Going paperless in the Canadian securities market Going paperless Going paperless in the Canadian securities marketin the Canadian securities market

Alberta Chapter – Canadian Bar Association

January 12, 2011

© 2011 CDS Clearing and Depository Services Inc.

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Points to cover today

CDS overview

Dematerialization

Book-Entry-Only Securities Services Agreement

Electronic entitlement payments and TRAX

Sample trust indenture – uncertificated securities

Issue eligibility

Electronic closings

Private placements

U.S. restricted securities

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CDS participants and owners

CDS is owned by six Schedule A banks, TSXand IIROC

Offices in Toronto, Montreal, Calgary, Vancouver

96 participants

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7 4 4 118

51Banks (11)Trust companies (8)Investment dealers (51)Other (11)Transfer agent limited participants (7)ATON limited participants (4)ACT limited participants (4)

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CDS - a top-rated central securities depository

AA Public DepositoryRating (Thomas Murray) retained in 2010

“CDS remains one of the top rated CSDs in the world. The strength of CDS confirms the excellence of Canada’s capital market infrastructure.”~ Simon Thomas,Thomas Murray

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Bank of Canada Mandate

CDS is recognized as– Critical infrastructure to the financial sector

– (provinces of ON & QC, and federal government)– of systemic importance (BoC, OSC, AMF)

Reliability is essential in terms of the services we provide and role we play in the financial sector

DematerializationDematerializationDematerialization

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Steps to dematerialization

Immobilization – CDS & Co. registered positions represented by certificated securities

held at CDS

Non-certificated inventory (NCI) securities– CDS & Co. registered positions represented by electronic records on

security holders’ register at issuer or transfer agent; other positions may be certificated

Book-entry-only (BEO) securities– 100% of security’s issue held by CDS is registered in CDS & Co.; no

certificates available outside CDS; may be global certificate or uncertificated

Uncertificated– Term used in provincial Securities Transfer Acts (STA) to represent

either NCI or BEO holdings

Dematerialization– Company board or legislation determines that no certificates to be

issued to represent company’s securities

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Examples of dematerialization

Canada Bonds and T-bills are fully dematerialized

Fully dematerialized countries:– Australia, Denmark, France, Japan, New Zealand, South

Africa

Countries initiating some form of dematerialization:– Belgium, India, Ireland, Italy, Netherlands, Norway, South

Korea, Spain, Sweden, UK, Ukraine, USA

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Impediments to dematerialization

In absence of legislation mandating dematerialization, CDS has been pursuing changes to market practice to eliminate certificates and cheques for entitlement payments

Documentation, such as trust indentures, requiring certificates for debt issuance

Reliance on paper for evidentiary purposes

Related processes are typically certificate-based (i.e. issuer buy-backs and stock options) replaced now with TRAX

Resistance to change

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Paper handling – it costs all of us!

Few participants in the securities industry benefit from paper certificates (e.g. couriers, printers)

Investors who report lost, stolen or fraudulent certificates have to pay to replace the certificate

Other costs are borne by issuers, brokers and financial intermediaries via:– custody and vault costs, audits, file maintenance– surety bonds– transporting physical certificates– loss replacements, clerical processing

Education and co-operation are needed to change this outdated "tradition"

BEO Securities Services AgreementBEO Securities Services AgreementBEO Securities Services Agreement

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BEO Securities Services Agreement

BEO Securities Services Agreement (BEO SSA) has replaced Letters of Representations (LORs)

Once signed, BEO SSA replaces the LOR for all securities held at CDS

BEO SSA comprises:– A short Agreement requiring signature by issuer and

electronic delivery to CDS– Issuer Procedures incorporated by reference as part of the

Agreement– BEO Acknowledgment, as part of the Procedures, for

signature by issuer and electronic delivery to CDS for each deposit of a new issue

Posted on www.cds.ca, as periodically amended

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BEO Securities Services Agreement

BEO SSA and Issuer Procedures:– Set out general provisions for making an issue eligible for

deposit and use of BEO services at CDS– Permits CDS to replace a lost or stolen certificate without a bond

of indemnity– Eligible BEO securities now include uncertificated securities– CDS holdings can be evidenced by entries of a CDS recognized

agent without any certificates being delivered to CDS– CDS recognized agent to provide daily closing balance

confirmation of registered holdings in CDS nominee name– Securities represented by a global certificate may be converted

to uncertificated issues with issuer agent’s agreement– Requires electronic payment of entitlements in same-day final

and irrevocable funds

Electronic Entitlement Payments and TRAXElectronic Entitlement Payments and TRAXElectronic Entitlement Payments and TRAX

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Electronic Payments for Entitlements

Effective November 1, 2011 all entitlement payments paid to CDS must be in electronic form and must be final and irrevocable

Transfer agents acting as paying agent in CDSX– TA assumes role or designates a CDS participant to act on their

behalf– TA provides CDS with payment details – CDS matches TA payments to events in CDSX to ensure accuracy– Once funding is in place, TA releases the funds in CDSX for allocation

to participants’ ledgers or advises its paying agent to release the funds

– CDS will work with TAs who wish to assume this role

LVTS payments also acceptable

CDS will be analyzing the cheques still received to determine how to move these payments to electronic form

Sample Trust Indenture – Uncertificated DebenturesSample Trust Indenture Sample Trust Indenture –– Uncertificated DebenturesUncertificated Debentures

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Uncertificated debentures: Key concepts

Trust indentures typically require paper certificate to be signed and delivered before debenture can be duly issued or a binding obligation

Certificates are used as evidence of ownership and are endorsed and given to the trustee to effect a transfer

CDS worked with the main corporate trustees to develop a sample indenture with provisions enabling issuance of uncertificated debentures– Use of master record and internal procedures of trustee for

authentication, issuance and record-keeping– Transaction statements and statements of account to reflect transfers,

payments, other changes pertaining to holders– Preferred form of global debentures deposited with CDS and payments

must be paid in electronic form

Sample trust indenture posted on www.cds.ca

Issue EligibilityIssue EligibilityIssue Eligibility

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General eligibility criteria

General eligibility criteria for deposit of issues in CDS (requirements may vary depending on particulars of issue):– A transfer agent recognized by CDS– No requirement for CDS to sign any documentation to effect a

transfer of a security– If there are features that require special procedures, CDS may not

make the issue eligible– The security must be defined in documentation, for example:

offering circulars, final prospectuses, offering memorandums, copies of certificates, statement of material facts, information circulars, shelf prospectuses and for name changes or reorganizations articles of amendments

– Denominated in Canadian or US funds

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Eligibility Fees

CDS has instituted a new fee for eligibility of all certificated issues (money market issues are exempt from the fee):Definitive certificates held by CDS $1,000BEO Global certificates held by CDS $500Uncertificated, no certificates held by CDS $0

Web-based process, similar to the ISIN issuance process, for requesting eligibility, collecting information and billing of the fees– The firm that requests the issue’s eligibility will pay the fee

– By credit card if a non-participant– CDS participants can choose to pay via credit card or via monthly

CDS invoices

Electronic ClosingsElectronic ClosingsElectronic Closings

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Electronic closings

Closings usually still rely on issuance of one or more certificates for exchange between issuer’s legal counsel and underwriter’s legal counsel

Exchange of payment typically done by wire transfer between closing parties’ financial institutions

Inefficient, risky and unnecessarily costly to still require certificate to be produced for exchange and then subsequently cancelled

CDSX functionality enables new issues to be closed in an electronic format

All parties involved in the closing must agree to manage the process without requiring a certificate

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Using CDSX to settle funds

Instead of wire transfers (LVTS), funds for closings can be exchanged in CDSX, provided issuer’s banker:

Prior to the closing– Issuer's bank enters a deposit request for the new issue security– Issuer's bank enters a CDSX trade against the underwriter, where the

quantity and value equal that of the new issue, with the trade’s value date equal to closing date

– Underwriter confirms the trade

At closing, after all documentation is accepted:– Transfer agent/custodian or CDS, as a custodian, confirms the deposit– The trade between the bank and underwriter settles in real-time– Bank credits the issuer's bank account based on funds received in

CDSX

Bank will settle its daily activity, including these funds, at CDS’s payment exchange, where settled funds are final and irrevocable funds

Private PlacementsPrivate PlacementsPrivate Placements

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Private placements

More private placements than IPOs year over year– In the last year 2,320 common equity private placements were

brought to market (statistics are from IIAC’s website)– As of November 30, 2010, there were 62 issues still in the hold

period and 111 issues where the hold period had expired

Participants are seeking ways to reduce certification and increase deposits in CDS– Certificated issuance of private placements has high costs and

risks– Average number of certificates held in CDS participant vaults: 800

(for smaller firms) to 25,000 (for larger firms)

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Possible impediments

Why are private placements not being made eligible in CDSX?– Lack of understanding of CDS eligibility criteria which allow deposits of

private placements – Belief that physical certificates provide issuers and transfer agents

better control on trading restrictions and provide a cross guarantee at closings

Since late 2009, when NI 45-102 and 45-102CP were amended, issuers are no longer required to obtain regulatory comfort to have their issues brought into CDSX and CDS has ceased applying settlement restrictions

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Eligibility criteria for private placements

Private Placement Eligibility RequirementsReporting Issuer

Non-Reporting Issuer

Apply online for ISIN through CDS Securities Management Solutions Inc (Available in April 2009) Required Required

Temporary ISIN assigned if there are freely traded shares Required Not Required

After 4 months and 1 day (end of the “hold” period) CDS runs an automated process to move all positions from the temporary ISIN to the unrestricted ISIN Required N/A

Attach necessary documentation regarding issue (Offering Memorandum, Subscriptions Agreement) Required Required

Book-entry-only (held by CDS or a TA in NCI format) Required Required

Register via recognized transfer agent Required Required

Confirmation letter from the issuer on when the hold period should be lifted Required Required

U.S. Restricted SecuritiesU.S. Restricted SecuritiesU.S. Restricted Securities

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U.S. Restricted Securities (144A, Reg S & D)

Non-reporting issuers bringing an issue to market in the US face restrictions (mandated by the SEC) on potential purchasers:

– 144A – Qualified Institutional Buyers– Reg S – Non-U.S. purchasers– Reg D – Accredited investors

In 2009 CDS implemented a new bulletin type for restricted securities whereby participants can advise others about requirements/processes for removing restrictions

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CDS Contact Information

Al-Karim NanjiManaging Director,Customer Service and Operations416 365-8631ananji@cds.ca

Dawn DaviesManager, Alberta Region403 232-5676ddavies@cds.ca

Going paperless in the Canadian securities market Going paperless Going paperless in the Canadian securities marketin the Canadian securities market