Direct registration system - a Canadian perspective on a U.S.-based solution

Effective Jan. 1, 2008, all securities listed on U.S. exchanges, including interlisted Canadian companies and their transfer agents, must be eligible for the direct registration system (DRS).

DRS allows investors to hold securities electronically, reducing risk and reducing the costs associated with holding and transferring physical securities. To meet the January deadline, Canadian issuers must ensure that U.S. listed securities are DRS eligible by:

• Participating in the Depository Trust Company’s (DTC) Fast Automated Securities Transfer (FAST) program
• Ensuring that company by-laws do not restrict holding securities electronically
• Confirming their transfer agent is eligible to participate as a DTC FAST participant

Issuers that are not in compliance with eligibility requirements will be sanctioned and ultimately subject to delisting according to the Securities and Exchange Commission (SEC). 

Meeting the DRS eligibility requirements does not mean automatic participation in DRS. Currently, issuers can elect to participate. It is possible however, that the SEC will require issuers to fully participate in the future.

The decision to participate for an issuer depends on the number of U.S. holders and the activity these holders generate. It is important to note that opting-out of DRS at a later date can cause confusion among U.S. financial intermediaries. In addition, investors whose positions were converted to book form would have to be issued certificates.  

The U.S. experience 

The roots of DRS can be traced back to the 1960s, when increased trading volumes overwhelmed the U.S. paper-based system of certificated positions.  

To deal with this paper crisis, a central depositary was recommended and adopted. However, it wasn’t until 1992 that a commission was created to determine if technology would make direct registration possible. The commission strongly favoured a direct registration system, but only as an additional form of security registration available to the holder.

In 1994, the U.S. listing criteria was changed to permit U.S. listed companies to issue securities using DRS. As a result of the rule changes by the exchanges, DRS eligible issuers are expected to grow from 2,000 issuers in 2006 to more than 10,000 issuers by 2008.

Although DRS has increased in use over the years - some transfer agents estimate 30 per cent of the register is held within DRS - most of these positions have been created through issuer initiated events such as stock splits and corporate actions. Currently less than two per cent of these shareholders make DRS transactions in any given year. As a result, the U.S. has not seen extensive integration, and industry participants continue to work at making the system more attractive and efficient.

Here are several DRS benefits: 

• Allows quicker settlement of transfers as certificates do not need to be delivered to a broker for processing by DTC
• Eliminates the risks and costs associated with paper certificates (replacing certificates, fraudulent claims)
• Processes a large number of positions efficiently
• Reduces broker-dealer costs

Disadvantages of DRS include:

• Complicated transfer process for Canadian participants who are (or are not) participants within DTC
• Inability to pledge securities held in DRS
• Inability to co-mingle DRS and dividend reinvestment   

A Canadian solution?

While DRS is not new, this is the first time that Canadian interlisted issuers are mandated to comply with the system. DRS does not have a corresponding Canadian equivalent and to participate, Canadian investors must use broker-dealers who are DTC participants.

This raises issues as some Canadian broker-dealers do not perceive DTC settlement as conventional practice. In addition, they may not see the benefit in DRS without a corresponding Canadian solution.

While the requirement to be eligible to participate in DRS is mandated, the actual participation is small. As more holders become comfortable with the idea of paperless transactions, the idea of electronic certification of registered positions could exponentially increase. In Canada, this increase may lead to finding a Canadian equivalent to a U.S.-based solution. 

By Charndeep Minhas, associate director, relationship management 

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Inform® is provided for general information purposes only and CIBC Mellon Trust Company, CIBC Mellon Global Securities Services Company, CIBC, The Bank of New York Mellon Corporation and their affiliates make no representations or warranties as to its accuracy or completeness. Readers should be aware the content of this publication should not be regarded as legal, tax, accounting, investment, financial or other professional advice nor is it intended for such use.