Conversion of Physical Shares into Book-Entry Form: Challenges in Relation to Pledged Securities
The transition from physical share certificates to book-entry securities represents a significant step towards modernizing Pakistan’s capital market infrastructure. The move towards dematerialization through the Central Depository System (CDS) aims to improve transparency, reduce risks associated with physical certificates, and streamline securities transactions. However, while the regulatory framework establishes a clear obligation for companies to convert physical shares into book-entry form, a practical challenge remains unresolved for companies whose shares are already pledged and lenders possess the physical share certificates.
Under Section 72 of the Companies Act, 2017 and Regulation 44 of the Companies Regulations, 2024, companies notified by the Securities and Exchange Commission of Pakistan (SECP) are required to replace physical shares with book-entry shares through a central depository. The SECP notification further requires certain unlisted companies to convert their physical shares into book-entry form before undertaking transactions such as transfers, allotments, rights issues, or buy-backs.
The challenge arises in cases where shareholders have pledged their shares as security for financing arrangements. In many project companies, infrastructure companies, and special purpose vehicles, the original share certificates are not held by shareholders but by lenders or security trustees under financing documents. These certificates are retained as part of the lenders’ security package.
The existing CDC conversion process caters to conversion only where the shareholders are in possession of their original share certificates. Under the process, shareholders are required to submit the securities deposit form, original physical share certificates, and relevant transfer documents for conversion into book-entry form. However, the existing process doesn’t seem to provide any specific path for a situation where the share certificates are in possession of the lenders. Upon our contact with CDC customer support, they confirmed the same.
Hence, shareholders cannot independently complete this requirement without involving the lenders. The lenders or security trustee acting on behalf of lenders may not feel comfortable returning the share certificates that are held as a security. Sometimes the share pledge agreement obligates a continued security and that the security should not be broken through the whole term of agreement. So in such a scenario the possible options that remain are amending the share pledge agreements or entering into another contract with the lenders
This creates a practical between following regulatory compliance and also maintaining secured financing arrangements. Releasing the original certificates to complete conversion leaves the security of lenders vulnerable. Conversely, retaining the certificates prevents completion of the conversion process. The legal framework does not currently provide a clear and specific mechanism explaining how pledged physical shares can be converted without disturbing existing security arrangements.
A practical solution would require a dedicated procedure for conversion of encumbered shares. Such a procedure could provide for mechanisms such as direct submission of certificates by the security trustee, simultaneous conversion and creation of electronic pledges, or a coordinated process involving the company, shareholder, lender, and CDC. The objective should be to ensure that conversion into book-entry form does not result in any interruption, release, or uncertainty regarding the lender’s security rights.
Dematerialization is an important regulatory development and should be encouraged. However, for the framework to operate effectively, the transition process must also address the realities of existing secured lending arrangements. Clear guidance from CDC on the treatment of pledged physical shares would provide certainty to companies, shareholders, and lenders while ensuring smooth implementation of the dematerialization regime.
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Salahuddin Abbasi
Islamabad