4.3. Unallocated securities

It is common practice that securities held in custody are used as security <1>. A custody arrangement can be described as an account to which one or more sub-accounts may be linked and on which securities are registered <2>. Often a bank account is linked to the custody account and included in the collateral arrangement. This way the collateral arrangement facilitates the trade in, substitution and top-up of collateral. One problem is that the collateral concerns fungible assets and is not identified in relation to the collateral-provider or the collateral-taker <3>. Another issue is that securities belonging to different owners often are mixed on nominee accounts.

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<1> Cf.: Myrdal S. . P. 474 - 475, who notes that it is quite common that all assets held in custody are pledged as collateral to the custodian. It is also common to include a clause that the customer is not allowed to dispose of the pledged assets without the custodian's consent thereby ensuring, that the security interest is perfected.

<2> Cf.: Swedish Securities Dealers Association General Conditions Governing Custodian Services, Bank (July 2009); General Conditions Governing Custody & Cash Account Services, Securities Company (July 2009).

<3> Ds 2003:38. P. 141 ff.

In the doctrine there has been discussion over whether it is possible to have a protected property right in fungible securities when the claim concerns a quantity or value. This question arises, inter alias, when the collateral-provider only pledges a part of the assets in a custody arrangement <1>. Is it possible to pledge a part of a custody arrangement without separating the collateral from the other assets? Moreover, is it possible for the collateral-provider to dispose of the excess value or quantity? It should be noted that the discussion was initially based on the premise that securities were issued in bearer format and thus existed in physical form (cf. below).

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<1> problem. P. 312 ff.

NJA, 1910. P. 216 provides a good starting point. In this case a debtor pledged a certain quantity of junk metal, which appeared to be of varied quality, as collateral. The question was whether the pledge was valid and enforceable as the collateral had not been separated from the rest of the junkyard and the debtor kept the right to dispose of the parts of the junkyard that were in excess of the quantity of the collateral. The Supreme Court held that as the collateral had not been separated and the collateral-provider was permitted to freely dispose of the excess quantities, the collateral-takers lacked a preference right in the collateral in the debtor's bankruptcy. Another factor that was troublesome was that the collateral was in the possession of a representative of the collateral-provider <1>. Justice Sjogren, who voted with the majority, developed an opinion that is renowned. He declared that it is a general principle that each property right must be tied to a specified thing. A quantity which is part of a larger warehouse or the like - a half generically specified thing - can as such be the object of a claim but not a property right. A mixture of different things, or of similar things of different qualities - for instance a warehouse - cannot to a non-identified part be the object of a property right. The basis for this is especially clear in the case of a pledge of chattels. In the interest of proper business relationships one has to demand that the collateral is specified and that the creditor, or a third party on its behalf, acquires the possession of the object. The former is a precondition for the latter; the acquisition of possession cannot take place without the object being a specified thing. N evertheless, under certain circumstances a pledge of a quantity which is part of a larger warehouse should be valid and enforceable. That a co-owner generally can pledge its share cannot be disputed. If the share that is pledged is expressed to be a fraction, or a certain quantity, is apparently irrelevant. It may also be that it is possible that a certain share can be pledged even when the whole is not the object of a co-ownership right, although this should not be too common. In the interest of proper business relationships, the creditor or a third party on its behalf must however acquire possession of the warehouse for the pledge agreement to be enforceable. Thus, even if one can approve of a pledge of a quantity of a larger warehouse, it cannot be done in the case in hand as the condition - that possession of the whole warehouse had passed-was not met. Justice Sjogren also pointed out that in certain cases co-possession of a warehouse shared between the debtor and the creditor is sufficient, however only if the creditor can prevent the debtor from disposing of the assets on its own <2>.

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<1> Cf.: Lindskog S. Om misstroende, JT, 1991 - 1992. P. 275 ff.

<2> The opinion is freely translated.

Pursuant to NJA, 1910. P. 216 it was more or less deemed impossible to pledge a quantity of a larger pool of fungible assets without the separation of the collateral <1>. This view has however been somewhat relaxed in recent years <2>. Some academics who have discussed the doctrine of specificity in relation to securities held in custody have come to the conclusion that in cases where it is practically meaningless and also costly to separate the collateral, the collateral-taker ought to have a protected property right in the custody over which it has control even if the collateral is only established to be a certain value or quantity of the whole, i.e. the assets are not identified as such <3>. Hastad, for instance, argues that a pledge of a quantity of a pool of homogenous securities ought to be valid and enforceable without separation even if the collateral-taker is allowed to dispose of the excess quantity <4>. Even where a certain value of a custody consisting of heterogeneous securities is pledged the collateral arrangement ought to be valid and enforceable, at least as long as the collateral-provider lacks the right to dispose of the collateral <5>. Walin and Lindskog also appear to be of the opinion that a security interest in a quantity of a heterogeneous pool of assets ought to be enforceable <6>. As for security interests specified in terms of value, the views appear to differ. Walin is of the opinion that a pledge of a value of a larger total is not a valid collateral arrangement, regardless of whether the pool consists of homogenous or heterogeneous assets. As custody arrangements can be pledged as a whole, i.e. with reference to the specific custody arrangement and with a provision stating that the security interest covers a certain amount, he argues that there is no need to allow a pledge in respect of the value <7>. Hastad argues that a pledge of a value of a pool of assets ought to be protected, at least as long as the collateral-provider lacks a right to dispose of the excess value <8>. Should the collateral-provider have a right to dispose of the excess value, it can either harm the collateral-taker by withdrawing the most valuable assets or benefit the collateral-taker by withdrawing the most worthless assets <9>. In Hastad's opinion the collateral-provider's right to dispose of the excess value is, however, more a question of perfection of the collateral, ie whether the collateral-provider has been cut off from disposing of the collateral, than a question of specificity <10>. Hastad moreover notes that a pledge of securities held in custody specified in relation to a certain value appears to imply that all securities kept in the custody arrangement are pledged with the restriction that the collateral-taker's right is limited by the underlying claim and the agreed value of the pledge <11>. It should also be noted that a share of a homogenous asset or pool of assets can be used as collateral on the condition that the collateral-provider is cut off from disposing of the asset or the pool <12>.

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<1> , Svensk I. P. 60 ff.; Rodhe K. Handbok. P. 196 f.; P. 335 f.; Myrdal S. . P. 480 f.

<2> . P. 335 - 336; cf.: idem., problem. P. 309 ff.

<3> Ds 2003:38. P. 54; Hastad T. Sakratt. P. 334 - 338; Walin G. Pantratt. P. 116; Myrdal S. Aterpantsattning. P. 479 ff.

<4> . P. 336; cf.: idem., problem. P. 328.

<5> . P. 336 ff.

<6> Lindskog S. Om misstroende. P. 280; Walin G. . P. 38 (fn. 2).

<7> Walin G. . P. 115 - 116.

<8> . P. 337.

<9> Ibidem.

<10> Ibidem.

<11> Cf.: . P. 336 - 337.

<12> Walin G. . P. 115; Rodhe K. Handbok. P. 437; Hastad T. Sakratt. P. 163; idem., problem. P. 316.

One closely related question is whether the collateral-provider has a right to substitute the collateral with the equivalent asset <1>. Another issue is whether the collateral-provider has a right to sell the collateral if the funds received are deposited into a bank account included in the collateral arrangement <2>. The current view appears to be that this ought to be possible as long as the collateral-provider is cut off from disposing of the collateral, and that general statements in the doctrine prohibiting substitutions of collateral should be ignored <3>.

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<1> Cf.: Myrdal S. . P. 475 (fn. 1611).

<2> . P. 334 f.

<3> Cf.: Arts. 2(2) and 8(3)(b) and Recitals 5, 16 Financial Collateral Directive; Walin G. . P. 114 - 115; . P. 334 f; Myrdal S. . P. 474 - 477; cf.: Helander B. . P. 526 f.; Rodhe K. Handbok. P. 436 ff.

The situation where the whole custody arrangement is pledged should also be acknowledged. Where the collateral-provider pledges all securities that are held in custody X (i.e. with a reference to the specific custody arrangement) without being restricted in respect of the disposal of the assets, it can be questioned whether a valid and enforceable security interest actually arises <1>. Should the collateral-provider not be cut off from disposing of the assets, it can also be questioned whether the interest has been properly perfected <2>.

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<1> Cf.: Walin G. . P. 112 - 113; . P. 333 - 334.

<2> . P. 334 f.; cf.: , Svensk I. P. 198 ff.

It should be noted that the above is only a summary of a quite detailed discussion and that Swedish law in this area is unclear. It should also be recognised that the discussion is based on the fact that until quite recently securities have been issued and traded in bearer format and so could be easily separated and identified. As previously pointed out, securities held in the VPC-system - regardless of whether they are held on owner or nominee accounts - are held on a fungible basis; ie they are unidentifiable in relation to their entitlement holders.

Another important fact is that securities registered on accounts are fungible intangibles. Unlike grain in a silo or oil in a tank they cannot be separated as they do not exist in the physical world. Only if the registration of the securities by the intermediary with a direct relationship with the ultimate investor is given similar legal effect to the possession of a document of title can the legal construct that securities can be separated be upheld. The question that preferably should be asked is whether this is necessary or whether the desired legal effect can be achieved by some other means.

In relation to securities held in the VPC-system it should be noted that since the registration of securities does not have constitutive effect, it does not establish that the registered person is the true owner <1>. Difficulties therefore arise as securities evidenced by book entry in respect of owner and nominee accounts are fungible intangibles and as such impossible to distinguish. Another troublesome fact is that the investor's right often is indirect; ie there is at least one party standing in between the investor and the issuer. Since the investor is dependent on the act by an intermediary, the right bears more resemblance to a personal right than a property right; the right is a claim on a person to perform in a certain way <2>. N evertheless, as the FIAA gives the registered person the legitimate capacity to act as the owner, ie as the one having the right to dispose of the financial instruments, it is argued that even if the financial instruments are unallocated and the register only evidences title, the person registered as the owner ought to have a property right in the instruments <3>. In relation to securities mixed with other entitlement holders' securities on nominee accounts, the entitlement holders are deemed to have at least a co-property right in the securities <4>. Should a shortfall arise, the securities ought to be shared on a pro rata basis <5>. It should also be noted that nominees are obligated to separate their owner accounts from their nominee accounts and that co-mingling of their own securities with the securities of their customers is prohibited <6>.

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<1> Prop. 1997/98:160. P. 177.

<2> Afrell L. & Bogdan M. om lagvalsregler vid av finansiella instrument, JT, 2001/02. P. 523; cf.: Lundstedt V. reflexioner, in: Festskrift Birger Ekeberg (PA Norstedt & , Stockholm, 1950). P. 334 f.

<3> Cf.: Ch. 6, §§ 1 and 7 AHIFA; cf. also: L. Afrell, H. Klahr & P. Samuelsson, i ( ed., Norstedts Juridik AB, Stockholm, 1998). P. 93.

<4> Cf.: problem. P. 311 f.

<5> Due to the lengthy procedures in relation to the administration and sale of co-owned assets under the Co-ownership Act, custody agreements often state that the Act shall not apply.

<6> Cf.: Prop. 1997/98:160. P. 121; Prop. 1987/88:108. P. 30.

It can be concluded that it is unclear whether an interest in securities identifiable through its value or a certain quantity is valid and enforceable under Swedish law. Considering the statements made in the preparatory works to the Financial Collateral Directive but also in the doctrine, it appears that this question would be determined in favour of the entitlement holder <1>. Should the judiciary try this question it would also be surprising if it were held that a right of separation were lacking, as it would undermine the whole structure of the Swedish securities holding system.

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<1> Prop. 2004/05:30. P. 36; Ds 2003:38. P. 54.