ADVANCED CORPORATE MARKETS LAWMarket Infrastructure Financial Directive = MIFIDTwo main areas: the global financial system and the EU capital market law.1.The global financial system – basic informationThere is a problem with respect to globalisation while studying law. It is easy to talk about global market or global economy, but the world “law” is strictly connected to a single state into borders. Law system is the opposite of globalisation by its definition itself.This is the starting point to understand why it is so difficult talking about globalisation and law together. Even in EU, where we do not have physical borders, if me, Italian citizen, buya car in France, that contract is governed by French law on the basis that I have signed thecontract in France. The same counts for a Frenchman that buys something in Italy.Otherwise, take the concept of real property: our concept of property does not exist legally in the same way in UK. In England they have the concept that all immovable property belongs to the crown. Even if you buy something immovable, it has to return to the crown by a hundred of years.In Italy you can divide property into shares. If you have full ownership of shares you can get eventual dividends. If you split and become “nudo proprietario”, you are not more entitled to the dividends. The one that takes the dividends is called “usufruttuario”. These are called “diritti reali di godimento”. But this idea is not spread abroad.Otherwise take marriage: in Italy you cannot be bigamous.Here you don’t have a principle called “stare decisis” if a judge in Italy makes a sentence, another judge is not bound to follow the sentence by judging another case. Following judges in Italy are not bound by precedent cases.In UK and USA, instead, the second judge is bound to follow the decision of the first one.All legal systems are different and valid in their state.In Italy we have Vatican City and San Marino republic that are two different states into the state. How could we talk about globalisation in terms of law?In globalisation the basic meaning should be “no borders”.In Italy, before 1942 (Italian civil code enacted), when someone committed a crime, apart from throwing him in jail, there was an optio n called “confino”. Sending someone to confino meant a place, like a small village, and you were there and you couldn’t go outside.Why cannot he be banned? Because the state has no powers outside, there should be international agreements.International law is basically the block of relations between the states, but international law is not globalisation. International is when a state tries to enter into an agreement with another state to found rules that are enforceable for both states.Imagine that nation and state mean the same thing. Inter + national = between + states.International has nothing to do with globalisation: in globalisation we do not have states.The image of globalisation is a globe without borders. International is a step away from globalisation, because international accepts the idea of borders and different nations.A good image of globalisation is financial capital market .In legal system we don’t have globalisation, but we have an exception: capital markets law is the only branch of law that is globalised. This happens because of:•Language →if you’re studying Italian private law in English and you find the world “contract”, you translate in Italian like “contratto”, but this in Italian law has aspecific meaning provided by Italian civil code. In order to find out what an Italiancontratto means I have to search for the civil code. Otherwise, the world contract inEnglish has a different meaning because it has a different definition.In capital markets there is the financial jargon, that is the same for everyone. It is stillEnglish, but to be understandable, you need specific economic knowledge (like “cap-and-floor”: speci fic financial meaning).“Upfront” = sort of payment at the beginning of the derivative contract.“Underline” = stocks or shares.•Sources of law (le fonti del diritto): in the normal legal system we have the hierarchy of the sources of law. For example, in Italy we have first Italian Constitution, thenthe law, then the regulations, the consuetudini (common practices). This list is inorder of importance.This is useful when we have the problem of inconsistency between the sources oflaw.The problem is when you have two inconsistent rules on the same level.When one is on the same level of the other, but it is more specific, the more specificwins and the more generic loses.Criteria: 1) the rule of higher grade shall amend or repeal the lower grade one2) The rule of lower rank cannot amend or repeal the higher grade one3) Two equal rules may change according to the chronological order4) The latest rule changes or repeals the previous one of the same gradeAnd if the inconsistency exists between two standards belonging to the same sources? It must be applied the “consecution”: the law enacted afterwards always prevails on the law enacted earlier.Do all legal systems have this kind of ranking? We have first law, then regulationsand last common practices.It would be impossible having a ranking like this into global law.How does it work if there is not ranking in the source of law?Which are the sources of the law?Example: if you owns more than a certain amount of shares of a listed company, youhave to declare to the public how many shares you have (in Italy this threshold is3%) → this disclosure rule exists in every law system in very similar terms.How is it possible having extremely similar rules in so many different markets whilethe meaning of property in Italy is different from the one in USA?How does capital markets work? Do they work according to economic and financialprinciples and hypothesis? It is a financial and economic issue, it has nothing to dowith law. Being economic and financial, it means that all capital markets into theworld would work according to financial and mathematical principles.According to the theorem of price discovering, we have a market where we havelisted shares, and then we have the world of information. There is a strong relationbetween prices and information. When the information is published, price maybe canchange. Otherwise, if the information is not published, the price does not move. Howfast will the information be incorporated by the price? In a perfect world the marketis efficient and the information is incorporated into the price very quickly. At thispoint, we need rules about how the information must be communicated by thecompanies to the market. Insider information are not yet published and should beused for judging the price of stock.Price discovering theory will drive all law makers in the law producing extremelysimilar rules→ price discovery theory is a reference.It is not an agreement, but a natural consequence. This is the first answer to theproblem of sources of law.La price discovery è un meccanismo finalizzato a determinare il prezzo di uno strumento finanziario partendo dalle informazioni a disposizione di ogni soggetto partecipante allo scambio. A loro volta i fattori informativi rilevanti si riflettono nelle schede di domanda e offerta dei partecipanti. Per un corretto processo di price discovery è pertanto necessario che l'informazione sia sui valori fondamentali del bene scambiato sia sulle condizioni dello scambio fluisca liberamente. Per tale motivo, un mercato concentrato, quanto meno dal punto di vista informativo, fornisce l'ambiente più adatto per una corretta price-discovery.I partecipanti al mercato hanno un naturale incentivo a cercare il miglior prezzo (il prezzo più basso per chi desidera acquistare e il prezzo più alto per chi desidera vendere) e ciò, in un mercato efficiente, conduce ad una unicità di prezzo mediante l’operare del meccanismo di arbitraggio.Huge amounts of public and not public organisations into finance: we need so manyinternational authorities into the financial community. Example: International Swapand Derivative Association (ISDA). All their guidelines are not binding, but they arestrongly followed by all the community. Even if they are not source of law, they arebest practice. This is why we have such a level of uniformity in terms of contracts.F/E – ISDA used by everybody.A taxonomy of the sources of law is expressly provided in art.1 of the Preliminary Dispositions of the Italian Civil Code. They are hierarchically ordered as follows:•Statutes→constitutional sources: the Constitution, constitutional laws and constitutional regional statutes.•Primary sources▪International treaties (with specific reference to antiterrorism treaties and NATO);sources of EU law with binding force (directive and regulations) and judgments ofthe European Court of Justice “declarative” of community law.▪Ordinary law (enacted by the parliament); regional statutes and regional laws;▪Acts having the force of law (in order, law decree and legislative decree) •Secondary regulations▪Government regulations; ministerial regulations; administrative regulations;prefectural regulations and of other local governments;▪The jurisprudence (in particular the judgements of higher courts);•UsagesThis list didn’t include the C onstitution, because the Civil Code was issued in 1942, while the Constitution in 1947.Could the global system work like our legal system? No: our legal system is strongly connected to the idea of state.Could the principle of inconsistency exist in the global financial system? It doesn’t properly exist: in this system there isn’t a sort of ranking in the sources of law. There are public financial institutions that public guidelines (sort of recommendation). These guidelines are not binding, butthey have an heavy weight because the authorities that issued them are very technical and specialised. The entire corps of these guidelines is a sort of set of rules.Global financial system is definitely different from an ordinary legal system for the idea of hierarchy, sources, law: completely detached from the idea of state, borders or frontiers.a.In GFS we find FINANCIAL PRODUCTS, that are the same for all systems(while in OLS we have contracts);b.MARKET (exchanges): not a single global market, but several very similarmarkets in each country. Rules of capital markets are identical (sort of law);NGUAGE: it’s the financial English (even in the same country there areno translations, but the native nouns);d.RULES: even if the rules in the different markets aren’t exactly the samethey are quite similar and rule the same subjects (i.e. each market has adisclosure rule).•Financial products: why can we talk about a global financial system in terms of law? The price discovery process (also called price discovery mechanism) is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers. The future and option markets serve all important functions of price discovery. The individuals with better information and judgement participate in these markets to take advantage of such information. When some new information arrives, perhaps some good news about the economy, for instance, the actions of speculators quickly feed their information into the derivatives market causing changes in prices of derivatives. These markets are usually the first ones to react as the transaction cost is much lower in these markets than in the spot market.Lex mercatoria (from the Latin for "merchant law"), often referred to as "the Law Merchant" in English, is the body of commercial law used by merchants throughout Europe during the medieval period.It evolved similar to English common law as a system of custom and best practice, which was enforced through a system of merchant courts along the main trade routes. It functioned as the international law of commerce. It emphasised contractual freedom and alienability of property, while shunning legal technicalities and deciding cases ex aequo et bono. A distinct feature was the reliance by merchants on a legal system developed and administered by them. States or local authorities seldom interfered, and did not interfere a lot in internal domestic trade. Under lex mercatoria trade flourished and states took in large amounts of taxation.Merchant world is similar to the global market: borders are enemy, a free space is needed to trade.2.The EU capital markets lawItalian law on capital markets is an execution of European law.At the EU we have heart harmonisation of capital markets law.In different states we have execution of regulations from EU.Main directive is MIFD2, then there are regulations and technical standards (these last are very specific rules). Directives are general rules, technical standards are issued by tech.entities and aim at giving very specific rules.1/1/2018 if a financial firm sells financial products to the public, they need to deliver a key- information document into which they have to show a ratio on risk performance about the product they are to sell. Level 1 is low risk, level 7 is very risky level. The math model is provided by the tech. standard and it is the same for everyone.Basically there are four pillars for the global financial system:•Language•Financial instruments (most important)•Sources•Master agreementsUsually the objective of the contract and the meaning of the contract are unique in the legal system. What are financial instruments? Into the markets, what is listed and exchanged is a financial instruments. There are many different kinds of financial instruments: derivative contracts, stocks, bonds…The object of a trade is a financial instrument. All set of rules, negotiation procedures… are all focused on financial instruments. Three big families: stocks, bonds or obligations, derivatives. We might ha ve simple options, or futures, or weather derivatives…even the one of the bonds is a world by itself: clean, subordinated bonds…The definition of financial product for the Italian law is established in “Testo Unico della Finanza” (TUF) Art.1, comma 1, let. U: “"prodotti finanziari": gli strumenti finanziari e ogni altra forma di investimento di natura finanziaria; non costituiscono prodotti finanziari i depositi bancari o postali non rappresentati da strumenti finanziari.” (financial instruments and any other form of investment with financial nature; bank or postal deposits, that are not financial instruments, do not constitute financial products).Financial products are tradable on the market, throughout all the markets.In terms of law, it is really interesting that the nature of financial instruments does not depend on the legal system. It doesn’t matter if a future is regulated by Italian or American law, because the nature of the future is expressed in a mathematical way, so it is the same in all the world. It doesn’t employ juridical terms. This counts for futures, swa p derivatives, options…Many financial instruments are simply exactly the same in all the world. The consequence is that, if we don’t have a legal burden on the product, it can move around the world easily.In Civil Law countries, the law is based on typical contracts, many kind of contracts are regulated by the law.Instead, a contract of leasing didn’t exist in Italy into the ’80 →we had to import this kind of contract from USA and UK.Divide the contract in two big families: is it a kind of contract (tipico) already regulated by the law or for which exists something similar in the market? (like banking contract, compravendita, lo cazione…)? The first family is closed and only the lawmaker can add something to this list.The second family is the one of contratti atipici, not provided into the civil code, but they have to complain with one main principle to be valid: if someone invents a new contract that is not provided by the law, this contract has to comply with Italian mandatory rules, so basic principles. If the contract does not satisfy basic principle of the law, the contract is illegal.In the late ’80, we had this new contract of leasing, because some financial firms started making new business. When the parties went before the judge there was a problem: the judge must apply rules to the contract → what kind of rules will the judge apply to this new contract? There should be a matching between the type of contract and the set of rules. Otherwise, if it is a new contract, how can I find out which type of rules to apply? The judge found out that the leasing was half a contract of sale and half a rent. At the end of the period you can redeem the car by payment or give the car back. Actually, at the beginning you don’t buy the car, because its owners is the leasing company, formally. At the end, you have option to purchase the car. Do you need to apply rules for sale or rent? The judge thought that the most important part of the contract was the sale, so he had to regulate it with sale regulations.We didn’t create leasing contract: we imported it from common Law countries.With derivatives all this mess doesn’t take place: all these legal concepts have not to be applied to derivative markets. For what concerns financial instruments, like an interest rate swap, the international regulation is the same in all the world. The core part for the interest rate swap is the mathematical formula, not the legal nature: legal features don’t give shape to the product. There are not legal barriers.An interest rate swap is an agreement between two parties (known as counterparties) where one stream of future interest payments is exchanged for another based on a specified principal amount. Fixed amount of money is exchange for variable amount of money. An IRS is a popular and highly liquid financial derivative instrument in which two parties agree to exchange interest rate cash flows, based on a specified notional amount from a fixed rate to a floating rate (or vice versa) or from one floating rate to another. They are used for hedging and speculating.This kind of contract was created by the financial system to allow the “money move” between banks without a physical move of the money. It is an exchange of banks’ needs and a financial transaction since the aim of the bank is speculating.Behind the concept of IRS there are not legal conce pt implied, there is not a peculiar legal system… so it is a contract according to what? When the IRS is listed on an exchange it is no more a contract but a product: it can be bought with an offer and it is not necessary to sign a product.We can say if a country “invented” a certain typical contract (USA, leasing), but this is impossible with derivative contracts: financial market invented them, maybe because it needed a determined type of contract.To build a proper financial system, we’d need judges and courts. We still have many local courts. The most important courts in the financial world are London, New York and Chicago.The Italian financial markets is capitalised as 700 billion of euros. Apple alone is worth 780 billion of euros. The financial instruments are regulated by contracts anyway: the 99% of the derivative contracts of the world are regulated by the same MASTER AGREEMENT. Then there are some attachments to it offering some specifications.The ISDA Master Agreement is the most commonly used master service agreement for OTC derivative transactions internationally. It is part of a framework of documents, designed to enable OTC derivatives to be documented fully and flexibly. The framework consists of a master agreement, a schedule, confirmations, definition booklets, and credit support documentation. The ISDA master agreement is published by the International Swaps and Derivatives Association.The master agreement is a document agreed between two parties that sets out standard terms that apply to all the transactions entered into between those parties. Each time that a transaction is entered into, the terms of the master agreement do not need to be re-negotiated and apply automatically.Although it is often viewed as a tool for banks and financial institutions, the Master Agreement is widely used by a wide variety of counterparties.Distinction between applicable law and jurisdiction. Applicable law is the law the parties have decided to apply to regulate the contract. Usually, if the parties belong to the same state, they’d choose the law of the country. Otherwise, when the counterparties are from different countries, according to MASTER AGREEMENT, you can choose between English or New York state law. Then there is the concept of value and jurisdiction.There is a principle, valid for all legal system, usually set into Latin: IURA NOVIT CURIA (the court knows the law). The point is that the court knows all laws that are applicable, not just Italian, if we are in Italy… Example: the parties choose English law, but they are Italians and they have to have their judgement in front of an Italian judge. Italian judge is in this case asked to apply English law. How is it possible that an Italian judge is going to apply English law? How could the judge be aware of the foreign law?The burden of the proof of the law is on the two parties: they have to provide the foreign law and demonstrate how it could be applied. Usually the Italian judge demands for an expert (consulente tecnico) that has to explain to him how to apply English law.The judges technically are not part of the global system, but we have in the world many cases of financial subjects judged in very similar ways. We had the same case because the product, interest rate swap, was the same, so we can compare all these cases.What is different? The applicable law, because Italian judge has to judge this case according to Italian applicable law… the difference is the specific rule applied by the judge, according to law traditions of the country.We can identify certain products whose content may differ under distinct regulations. On the contrary, we do not observe this with derivatives: to understand what a derivative product is, it is sufficient to understand its financial function, since its distinctive features have an economic and not a legal nature.Observing the use of certain financial terms in the market practices, we noted that, when a financial instrument or a transaction is mainly characterized by its financial content (rather than its regulation), such words are homogeneously used in different markets.On the contrary, when the regulation is what characterizes the instrument or the transaction, the same terms, used in different markets, may instead refer to different phenomena and, moreover, the meaning of the terms characterized by their legal discipline is often debated also within the same jurisdiction.Such phenomenon of alignment in derivatives, of the use of financial terms, is , in our opinion, the result of two major causes:1-The predominance of the financial content over the legal discipline, which facilitates the use of the same terms in different countries.2- A recurrent absence of a juridical system of origin. Indeed, such terms are generally not crafted by legislators or regulators, but come into being in the financial market praxis and activities, which often involve more than a market at a time. In this sense, we call such phenomenon the “stateless finance”, which is growing fast and it is contributing to develop a cross-border market where the players use the same language and often face the same problems.Division between the banking system as a system for financing firms and capital markets. 80% of money allowed to companies comes from banking system in Europe; while in USA it is much more common going public: asking money to the public instead of banks. As an example, in Italy we have crowdfunding rules.Share = scrip, equity or stocks.Two different worlds: the real one, with products, and the markets, with financial instruments.The focus of the capital markets is how the markets work and how is trading on financial markets. In the European Union law, the definition of financial instrument is any form of investment that has financial nature. Imagine that A purchases a house for two main reason: the first is that he just needs a house; the second is for making an investment: he is buying this house because he wants to resell it at a higher price to B. The first option is made by buying a single contract, a contract of salefrom the seller B. In the second option, we have the first contract by which A becomes owner of the real estate, and then we have a second contract to sell the property at a higher price. The second sale is not happening by change, but because it was thought as an investment. If we buy a house in order to resell making an investment, that’s an investment → it is not a question of change, it was thoughtlike this since t he very beginning. If you’re looking for a house where to live, part of the evaluation will be my personal needs and taste. In the second option, where I am looking for a house where to make an investment, my standards are different because I won’t take in to account personal taste. If a house is going to take much more value in the next six months, I’ll buy it because I’ll do a good investment: the house is an item and I do not have to like it.This is the basic concept for doing an investment. Anyway, this is the investment on a real item: how would we turn this real investment into financial investment? To turn this operation into financial market, the object of the operation should be a financial instrument.Imagine that there is a real estate company, whose business is investing into real estates. Imagine A buying shares of the company: the shares of the company follow the definition of financial instruments. Anyway, the object behind is always the same.The risk we are taking is connected to the same real estate market. The financial risk A’s taking with the shares is the same due to the business of the company, linked to the real estate market. Otherwise, this is a financial investment because A’s buying shares. In both cases the estate market works as underlying.On the other hand, there are new risks, like CFO information risks, or possibility that bad news drag down the prices of stocks. Even if the underlying of the investment is very similar, we are acquiring more risk, and at the same time we have the possibility of collecting much more money. Moreover, buying one single real estate, I bet all my money on it. If I buy a share of something, I bet just on that share of that real estate and I can diversify. If I pull together three different companies, I can constitute an investment fund and, if I buy a share of it, I am investing in three different companies.In the market you can even find funds of funds → invest in thousands of real estate companies.23/3/2017We have spotted some basic pillars in global financial system:•Language: financial type of English (stocks, bonds, derivatives) stuff that is usually listed on financial markets. Financial instruments are the same in all the countries of the world. Think about the meaning of property: we have a definition in our civil code that is different from the one in Commonwealth.The objects of a trade (financial instruments) are otherwise the same in all the world.The unique exception are shares. The rights of the shareholders are different in all the countries. For example, the rights of a USA shareholder are different from the rights of a shareholder according to Italian law.Think about a derivative contract (ex. interest rate swap): most of swap are regulated by standard contracts that are English. This is valid for options, futures, equity swap, foreign swaps, weather derivatives…Then we have another family of financial instruments: bonds (obbligazioni).•Sources of law: usually there is a hierarchy into the source of law:❖European Union Treaty + Italian Constitution❖Technical meaning of law: acts enacted by Italian parliament → legislative decree.。