Legal Aspects of Finance
Slide Set 5
Investment Firms
- Legal Standards on Customer Relations
- Other Regulation of Investments Firms
Matti Rudanko
Legal Basis
DIRECTIVE 2004/39/EC
OF THE EUROPEAN
PARLIAMENT AND OF
THE COUNCIL of 21
April 2004
• on markets in financial
instruments amending
Council Directives
85/611/EEC and 93/6/EEC
and Directive 2000/12/EC of
the European Parliament
and of the Council and
repealing Council Directive
93/22/EEC (Markets in
Financial Instruments
Directive / MiFID)
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COMMISSION
DIRECTIVE
2003/125/EC of 22
December 2003
• implementing Directive
2003/6/EC of the European
Parliament and of the
Council as regards the fair
presentation of investment
recommendations and the
disclosure of conflicts of
interest (Commission
Investment
Recommendations
Directive)
Legal Basis, cont.
Act on Investment
Services (14.12.2012 /
747)
• Repeals: Act on Investment
Service Companies (2007)
FSA Standard 5.5:
Investment
recommendations and
accepted market
practices
FSA Standard No 1.3:
Reliable Administration
and Arrangement of
Activities
FSA Standard 2.4:
Customer identification
and customer due
diligence. Prevention of
money laundering,
terrorism financing and
market abuse
FSA Standard No 2.1:
Standard on code of
conduct for the
provision of financial
services.
FSA Standard No 2.3:
Standard on financial
services agreements
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Investment Firms 1
Banks
Finance
and credit
card
companies
Investment
companies
Special
credit
institutions
• Municipality Finance,
Finnvera, Finnish
Export Credit
• owned by the public
sector
• carry risks that a
private financier does
not want to assume.
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• Invest in shares or
real estate.
Investment Firms 2
Mutual
funds
• Mutual Funds Act and the EU UCITS (Undertakings for Collective
Investment in Transferable Securities) directive
Insurance
institutions
• manage securities transactions based on their customers’ orders to buy
or sell
Securities • In October 2004 there were 47 investment service businesses in Finland
brokers
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Financial Organizations
Federation of Finnish
Financial Services
• Merger of The Finnish Bankers’
Association, Federation of Finnish
Insurance Companies and The
Finnish Finance Houses
Association
The Finnish Venture
Capital Association.
The Advisory Office for
Bank Customers
The Finnish Association of
Mutual Funds
The Finnish Securities
Complaint Board
The Finnish Association of
Securities Dealers
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Customer Relations
Act on Investment Services (AIS) Ch. 10
A securities intermediary shall conclude a contract on the provision of
investment services in writing. The liability to conclude a contract in
writing shall, however, not apply to a securities intermediary when he
provides investment services to a professional investor. (Sect. 3)
AIS Ch. 1 Sect 18, Ch.10 Sect. 1: professional / non-professional investors,
eligible counterparties (Ch. 1 Sect. 19, Ch.10 Sect. 11)
• Investor compensation fund: only non-professional investors
• Classification of clients and agreements on it; information to be given to the
client on the status as an investor
• Register by the FSA on professional investors
• Eligible counterparties: exceptions from certain intermediary duties
In a contract relating to the provision of investment services, a
securities intermediary may not employ a term that is contrary to
proper practice or otherwise unconscionable for the client.
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Eligible Counterparties
An Eligible Counterparty (ECP) is an
entity that is authorised or regulated
to operate in the financial markets
that is not given investment advice
and belongs to one of the following
categories:
If such clients are provided with
investment advice, they will be
treated as Professional Clients
instead.
•Investment firms, Credit institutions,
Insurance companies
•UCITS and their management
companies
•National governments and their
corresponding offices, including
public bodies that deal with public
debt
•Central banks and supranational
institutions
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ECPs receive the lowest level of
protection under MiFID.
Customer Relations, cont.
“Know your customer” (AIS Ch
12 sect. 3)
• the financial resources and experience
• Information on services suitable for the
client
• Prevention of money laundering and
funding of terrorism
A securities intermediary
shall aim at avoiding
situations involving
conflict of interests and,
upon their occurrence,
treat the client in
accordance with proper
practice. A securities
intermediary shall treat his
clients equally.
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A securities intermediary
shall execute his orders
carefully and in the best
interest of the client
without undue delay.
Systematic internalisers
Investment firm
which,on an
organised,
frequent and
systematic
basis, deals on
own account by
executing client
orders outside a
regulated market
or an MTF
• Advance announcement to the FSA
• They shall publish a firm quote in
those shares admitted to trading on a
regulated market for which they are
systematic internalisers and for which
there is a liquid market.
• In the case of shares for which there
is not a liquid market, they shall
disclose quotes to their clients on
request.
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Systematic internalisers 2
Systematic internalisers shall
execute the orders they receive
from clients in relation to the shares
for which they are systematic
internalisers at the quoted price at
the time of reception of the order.
Systematic internalisers may
refuse to enter into or
discontinue business
relationships with investors
on the basis of commercial
considerations such as the
investor credit status, the
counterparty risk and the
final settlement of the
transaction.
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Systematic internalisers shall
be allowed to decide, on the
basis of their commercial
policy and in an objective
nondiscriminatory way, the
investors to whom they give
access to their quotes. To
that end there shall be clear
standards for governing
access to their quotes.
Post-trade disclosure by investment
firms
• Investment firms which, either on own account
or on behalf of clients, conclude transactions in
shares admitted to trading on a regulated
market outside a regulated market or MTF, shall
make public the volume and price of those
transactions and the time at which they were
concluded.
• Declaration of suspicious transactions to the
FSA (SMA Ch. 14 Sect. 5)
– Transactions suspected to include insider trading or
market manipulation
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Investment services
Purchase, sale, transfer and
subscription of investment
targets in one’s own name
on behalf of another;
brokerage on or execution
of orders for investment
targets (securities
brokerage)
submission of binding
bids and offers in
investment targets,
their publication and
notification to investors
and trading in them on
one’s own account
(securities dealing)
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submission and
publication of binding
bids and offers in
investment targets
continuously or on
request under a
contract concluded
with a marketplace or
an issuer; public trade
in one’s own name
based on such
contracts (market
making)
Investment services, cont.
management of
investment targets
under a client-byclient contract in
which decisionmaking power has
been granted to the
contractor (asset
management)
Investment advice
Issue of subscription
commitments in
connection with the
issue of a security or
the conclusion of a
derivatives contract
(emission
guarantee)
acquisition of
subscribers for
investment targets or
arrangement of their
subscriptions
(emission
arrangement)
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Corporate Finance
Arranging
long term
financing
• services relating to issues of securities:
• Emission arrangements / guarantees
• venture capital
• mezzanine instruments: preferred stock,
subordinated loans, options, convertible
bonds
• company restructuring
• syndicated loans
• securitization
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Securitization
http://www.investopedia.com/terms/s/securitization.asp
• An issuer creates a financial instrument by combining
other financial assets and marketing different tiers of the
repackaged instruments to investors.
• The process promotes liquidity in the marketplace
• E.g. mortgage-backed securities:
– combining mortgages into one large pool
– dividing the large pool into smaller pieces based on each
individual mortgage's inherent risk of default
– smaller investors can purchase shares in a larger asset pool
(portions of a mortgage) as a type of bond. Without the
securitization of mortgages, retail investors may not be able to
afford to buy into a large pool of mortgages.
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Mezzanine and restructuring
• Mezzanine
–
–
–
–
• Restructuring
subordinated loans
options, option loans
convertible bonds
preferred stock
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– mergers
– diffusions
– share / asset deals,
takeovers
– LBO, MBO
LBO (Figure from Wikipedia)
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LBO, cont.
• A leveraged buyout (LBO) is when a company or single asset
(e.g., a real estate property) is purchased with a combination of
equity and significant amounts of borrowed money, structured in
such a way that the target's cash flows or assets are used as the
collateral (or "leverage") to secure and repay the money borrowed
to purchase the target-company/asset.
• Since the debt (be it senior or mezzanine) has a lower cost of
capital (until bankruptcy risk reaches a level threatening to the
lender[s]) than the equity, the returns on the equity increase as the
amount of borrowed money does until the perfect capital structure is
reached. As a result, the debt effectively serves as a lever to
increase returns-on-investment.
• (Wikipedia)
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MBO
• A transaction where a company’s management team purchases the
assets and operations of the business they manage.
• A management buyout (MBO) is appealing to professional
managers because of the greater potential rewards from being
owners of the business rather than employees.
• MBOs are favored exit strategies for large corporations who wish to
pursue the sale of divisions that are not part of their core business,
or by private businesses where the owners wish to retire.
• The financing required for an MBO is often quite substantial, and is
usually a combination of debt and equity that is derived from the
buyers, financiers and sometimes the seller.
• (Investopedia)
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Basics about Finance
Forms of finance differ in four respects:
Right to control
Equity, Debt capital, Mezzanine (e.g.
capital loan, preferred stock)
• Owners: yes – preferred stock, capital loan and other creditors: no
Mandatory yield
• Equity and capital loan: No - debt capital: Yes
Determination of yield
• Debt and capital loan: fixed - equity: variable
Position in the order of payment in liquidation
• 1) creditors – 2) capital loan creditors – 3) owners
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Investment Firms 3
Investment
banking
Venture
capital
investors
• manage share issues, acquisitions, mergers, and general
accounting and financial consultation.
• fixed-term, equity-based investment in SMEs not listed on the
stock exchange but with good growth potential.
• convertible bonds, bonds with warrants and mezzanine financing
• at the end of the term, the venture capitalist’s investment is
realised: selling his or her shares to other company owners /
acquiring new owners / listing the company on the stock
exchange.
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Investment banking
•Emission arrangement
UNIVERSAL BANKING (cf. narrow banking)
•Emission guarantees
• subscription
commitments
(underwriting )
BANKING
Commercial banking
Forwarding of
financing and
payments
•services relating to
issues of securities
Investment banking
Securities
activities
Corporate Finance
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• asset management
•decision making power
with the contractor
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Roles of an investment firm
I
n
v
e
s
t
m
e
n
t
f
i
r
m
Issue of securities
subscriber
roles
agent
financier
issuer
roles
•emission arranger
•emission guarantor
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Emission arrangement
Issuer
No contractual relations
Emission arranger
(if authority from the issuer)
investors
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Liability norms relating to the roles
Authorized agent
of the subscriber
(contractor)
• norms on commission
contract (agency) (KK
Ch. 18)
Emission arranger
Emission
guarantor
• liability norms on the
contractual relationship
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• norms on disclosure
duties on securities
markets
• contract law norms on
commission contract
Syndicated loans / emissions
• Managing underwriter
– concludes the contract
with the issuer as an
agent of the group
• divided syndicate
contract
– responsibilities of the
members
• selling group
– marketing
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Contracts
• Emission arrangement /
syndicate
• the arranger is
responsible for following
the official norms
• contents of contracts
– mutual liabilities
– indemnity: exemption of the
agent from e.g. disclosure
liability
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