Once upon a time, in a far simpler world, corporations and their shareholders had a direct relationship with each other. Corporations could follow any change in shareholdings directly from the share register, and shareholders could exercise a degree of control by directly voting at meetings. However, in the US, as the share capital of public companies, and the velocity of trading in the shares, greatly increased, so did the friction in this trading.
The ‘paper blizzard’ in the late 1960s froze the US market, when record keeping could no longer keep pace with share trading, and intermediaries seized the opportunity to present themselves as the solution to these issues arising from the direct relationship between corporations and shareholders. Computers, of course, assisted greatly and contributed to establishing what came to be known as the Indirect Holding System (IHS) of shares, the success of which throughout most of the world has driven a very high degree of financial integration. The main trait of the IHS is that public companies issue their shares in the name of Central Securities Depositories (CSDs) or similar, and shareholders transfer their shares only via intermediaries, which settle transactions on an aggregated basis as book entries.
Although market liquidity benefits from such intermediation, the system challenges the corporate governance of public companies because it introduces a discrepancy between the ‘beneficial shareholders’, namely the ones having a real economic interest in the shares and those who have legal title to them, ie, the CSDs. The result of the IHS is that public companies barely know who their ‘beneficial shareholders’ are and shareholders struggle to exercise their rights including to vote at company meetings. For this reason, complex proxy-voting systems have developed concurrently with the IHS.
The analysis in our recent paper, highlights how current proxy-voting systems rely on different layers of intermediaries (financial institutions and information service providers) that leads to ‘pass-it-along’ architectures that burden the corporate governance of public companies with three sets of inefficiencies. First are the inefficiencies directly linked to the complexity embedded in proxy-voting chains (for instance, uncounted and miscounted votes). Second are the inefficiencies arising from the lack of transparency in share ownership, which can lead to over-voted ballots that undermine the ultimate reliability of decisions. Thirdly, the current architectures favor the abuse of practices based on the separation of voting rights from the economic interest of shares.
Blockchain and distributed ledger technology (together ‘DLT’) is widely and enthusiastically viewed as a potential solution to the issues driven by the IHS because it is capable of fixing the most salient cause of these problems: the discrepancy between ‘recorded’ and ‘beneficial shareholders’.
Our analysis seeks to transcend the hype around DLT and evaluate the actual, substantial potential of DLT to increase transparency where the IHS has failed: around shareholder ownership. More transparent shareholder ownership is the first step towards realizing more efficient and effective proxy-voting systems that can bring the reality of corporate governance back into line with the theory of corporate ownership and control. In addition such transparency can improve share settlement and practices like securities collateral and rehypothecation.
We suggest that the major benefits offered by share registration and proxy-voting organized on DLTs include a reduction in voting process errors, which reduces agency problems and fosters higher market liquidity and greater legitimacy of decisions, and an increase in participation among corporate stakeholders before meetings, for the betterment of corporate governance and performance.
Of course, higher shareholder ownership transparency drives new risks, to which regulation must respond. These include risks related to the privacy of shareholders’ identity. On the one hand, DLT responds well to the calls of international organizations advocating for more ownership transparency, but on the other hand, it makes privacy protections even more important.
The paper concludes, therefore, with a call for regulation to establish a legal framework for digital identity management of shares so that proxy-voting systems based on DLT can benefit the corporate governance and shareholder democracy of public companies.
Federico Panisi is a PhD candidate at the Department of Law, Università degli Studi di Brescia, Italy.
Ross P Buckley is Scientia Professor and King & Wood Mallesons Chair in International Finance Law at the University of New South Wales, Australia.
Douglas W Arner is Kerry Holdings Professor in Law at the University of Hong Kong, Senior Fellow of Melbourne Law School, University of Melbourne and a Non-Executive Director of Aptorum Group.