Over-the-counter stock pledge refers to a transaction where a fundraiser pledges the stocks it holds to obtain funds from eligible financial investors such as banks, trusts, insurance companies and fund subsidiaries, other than securities companies and their asset management plans, and agrees to repay funds for release of the pledge in the future.
Funds supervision and risk control with respect to over-the-counter stock pledges are flexible. The Notice of Relevant Matters Concerning Over-The-Counter Equity Pledge Transactions of Securities Companies issued by Securities Association of China in 2018 provides that securities companies shall not provide third parties such as banks, trusts and other institutions or individuals with third-party intermediary services such as marking to market and closing position through financing secured by over-the-counter stock pledges. With this prohibition of intermediary services, the rights of over-the-counter stock pledges are more difficult to realize.
The ways to realize the rights of over-the-counter pledged stocks consist of non-judicial disposal and judicial disposal. According to article 19 of the Implementation Rules for the Securities Pledge Registration Business of China Securities Depository and Clearing Corporation Limited, there are two non-judicial disposal methods for over-the-counter stock pledges.
First, the parties to the pledge apply to China Securities Depository and Clearing Corporation Limited for changing the registration status of the securities pledge from “non-sellable pledge registration” to “sellable pledge registration” according to the provisions of the pledge contract submitted during registration of the securities pledge, or the separate pledge securities disposal agreement, and pay the pledgee first with the proceeds from the sale of pledged securities.
Second, the parties to the pledge apply to China Securities Depository and Clearing Corporation Limited for compensating the pledgee by transfer of pledged securities to the pledgee according to the provisions of the pledge securities disposal agreement.
There are three types of judicial disposal of over-the-counter stock pledges in judicial practice, i.e., litigation, arbitration and application for execution notarization. If any of the above-mentioned judicial disposal methods is adopted, it is generally necessary to take preservation measures at the same time to seal up and freeze the fund and securities accounts corresponding to the stocks of the listed company.
With respect to unrestricted tradable shares, the court, in addition to entrusting the securities company to conduct centralized competitive bidding in the secondary market and gradual reduction of shareholdings, also transfers the pledged stocks to the execution applicant, and then hands them over to the securities company for sale.
The risk of restriction on disposal proportion of pledged stocks
The Several Provisions on Reduction of Shareholdings by Shareholders, Directors, Supervisors and Officers of Listed Companies provides corresponding restrictions on reduction of shareholdings by shareholders, directors, supervisors and officers of listed companies. The total number of shareholdings reduced by a pledgor in a company for a period of time shall not exceed a specific proportion of the total number of shares of the company.
Meanwhile, the pledgor shall fulfil the requirements on corresponding announcements and disclosures. Therefore, when the over-the-counter stock pledge rights are realized, the statutory announcement requirements and restrictions on sale will affect the pledgor in selling a large number of stocks in a short period of time, and even hinder the realization of the pledge.
We suggest distinguishing the restrictions on the proportion of shareholding reduction with respect to centralized competitive bidding, block trade and transfer by agreement, to choose a favourable way for shareholding reduction for the pledgor in the pledge securities disposal agreement.
The risk of freezing and deduction of pledged stocks
During registration of the stock pledge, any third party may still apply to judiciary authorities for freezing and disposal of the pledged stocks due to its debtor-creditor relationship with the stockholder. However, the different state of stock pledge registration has different effects on the pledgee.
The transfer formalities are not applicable to the pledge stocks with the “non-sellable pledge registration state”. Even if the mandatory judicial deduction is carried out, the pledgee also enjoys the priority of compensation from the proceeds of auction and sale of the pledged property according to the Provisions of the Supreme People’s Court on Several Issues Concerning the Execution Proceedings of the People’s Court (Trial).
The pledged stocks with the “sellable pledge registration state” may be regarded as the pledgee’s consent to the stock transfer, which may lead to a risk of being frozen or deducted by the judicial authorities. It is recommended that when changing the status of the pledge stocks to “sellable pledge registration”, the pledgee should require the pledgor to deposit a certain amount of funds in the settlement account in advance, or to provide a deposit, and entrust the bank of the securities trading account to monitor the disposal proceeds.
Risk of disposal of restricted shares
The existing regulations do not provide the issue of disposal of the issued and listed shares that are prohibited to be transferred within a certain period of time, or under certain conditions for legal reasons, regulatory requirements or public commitments. There is a big conflict between judicial power and administrative supervision power.
The authors recommend that the execution applicant refer to the way taken in the Answers to Difficult Issues of Execution of Jiangsu High People’s Court, that is, the execution applicant applies for the compulsory deduction and transfer of the restricted shares to its account, and disposes of the restricted shares after they are converted to tradable shares upon completion of release procedure.
Moreover, the pledgor should be required to issue a commitment of no restriction on transfer of stocks other than legal and regulatory requirements at the beginning of the over-the-counter stock pledge transaction. Nevertheless, there are still big difficulties and uncertainties in disposal of restricted shares because the transferees of the restricted shares are bound by the original stock restrictions or commitments.
In summary, the realization of over-the-counter stock pledge rights is the process of a power game between the pledgee and the pledgor and other creditors. There may be risks of restriction on disposal proportion of pledge stocks, judicial freezing and deduction of pledged stocks, or disposal of restricted shares in both judicial disposal and non-judicial disposal methods. The key for the pledgee to prevent risks is to improve the active management ability in the over-the-counter stock pledge business and strictly regulate the entire pledge process.
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