holding system of computerized book entries, the laws continued to be based on possession of paper certificates.

But now, under the STA, when investors buy a security, their interest will be recorded on the securities dealer’s books rather than on the issuer’s. The brokerage will have its interests recorded on the books of the clearing agency through which every trade goes — Clearing and Depository Services Inc. in Toronto.

“Our reason for supporting the act is because of the large values we deal with. One wants to have legal certainty, in terms of the end result as well as what happens in the industry itself,” says Thomas Marley, vice president of CDS.

“The gross value of trades that get reported on a daily basis are in excess of $200 billion,” he adds. “We had our peak transaction day on Nov. 1, 2006, on which we had 600,000 trades reported to us. Last year, we averaged 400,000 trades a day, primarily from the stock exchange, but also from the over- the-counter and bond markets. The other number for putting this into perspective is this: we currently have under our control about $3 trillion of securities on deposit.”

For Canada, the STA’s major innovation is to provide a complete and coherent set of rules to govern the indirect holding system — that is, the chain of computer database entry holdings (or book-based holdings) that starts with the issuer and CDS, passes down through one or more tiers of dealers and ends with the individual investor.

“In terms of day-to-day business, it’s not going to change a lot, from the capital market’s perspective,” says Mitsopulos. “The act largely codifies what’s being going on in the market for some time.”

But there are important changes: first, the administration of the markets will clear trades “a lot faster”; second, there is a major change in terminology.

“Two key concepts are ‘security interest’ and ‘security entitlement.’ What we’ve done is create, through the use of these terms, obligations on participation all up and down the sales cycle and the capital markets,” says Mitsopulos. “Individuals holding an electronic trading account now have a codified bundle of rights in relation to their stockbroker. Their stockbroker has a bundle of rights from whomever it picks up the stock — for example, CIBC or an AGF Funds Inc. mutual fund.”

These concepts are also important for pledging securities as collateral, which, until now, has been an exercise of legal uncertainty. But the STA and corresponding changes to the Personal Property Security Act provide a simple and secure method for using these investments as collateral for loans.

@page_break@“One of the most significant changes in practice will arise when a secured party wants to rely on a securities account at another financial institution as collateral for a customer’s obligations,” says John Cameron, a lawyer with Torys LLP in Toronto. “In typical cases, the secured party will need either to arrange for the securities to be transferred into the secured party’s security account at CDS, at a securities dealer or at a custodian or ask the customer’s securities dealer or custodian to sign a control agreement to protect the secured party’s interests under the new laws.”

A secured party can take similar steps to secure an interest in uncertified securities, such as mutual fund units or shares held directly by a customer, Cameron adds, pointing out that “securities dealers and custodians holding a security interest in their own customer’s accounts need not take any additional steps under the new laws. Where securities are evidenced by a certificate (shares of a private company, for example), a secured party can still protect its interests by obtaining possession of the certificate, duly endorsed.”

In light of the new law, Cameron advises securities dealers, securities custodians and mutual fund issuers to review their account documents. They should also revise the agreements to employ the new terminology and — until the other provinces have passed similar legislation — they should specify that the laws of Ontario, or Alberta, apply. IE