Compliance Report ISSA Recommendations 2000

ISSA - International Securtities Services Association

Compliance to the ISSA Recommendations 2000

Market: South Africa

Status: February 11, 2002

Recommendation 1
Recommendation 2
Recommendation 3
Recommendation 4

Recommendation 5
Recommendation 6
Recommendation 7
Recommendation 8

Market selection

Recommendation 8

Local laws and regulations should ensure that there is segregation of client assets from the principal assets of their custodian; and no possible claim on client assets in the event of custodian bankruptcy or a similar event. Regulators and markets, to further improve investor protection, should work:

to ensure clarity on the applicable law on cross border transactions
to seek international agreement on a legally enforceable definition of finality in a securities transaction
to ensure that local law fully protects the rights of beneficial owners
to strengthen securities laws both to secure the rights of the pledgee and the protection accorded to client assets held in Securities Systems.

1. Under local rules and regulations, what are the segregation requirements for keeping client assets and custodian assets in the depository?
STRATE does not keep details of the beneficial owners of uncertificated securities held in the system. These records are kept in the sub-registers maintained by the CSDPs.

In terms of the Custody and Administration of Securities Act, 1992 and the Rules of STRATE, the client's assets are segregated in the account:

A CSDP must ensure that all eligible securities deposited with it by a client are entered in an (uncertificated securities) account, maintained by the CSDP for the client reflecting the number or nominal value of the securities of each kind deposited and all entries made in respect of such securities relating to such a client (Rules 1.2 and 6.1.4).
A CSDP may open two or more (central securities) accounts in STRATE in the name of the CSDP, each account reflecting the number or nominal value of uncertificated securities of each kind deposited with STRATE by the CSDP for:

Its own account and all entries made in such account, or
The account of its client and all entries made in such an account (Rule 6.3.1.2)

An account opened for a client must be designated by a CSDP as an uncertificated securities account and clearly distinguishable from the CSDP's own account (Rule 6.3.2.3)
A CSDP's system of internal control and risk management must be designed to ensure that there are procedures to safeguard the CSDP's assets and assets belonging to other persons to which the CSDP is accountable and to control liabilities (Rule 7.5.2.2)

The nominee concept is also recognised in terms of South African law. The names of the investors registered in the nominee name of a CSDP or Broker/dealer will not appear in the CSDP's sub-register which is recognised in the Companies Act, 1973 as part of the company's main register. However, individual investors behind the nominee will not be disenfranchised in any way. Recent amendments to the Companies Act (disclosure of beneficial interests in securities - S140 (A) and the JSE Listing Requirements ensure that issuer companies will receive a regular register identifying beneficial owners and their securities.
Issuers are also required to submit to beneficial owners all circulars, notices and annual financial statements and to treat the beneficial owner as if he/she was a shareholder.

2. How are clients' assets protected in the event of insolvency of a custodian or depository? STRATE (depository) holds only the control total of uncertificated securities. The insolvency of STRATE will thus not have an effect on the client's assets. The law protects CSDP held assets from claims and liabilities of STRATE through segregated accounts. STRATE cannot assess a lien on CSDPs' accounts.
Furthermore, the legislation (Custody and Administration of Securities Act, 1992) makes it clear that the ownership of the securities deposited does not pass through to the depository, but remains with the owner. The insolvency of the STRATE depository would only affect administrative and operational issues.
Risks do not lie with STRATE but rather with the CSDPs who hold the record of ownership in uncertificated form on behalf of their clients. The CSDPs' risk is provided for in our legislation and rules (as per the entry criteria). Each CSDP is responsible for its own losses.

In respect of transactions on the JSE, responsibility to settle confirmed settlements which subsequently fail will revert to the broker/dealer and failing him to the JSE acting through the Settlement Authority which will step in to ensure that settlement takes place and will take action against the non-performing broker/dealer. Settlement risk falls on the broker that introduced the trade in terms of JSE (JSE Securities Exchange South Africa) Rules. The JSE penalises brokers if they fail to settle a transaction. In addition, any party suffering a loss would be entitled to a claim against the JSE Guarantee Fund in terms of the JSE Rules.

Section 35A (5) of the Insolvency Act excludes property disposed of in terms of the rules of an exchange. Thus, if the rules of the exchange regulate the settlement and if a transaction is settled after the lodgment of the application for winding up, the disposition of property in terms thereof cannot be attacked.

3. Does local law recognise the existence of beneficial owners who may differ from the legal owner of a security?
Yes.
Legal shareholders with regard to STRATE:

In terms of S 91(A) of the Companies Act 1973, the legal registered record of holding balances for a STRATE approved security may be recorded on a :

CSDP sub-register in name of a nominee; or
CSDP sub-register in own name of client/investor

In terms of the Companies Act, the holding balances maintained by the CSDPs are the records of legal title. Holdings on the CSDP's sub-register are recognised in law as if they were maintained directly by the Issuer.
A transfer in the STRATE environment constitutes a transfer of legal title.
A CSDP may have one or more of the following (uncertificated securities) accounts in their books:

An account in the CSDP's own name
An account in the name of a nominee company controlled by the CSDP
An account in the name of such other person as the client may direct (Rule 6.3.2.4)

Beneficial shareholders

The CSDP must ensure:

That the election by a client to deposit securities in the name of the nominee of the CSDP and not the client's own name shall in no way diminish the rights of the client as a member of the issuer of the securities and the CSDP shall ensure that the client is timeously advised of, and is in a position to exercise its rights as a member of the issuer as if the client was the registered member (legal owner) of the issuer (Rule 7.4.1.1)
All interest, dividend and other payments received by it from an issuer will be paid to the client upon receipt (Rule 7.4.1.2)
All notices regarding rights and other benefits accruing to the securities which are received by the CSDP from the issuer are conveyed within a reasonable time to the clients (Rule 7.4.1.3)

The standards of record keeping which apply to uncertificated securities in the subregister (register of legal owners) kept by the CSDP shall also apply and be maintained by the CSDP in respect of other records of the underlying clients of CSDP (beneficial owners recorded on the subregister Rule 6.3.2.6)
In terms of S 140 (A) of the Companies Act, 1973, nominee companies are obliged to disclose to a company the names of all beneficial shareholders every three months. Companies are obliged to keep this information open to public scrutiny. In addition, companies are obliged to publish the names and holdings of all beneficial owners of 5% or more of the shares in the company, in their annual financial statements.
Disclosure of beneficial ownership is enhanced by the provisions of the JSE Listing requirements

4. Does local law clearly define the point of time when a settlement, both for the security and the cash involved, achieves finality and thus cannot be unwound?
Yes, when title to the securities pass between CSDPs. This is when the book entry is made on the accounts of STRATE and the CSDP's accounts. Firstly, there is a freezing of securities balances, upon which STRATE performs the transfer of ownership once the payment through the Central Bank has been made. Once STRATE confirms to the CSDP that settlement has taken place, the CSDP must reflect the entry in its books. Final and irrevocable transfer of ownership then occurs. The entry cannot be reversed. Delivery versus payment applies and is final and irrevocable on T+5. The entry will not take place unless the cash has been received.

Section 91A(4)(a) of the Companies Act provides: 'Transfer of ownership in an uncertificated security shall be effected upon the debiting and crediting, respectively, of both the account in the subregister from which the transfer is effected and the account in the subregister to which the transfer is to be made in accordance with rules of the central securities depository'.
Settlement of transactions in uncertificated securities, including off market trades, must take place in the manner determined by STRATE and in accordance with the rules of the JSE (Rule 6.8.1).

5. Does a pledgee have an absolute right to realise their security at all times? Yes. The Custody and Administration of Securities Act, 1992 makes provision for the pledging of securities deposited in a depository. The common law rules on the protection of rights of the pledgor and pledgee remain unaltered.

6. Does the depository have loss sharing provisions in its rules, and how would these be applied? No. STRATE does not assume any responsibility for losses that may arise due to the actions of the CSDPs. STRATE has insurance cover against certain aspects of negligence or system failure (STRATE Rules require insurance for specific instances). Claims in respect of these items will be accepted.

1.	Under local rules and regulations, what are the segregation requirements for keeping client assets and custodian assets in the depository?	STRATE does not keep details of the beneficial owners of uncertificated securities held in the system. These records are kept in the sub-registers maintained by the CSDPs. In terms of the Custody and Administration of Securities Act, 1992 and the Rules of STRATE, the client's assets are segregated in the account: A CSDP must ensure that all eligible securities deposited with it by a client are entered in an (uncertificated securities) account, maintained by the CSDP for the client reflecting the number or nominal value of the securities of each kind deposited and all entries made in respect of such securities relating to such a client (Rules 1.2 and 6.1.4). A CSDP may open two or more (central securities) accounts in STRATE in the name of the CSDP, each account reflecting the number or nominal value of uncertificated securities of each kind deposited with STRATE by the CSDP for: Its own account and all entries made in such account, or The account of its client and all entries made in such an account (Rule 6.3.1.2) An account opened for a client must be designated by a CSDP as an uncertificated securities account and clearly distinguishable from the CSDP's own account (Rule 6.3.2.3) A CSDP's system of internal control and risk management must be designed to ensure that there are procedures to safeguard the CSDP's assets and assets belonging to other persons to which the CSDP is accountable and to control liabilities (Rule 7.5.2.2) The nominee concept is also recognised in terms of South African law. The names of the investors registered in the nominee name of a CSDP or Broker/dealer will not appear in the CSDP's sub-register which is recognised in the Companies Act, 1973 as part of the company's main register. However, individual investors behind the nominee will not be disenfranchised in any way. Recent amendments to the Companies Act (disclosure of beneficial interests in securities - S140 (A) and the JSE Listing Requirements ensure that issuer companies will receive a regular register identifying beneficial owners and their securities. Issuers are also required to submit to beneficial owners all circulars, notices and annual financial statements and to treat the beneficial owner as if he/she was a shareholder.
2.	How are clients' assets protected in the event of insolvency of a custodian or depository?	STRATE (depository) holds only the control total of uncertificated securities. The insolvency of STRATE will thus not have an effect on the client's assets. The law protects CSDP held assets from claims and liabilities of STRATE through segregated accounts. STRATE cannot assess a lien on CSDPs' accounts. Furthermore, the legislation (Custody and Administration of Securities Act, 1992) makes it clear that the ownership of the securities deposited does not pass through to the depository, but remains with the owner. The insolvency of the STRATE depository would only affect administrative and operational issues. Risks do not lie with STRATE but rather with the CSDPs who hold the record of ownership in uncertificated form on behalf of their clients. The CSDPs' risk is provided for in our legislation and rules (as per the entry criteria). Each CSDP is responsible for its own losses. In respect of transactions on the JSE, responsibility to settle confirmed settlements which subsequently fail will revert to the broker/dealer and failing him to the JSE acting through the Settlement Authority which will step in to ensure that settlement takes place and will take action against the non-performing broker/dealer. Settlement risk falls on the broker that introduced the trade in terms of JSE (JSE Securities Exchange South Africa) Rules. The JSE penalises brokers if they fail to settle a transaction. In addition, any party suffering a loss would be entitled to a claim against the JSE Guarantee Fund in terms of the JSE Rules. Section 35A (5) of the Insolvency Act excludes property disposed of in terms of the rules of an exchange. Thus, if the rules of the exchange regulate the settlement and if a transaction is settled after the lodgment of the application for winding up, the disposition of property in terms thereof cannot be attacked.
3.	Does local law recognise the existence of beneficial owners who may differ from the legal owner of a security?	Yes. Legal shareholders with regard to STRATE: In terms of S 91(A) of the Companies Act 1973, the legal registered record of holding balances for a STRATE approved security may be recorded on a : CSDP sub-register in name of a nominee; or CSDP sub-register in own name of client/investor In terms of the Companies Act, the holding balances maintained by the CSDPs are the records of legal title. Holdings on the CSDP's sub-register are recognised in law as if they were maintained directly by the Issuer. A transfer in the STRATE environment constitutes a transfer of legal title. A CSDP may have one or more of the following (uncertificated securities) accounts in their books: An account in the CSDP's own name An account in the name of a nominee company controlled by the CSDP An account in the name of such other person as the client may direct (Rule 6.3.2.4) Beneficial shareholders The CSDP must ensure: That the election by a client to deposit securities in the name of the nominee of the CSDP and not the client's own name shall in no way diminish the rights of the client as a member of the issuer of the securities and the CSDP shall ensure that the client is timeously advised of, and is in a position to exercise its rights as a member of the issuer as if the client was the registered member (legal owner) of the issuer (Rule 7.4.1.1) All interest, dividend and other payments received by it from an issuer will be paid to the client upon receipt (Rule 7.4.1.2) All notices regarding rights and other benefits accruing to the securities which are received by the CSDP from the issuer are conveyed within a reasonable time to the clients (Rule 7.4.1.3) The standards of record keeping which apply to uncertificated securities in the subregister (register of legal owners) kept by the CSDP shall also apply and be maintained by the CSDP in respect of other records of the underlying clients of CSDP (beneficial owners recorded on the subregister Rule 6.3.2.6) In terms of S 140 (A) of the Companies Act, 1973, nominee companies are obliged to disclose to a company the names of all beneficial shareholders every three months. Companies are obliged to keep this information open to public scrutiny. In addition, companies are obliged to publish the names and holdings of all beneficial owners of 5% or more of the shares in the company, in their annual financial statements. Disclosure of beneficial ownership is enhanced by the provisions of the JSE Listing requirements
4.	Does local law clearly define the point of time when a settlement, both for the security and the cash involved, achieves finality and thus cannot be unwound?	Yes, when title to the securities pass between CSDPs. This is when the book entry is made on the accounts of STRATE and the CSDP's accounts. Firstly, there is a freezing of securities balances, upon which STRATE performs the transfer of ownership once the payment through the Central Bank has been made. Once STRATE confirms to the CSDP that settlement has taken place, the CSDP must reflect the entry in its books. Final and irrevocable transfer of ownership then occurs. The entry cannot be reversed. Delivery versus payment applies and is final and irrevocable on T+5. The entry will not take place unless the cash has been received. Section 91A(4)(a) of the Companies Act provides: 'Transfer of ownership in an uncertificated security shall be effected upon the debiting and crediting, respectively, of both the account in the subregister from which the transfer is effected and the account in the subregister to which the transfer is to be made in accordance with rules of the central securities depository'. Settlement of transactions in uncertificated securities, including off market trades, must take place in the manner determined by STRATE and in accordance with the rules of the JSE (Rule 6.8.1).
5.	Does a pledgee have an absolute right to realise their security at all times?	Yes. The Custody and Administration of Securities Act, 1992 makes provision for the pledging of securities deposited in a depository. The common law rules on the protection of rights of the pledgor and pledgee remain unaltered.
6.	Does the depository have loss sharing provisions in its rules, and how would these be applied?	No. STRATE does not assume any responsibility for losses that may arise due to the actions of the CSDPs. STRATE has insurance cover against certain aspects of negligence or system failure (STRATE Rules require insurance for specific instances). Claims in respect of these items will be accepted.