【重磅】公司法学习法笔记(全英)-CORPORATE MARKETS LAW-哈佛大学法学院完整版

ADVANCED CORPORATE MARKETS LAW

Market Infrastructure Financial Directive = MIFID

Two main areas: the global financial system and the EU capital market law.

1.The global financial system – basic information

There 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, buy

a car in France, that contract is governed by French law on the basis that I have signed the

contract 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 a

specific meaning provided by Italian civil code. In order to find out what an Italian

contratto means I have to search for the civil code. Otherwise, the world contract in

English 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 still

English, 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, then

the law, then the regulations, the consuetudini (common practices). This list is in

order of importance.

This is useful when we have the problem of inconsistency between the sources of

law.

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 specific

wins and the more generic loses.

Criteria: 1) the rule of higher grade shall amend or repeal the lower grade one

2) The rule of lower rank cannot amend or repeal the higher grade one

3) Two equal rules may change according to the chronological order

4) The latest rule changes or repeals the previous one of the same grade

And 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 regulations

and 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, you

have to declare to the public how many shares you have (in Italy this threshold is

3%) → 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 while

the meaning of property in Italy is different from the one in USA?

How does capital markets work? Do they work according to economic and financial

principles and hypothesis? It is a financial and economic issue, it has nothing to do

with law. Being economic and financial, it means that all capital markets into the

world would work according to financial and mathematical principles.

According to the theorem of price discovering, we have a market where we have

listed shares, and then we have the world of information. There is a strong relation

between prices and information. When the information is published, price maybe can

change. Otherwise, if the information is not published, the price does not move. How

point, we need rules about how the information must be communicated by the

companies to the market. Insider information are not yet published and should be

used for judging the price of stock.

Price discovering theory will drive all law makers in the law producing extremely

similar rules→ price discovery theory is a reference.

It is not an agreement, but a natural consequence. This is the first answer to the

problem 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 many

international authorities into the financial community. Example: International Swap

and Derivative Association (ISDA). All their guidelines are not binding, but they are

strongly followed by all the community. Even if they are not source of law, they are

best 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 of

the 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);

?Usages

This 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:

they 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 similar

markets in each country. Rules of capital markets are identical (sort of law);

https://www.360docs.net/doc/4d17041933.html,NGUAGE: it’s the financial English (even in the same country there are

no translations, but the native nouns);

d.RULES: even if the rules in the different markets aren’t exactly the same

they are quite similar and rule the same subjects (i.e. each market has a

disclosure 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 law

Italian 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.

?Language

?Financial instruments (most important)

?Sources

?Master agreements

Usually 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

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.

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

from 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 thought

like 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.

23/3/2017

We 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:

This kind of hierarchy does not exist in the global system, because this ranking requires a state and there is not a global, supranational state with a supranational ranking of the law.

Otherwise, there are the same kinds of rules about markets, financial products and regulations in financial market → this is an unique in terms of law.

Ex. :price discovery theorem → lead how the market should work

Liquidity of the market is another example of this.

The law is the instrument (legal) to govern the market itself, because we need laws to govern the market. Rules are there to make financial theories possible →uniformity in financial theories drives uniformity into rules. In this way the market is made efficient.

?Financial instruments

?Master agreements

?Markets → Remember: If we use a financial instrument we are on financial market.

Instead of buying a real property I buy stocks of a company that buys and sells real estates on the market. The shares are a financial instrument. There is a difference between investing directly in a real estate, from investing in funds of real estates, shares, bonds and other financial products → huge diversification of the risk, but you are taking at the same time new type of financial risks that you did not have on real estate market →there is the problem of information: you can have both advantage and disadvantage.

Do we have a law definition of financial markets? We have a legal definition in the directive that is called MIFID.

Now the world is no more organised by financial markets, but by trading venues: definition by MIFID number2 directive.

Each category of trading venue will have the same transparency requirements and similar organisational and market surveillance provisions.

What MIFID directive is about?

In the ’80s in Europe there was not a specific legislation on capital or financial markets. All the financial business was pretty wild and not regulated at all.

In ’80s we had the first legislation about fondi comuni di investimento.

Then, in the 1998, in Italy, we had the Testo Unico Finanziario.

Since 1998, we really had a huge number of European regulations about financial markets.

In 2007 we had the first MIFID. It was a big innovation because it was the first step to standardisation into capital markets in EU. It will be replaced by MIFID2 in 1/1/2018.

On 14 January 2014, EU legislators reached political agreement on reforms to the Markets in Fina ncial Instruments Directive (“MIFID”) that will renovate financial services regulation in the European Union.

The changes consist of a new MiFID II and MiFIR.

MiFID I’s goal was to make EU financial markets more integrated, competitive and efficient. While the introduction of Multilateral Trading Facilities (MTFs) had increased the competition between trading venues, it had also resulted in market fragmentation, which complicated the collection of trade data. A significant amount of bonds and derivative instruments were traded outside organised venues, obstructing price discovery and allowing risk to build up. In order to increase transparency and create a more level playing field, the new legislation states that all organised trading will now take place either on regulated trading venues (RM,MTF,OTF) or by

MiFID II and MiFIR provide an updated harmonised legal framework governing the requirements applicable to investment firms, regulated markets, data reporting services providers and third country firms providing investment services or activities in the Union.

To determine which firms are affected by MiFID and which are not, MiFID distinguishes between "investment services and activities", listed in Section A of Annex I) and "ancillary services", Listed in Section B of Annex I.

If a firm only performs ancillary services, it is not subject to MiFID.

MiFID covers almost all tradable financial products, listed in Section C of Annex I

MiFID II and MiFIR aim to enhance the efficiency, resilience and integrity of financial markets, notably by:

1.Achieving greater transparency for equities and non-equities trade regimes;

2.Bringing more trading onto regulated venues;

3.Fulfilling the Union’s G20 commitments on derivatives:

o mandatory trading of derivatives on regulated venues,

o introduction of position limits and reporting requirements for commodity derivatives,

o broadening the definition of investment firm to capture firms trading commodity derivatives;

4.Facilitating access to capital for SMEs;

5.Strengthening the protection of investors;

6.Regulating technological development: algorithmic traders and high-frequency trading;

7.Introducing provisions on non-discriminatory access to trading and post-trading services

in trading of financial instruments notably for exchange-traded derivatives;

8.Strengthening and harmonising sanctions.

As regard the second point, to bring more trading onto regulated venues, the legislation will introduce a new type of trading venue, the organised trading facility (“OTF”), to capture multilateral trading in non-equity instruments that does not currently take place on regulated markets (“RMs”) or multilateral trading facilities (“MTFs”).

The requirements for MTFs have been aligned with those of RMs so that investment firms and market operators operating an MTF will be required to have (a) systems and measures in place to manage, identify and mitigate risks, (b) effective arrangements for the efficient and timely finalisation of transactions and (c) sufficient financial resources for its orderly functioning.

Unlike RMs and MTFs, operators of OTFs will have discretion as to how to execute orders, subject to pre-transparency and best execution obligations. Moreover, RMs and MTFs are not allowed to execute client orders against proprietary capital, or to engage in matched principal trading, while it is permitted in some cases with client consent in OTFs.

We have some big areas inside the MIFID: what investment firms are? How they are regulated inside Europe? How do investment firms provide investment funds to the public? a bank is a kind of investment firm, like a financial intermediary.

Investment firms could only do business about investment services. It is a closed number of services: ex. Managing and advising about portfolios, financial advices to clients. This is a reserved area of business: to provide investment services you have to be authorized.

Investment firms provide financial services like financial instruments to the public.

MIFID is a single directive, but there are other different European regulations and technical standards (so a package of rules) that are to be executed together from 2018.

Regulated markets means a multilateral system. Multilateral system means any system in which multiple third parties buying and selling in the system are able to interact in the system. It is hard to find legal terms in this definition.

We are to trade a financial instrument at the same table. We start a negotiation and we decide the price into a contract of sale of the shares. This contract of sale is perfectly valid. Anyway, this contract of trading does not fall into the definition: it has something that is missing with respect with what happens into a financial market → in the example we do not have a financial market. In financial market you do not know who is the counterparty. When you trade on the market, you just insert your order into the system, then your offer is matched with someone and you have automatically the matching of the transaction. In the first example the matching was not automatic. The market is the system between the seller and the buyer.

A contract is an agreement between two parties, where a party makes a proposal and the other accepts. When you buy the newspaper or you buy something in the supermarket, you are executing a contract of sale with the counterparty. If you move on the financial market and you do not know your counterparty, there is a multilateral system between the two. If there is not a market there is just A and B, a proposal and an acceptance, and nothing more between them. If we are on the market, we have a computer system where

B puts his offer, that enters into the market, and because of the market, it ends to A → there is not a direct confrontation between A and B. There is a book on the system that is divided in two.

Ex.: the price of an Apple stock is 120$ per share. On the left of the book, someone sells 500 shares at the price of 121$. On the right of the book, there is a guy that wants to buy 500 shares at 119$ →here there is not market. Then there is a guy on the left that wants to sell 300 shares at 121,5$ and, on the right, someone that wants to buy 300 shares for 118,5$.

The more you continue reading the book forward the bottom, the higher the prices for the sellers (left) and the lower the price on the right (buyers). If the first guy on the right decides to accept the offer buying 500 shares for 121$, the first guy on the right and the first on the left disappears from the book and price evolves.

Liquidity is given by the number of shares and how fast the price is matched. This is the way a trader moves into a multilateral system. What is mainly traded are interests. The only exchanges are the ones happening on the top of the book.

(19) ‘multilateral system’ means any system or facility in which multiple third-party buying and selling trading interests in financial instruments are able to interact in the system;

(21) ‘regulated market’means a multilateral system operated and/or managed by a market operator, which brings together or facilitates the bringing together of multiple third-party buying and selling interests in financial instruments –in the system and in accordance with its non-discretionary rules –in a way that results in a contract, in respect of the financial instruments admitted to trading under its rules and/or systems, and which is authorised and functions regularly and in accordance with Title III of this Directive;

If the list is not moving fast, it means that there is not so much market for that stuff → if the book is reliable it contains much information. For example, I put on the left a big order of 1000 shares for

technique is a manipulation of the market to buy shares at a lower prices → to make sellers lower their price. After you cancel the order to avoid manipulation of the book→ that now is illegal. Regulated market, multilateral trading facility and organised trading facilities = three different types of trading venues.

22) ‘multilateral trading facility’or ‘MTF’ means a multilateral system, operated by an investment firm or a market operator, which brings together multiple third-party buying and selling interests in financial instruments – in the system and in accordance with non-discretionary rules – in a way that results in a contract in accordance with Title II of this Directive;

Non-discretionary rules = no man intervention.

A very simple rule is that the higher offer is the first to be listed into the book.

In a regulated market we only have market operators, whilst in 22) we can have market operators and investment firms. The difference between 21) and 22) is in rules applied in the market.

23) ‘organised trading facility’or ‘OTF’ means a multilateral system which is not a regulated market or an MTF and in which multiple third-party buying and selling interests in bonds, structured finance products, emission allowances or derivatives are able to interact in the system in

a way that results in a contract in accordance with Title II of this Directive;

39) ‘algorithmic trading’means trading in financial instruments where a computer algorithm automatically determines individual parameters of orders such as whether to initiate the order, the timing, price or quantity of the order or how to manage the order after its submission, with limited or no human intervention, and does not include any system that is only used for the purpose of routing orders to one or more trading venues or for the processing of orders involving no determination of any trading parameters or for the confirmation of orders or the post-trade processing of executed transactions;

We have computers that decide automatically to buy or to sell by an algorithm. In the last seven years, most of the trade have been made by computers. More than 60% of the trades in New York stock exchange were made by high frequency algorithmic trading.

(40) ‘high-frequency algorithmic trading technique’means an algorithmic trading technique characterised by:

(a) infrastructure intended to minimise network and other types of latencies, including at least one of the following facilities for algorithmic order entry: co-location, proximity hosting or high-speed direct electronic access; EN L 173/384 Official Journal of the European Union 12.6.2014

(b) system-determination of order initiation, generation, routing or execution without human intervention for individual trades or orders; and

(c) high message intraday rates which constitute orders, quotes or cancellations;

First of all, the ESMA estimated in his 2014 report the overall level of HFT activity in their sample, explaining which type of market participant acts as HFT.

They observe that HFT activity accounts for 24% of value traded for the HFT flag approach and 43% for the lifetime of orders approach.

The HFT flag approach provides the lowest estimates for HFT activity, while, under the lifetime of orders approach, most of the trading activity carried out by HFT firms is identified as HFT activity. Therefore, the difference between the two approaches, 19%, is mainly explained by HFT activity of investment banks. They found similar results for the number of trades and orders.

Their results also show that the level of HFT activity varies widely between trading venues and that HFT activity is linked to market capitalisation with HFT activity increasing with the market capitalisation of stocks.

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 feature has an economic and not a legal nature.

Derivatives exist and are regulated in different ways in several judicial systems, but their financial nature and structure is exactly the same in all the judicial systems. This phenomenon is typical and exclusive of certain financial products.

What characterizes the derivative is its financial (and not its legal) content: such products may 1) easily increase in number and 2) move to different markets more easily than others and so poison more than a market, as it happened with the Residential Mortgages Back Securities.

30/3/2017

Subjects for group work:

?Dark pools: dark pools are a particular kind of multilateral system.

Dark because they do not follow usual rules about market transparency: the trades are made without as much information as in the regulated market →so called blind trades. Quite common, even if they are dedicated only to certain types of financial products. You have to sell or to buy a fixed stake of shares.

If you go on the market and you try to buy 5% of the capitalisation of a certain company, the price of the shares will increase. It is not easy to buy a large stake of shares because of the price answer. How can you buy the same number of shares avoiding this type of market behaviour? →You can use dark pool, as in dark pools the traders do not access to the trading book. Trading book is to understand how the market will move. As the trade is blind, none can knows how many shares do you need.

?CONSOB versus STC

?Credit Default Swap: involved in financial crisis of 2008. They were one of most popularly used derivatives. If you want to obtain a sort of insurance because you have some corporate bonds in your pockets, one possibility is to buy a CDS → it acts like a hedge.

?Hedge hefting

?Product governments: new rules to be implemented in 2018. There must be a match between the product risk profile and the client risk profile.

?Regulation Market Abuse: strict rules about disclosure for price sensitive information. We have a specific Market Abuse Directive.

?Case studies: find some specific case studies of market abuses.

Definition of trading values according to MIFID2→three different types of systems: regulated markets, multilateral trading facilities and organised trading facilities. All together they are named as trading values. They all are multilateral systems, which is the definition by law of financial markets.

The core part of definition of multilateral system is that the trading occurs with no discrimination →no discretionary in matching the trading: trading made automatically without human intervention. Different from normal negotiation between two parties outside of the market.

The parties do not know each other. In the market the proposal is made to the public and not

We do not have a legal definition of interest. Whatever is connected to the market is somehow an interest.

Algorithm trading and high frequency algorithm trading machine: quite new → 2007.

Now this is the first case that we have specific rules on algorithm trading (in MIFID2).

Black Rock substitutes a trader with a robot (algorithm machines).

We might have one single stock that is listed in more than one trading value at the same time.

L et’s say Apple stock be listed in market1, market2 and market3.

Market1 can be a regulated market (at NY), market2 can be alternative trading system (not regulated market) and market3 can be a dark pool. The differences into these three markets might be substantial. In some very wild dark pool you do not have stock losses regulation.

These markets are very different in infrastructures → one can be faster than another. One can be more or less liquid than the other.

If Apple is listed at the same time into three different markets, its price could not be the same at the same time in the different markets. You might have slight differences in stock price at the same time, even if they tend to be the same, you can have a fraction of time in which it is not the same →the participants of the three markets are not the same.

Trader1 needs to buy 100 Apple at 150$ per share.

It is possible that in order to buy rapidly 100 shares, you have to split your order into all the available trading values. All 100 are not available on market1, maybe in market1 there are only 80 shares (at that price). 10 shares can be on market2 and the rest on market3.

When you send your order out, it is split in a router into three different orders.

The three orders do not reach the final destination at the same time: it depends on the location of trading values. The first market to be reached is the closer to the trader. While the first order is already arrived, the other two are still travelling, and they are intercepted by HFT machine, which is watching the market.

It understands someone is trying to buy 100 shares for 150$ each, and so they deduce that there will be some other orders to cover the demand. They know all the market in which Apple is traded. As a consequence, while orders for market2 and market3 haven’t arrived yet, HFT buys Apple shares for 150$, and when the orders finally reach the market2 and 3, it is found that HFT acquired the shares at 150$ and is going to sell them at 155$.

In the end, order2 and order3 are not matched. The trader has to send new orders now.

It is only a question of speed: front running. This is way the sped is so important on high frequency trading. This technique to manipulate the market is banned in MIFID2.

Many in the industry cite a number of advantages resulting from high frequency and algorithmic trading, such as creating greater liquidity, lowering costs for investors, increased volume, narrower spreads, reduced short-term volatility and better price formation and execution of orders for clients.

However, regulators believe that algorithmic trading has the potential to cause rapid and significant market distortion. Specifically there are concerns over the high order cancellation rate, increased risk of overloading systems, increased volatility, the ability of algorithmic traders to withdraw liquidity at any time and insufficient supervision by competent authorities. Moreover, HFT firms have information advantage due to proximity and lack of regulation could lead to manipulation of market (spoofing, quote stuffing).

Once an investment firm is authorised, certain on-going compliance requirements, such as the obligation to store, for at least 5 years, accurate and time-sequenced records of all the orders placed by the firm in an approved form and make available to the competent authority on request.

Moreover, a firm engaging in algorithmic trading will be required to have in place effective systems and risk controls to ensure that its trading systems are resilient and are subject to appropriate thresholds, which prevent sending erroneous orders.

The aim of these rules, together with the introduction of automated trading stops, the increase of minimum tick size, cancellation restrictions and enforcement minimum holding period, is to limit the HFT phenomenon, since it can have a large role in stock market crashes.

One of the first market crash, in which HFT played an important role contributing to it by demanding immediacy ahead of other market participants, is the “Flash Crash” of May 6, 2010.

Tick size rule which is the minimum offer possible to buy or to sell something? If you have 10 euros, can you offer 10,01? It depends on the rule about thick size. If the rule says that the minimum tick size is 0,50 cents, you can only offer 0,5. Higher the thick size, slower is the HFT.

A tick size is the minimum price movement of a trading instrument. If a stock has a tick size of 0,50$, and a current price of 20$; the associated price can move to 20,50$, but cannot move to 20,25$.

Collocation is one of main rules of MIFID2: fiscally all participants to the market must have the same proximity to the market servers. Anyone that wants to have a direct access must be guaranteed to have the same access as anyone else.

Two main techniques to avoid HFT excessive trading: tick prices and minimum holding period.

US Commodity Futures Trading Commission (with SEC): flash crash on the markets in 2010 because of HFT techniques.

10 pages about executive summary + chapter1 (page 9) Trading in a broad market + chapter2 Market participants and liquidity.

E-mini are a kind of derivative contracts.

31/3/2017

What happened in 2017? Stock prices during the day of the flash crash.

NB: almost everything happened at 14:30, during 30 minutes.

During these 30 minutes we can see the collapse of the market index. This happened because of the HFT. Huge collapse of 4-5% points of D&J index occurred in few minutes.

Such a big collapse is really rare, especially in such a short time.

As quickly as the collapse it returned at the same level. Quick and wild movement in few minutes. The Down- Jones index was reflecting what happened in the E-mini market.

E-mini market is composed of derivative trading values where the HPD were trading derivatives contracts. The E-mini is called E-Mini500 because the underline of that derivative contracts are the first Down-Jones 500 stocks.

There is a connection between the trading-values, like E-mini trading-values, that are specialised in derivative contracts, and the regulated market, where we do not have derivative contracts, but only stocks.

Otherwise, if you have a derivative, you have to hedge your position by acquiring fiscally the underlying. This is the connection between the regulated market and the smaller E-mini market.

All the regulated markets are connected.

You can have a trading value specialised on some kind of derivatives, or only on some types of co mpanies… but they are all connected.

A trading machine is used to trade at the same time in more than one trading values.

The May 6, 2010, Flash Crash was a United States trillion-dollar stock market crash, which lasted for approximately 36 minutes.

The joint 2010 report by SEC (Securities and Exchanges Commission) and CFTC (Commodity Future Trading Commission) portrayed a market so fragmented and fragile that a single large trade could send stocks into a sudden spiral.

They highlighted how a large mutual fund firm selling an unusually large number of E-Mini S&P contracts first exhausted available buyers, and then how HFT started aggressively selling, accelerating the effect of the mutual fund's selling and contributing to the sharp price declines that day.

May 6 started as an unusually turbulent day for the markets.

Since the very beginning, there was unsettling political and economic news concerning European debt crisis.

At about 1pm the euro began a sharp decline against both the US dollar and the Japanese yen.

By the early afternoon broadly negative market sentiment was already affecting an increase in the price volatility of some individual securities.

Therefore, "a large fundamental trader initiated a sell program to sell a total of 75,000 E-Mini S&P contracts, valued at approximately $4.1 billion, as a hedge to an existing equity position. This large fundamental trader chose to execute this sell program via an automated execution algorithm that was programmed to feed orders into the June 2010 E-Mini market to target an execution rate set to 9% of the

trading volume calculated over the previous minute, but without regard to price or time.

A similar size sell order was executed in the E-Mini in the 12 months prior to May 6 by the same firm, but through a combination of manual trading and several automated algorithms taking into account price, time, and volume, which took 5 hours to be completed.

However, on May 6 the Sell Algorithm chosen by the large trader to only target trading volume, completing extremely rapidly in just 20 minutes.

This sell pressure was initially absorbed by high frequency traders.

High frequency traders accumulated a net long position of about 3,300 contracts.

However, between 2:41 pm and 2:44 pm, high frequency traders aggressively sold about 2000 E-mini contracts in order to reduce their temporary long position.

In the report, they described two liquidity crises: one at the broad index level in the E-Mini, the other with respect to individual stocks.

In the first one, the combined selling pressure from the sell algorithm, HFTs, and other traders drove the price of the E-Mini S&P 500and the price of SPY S&P 500 indexes, due to cross-market arbitrageurs, down approximately 3% in just four minutes.

Still lacking sufficient demand from fundamental buyers or cross market arbitrageurs, HFTs began to quickly buy and then resell contracts to each other due to insufficient demand, generating a “hot-

As prices in the futures market fell, trading on the E-Mini was paused for five seconds when the Chicago Mercantile Exchange ('CME') Stop Logic Functionality was triggered in order to prevent a cascade of further price declines.

In that short period of time, sell-side pressure in the E-Mini was partly alleviated and buy-side interest increased. When trading resumed, prices stabilized and shortly thereafter, the E-Mini began to recover, followed by the SPY.

The E-mini and SPY are the two most active stock index instruments traded in the electronic futures and equity market. Both are derivative products designed to track stocks in the S&P 500 Index, which in turn represents approximately 75% of the market capitalization of US listed equities.

The second liquidity crisis occurred in the equities markets.

Automated trading systems used by many liquidity providers temporarily paused in reaction to the sudden price declines observed during the first liquidity crisis.

Based on their respective individual risk assessments, some market makers and other liquidity providers widened their quote spreads, others reduced offered liquidity, and a significant number withdrew completely from the markets.

HFTs in the equity markets traded proportionally more as volume increased, and were overall net sellers in the rapidly declining broad market along with most other participants.

Even though prices in the E-Mini and SPY were recovering from their severe declines, sell orders placed for some individual securities and ETFs (Exchange Traded Funds) found reduced buying interest, which led to further price declines in those securities.

As liquidity completely evaporated in a number of individual securities and ETFs, participants instructed to sell (or buy) at the market found no immediately available buy interest (or sell interest) resulting in trades being executed at irrational prices as low as one penny or as high as $100,000. These trades occurred as a result of so-called stub quotes, which are quotes generated by market makers at levels far away from the current market in order to fulfil continuous two-sided quoting obligations.

After a short while, as market participants had time to react and verify the integrity of their data and systems, buy-side and sell-side interest returned and an orderly price discovery process began to function, and by 3:00 p.m., most stocks had reverted back to trading at prices reflecting true consensus values. Nevertheless, between 2:40 p.m. and 3:00 p.m., over 20,000 trades were executed at prices 60% or more away from their 2:40 p.m. prices.

After the market closed, the exchanges and FINRA (Financial Industry Regulatory Authority) met and jointly agreed to cancel (or break) all such trades.

Since the E-mini and SPY both track the same set of S&P 500 stocks, cross-market arbitrage between these two products kept their prices closely aligned during their rapid declines. However, in the moments before prices of the E-Mini and SPY both hit their intra-day lows, the E-Mini suffered a significant loss of liquidity during which buy-side market depth was not able to keep pace with sell-side pressure.

Four minutes later, when prices in the E-Mini and SPY were recovering, buy side market depth for SPY reached its daily low.

There does not appear to have been a fundamental liquidity event in S&P 500 stocks that preceded and drove price declines in the E-Mini and SPY.

?Under stressed market conditions, the automated execution of a large sell order can trigger extreme price movements, especially if the automated execution algorithm does not take prices into account;

?High trading volume is not necessarily a reliable indicator of market liquidity;

?Reminder of the inter-connectedness of derivatives and securities markets.

?Pausing a market can be an effective way of providing time for market participants to reassess their strategies, for algorithms to reset their parameters, and for an orderly market to be re-established.

There have been 7 spikes in less than one second. This possibility to make money could only be exploited by machines.

The events of May 6 can be separated into 5 phases:

1.During the first phase, from the open through about 2:32 pm, prices were broadly declining

across markets, with stock market index products sustaining losses of about 3%.

2.In the second phase, from about 2:32 pm through about 2:41 pm, the broad market began to

lose more ground, declining another 1-2%.

3.Between 2:41 pm and 2:45:28 pm in the third phase lasting only about four minutes or so,

volumes spiked upwards and the broad markets plummeted a further 5-6% to reach intraday lows of 9-10%.

4.In the fourth phase, from 2:45 pm to about 3:00 pm, broad market indices recovered while at

the same time many individual securities and ETFs experienced extreme price fluctuations and traded in a disorderly fashion at prices as low as 1 penny or as high as 100,000$.

5.Finally in the fifth phase starting at about 3:00 pm, prices of most individual securities

significantly recovered and trading resumed in a more orderly fashion.

Financial products into the MIFID Directive

MIFID → from 1 to 150 there are whereas (premesse) to articles.

Annexe1 is the list of services and activities.

Imagine we have client A, client B and the market.

Usually the client cannot access directly the market→he has to use an intermediary or an investment firm which is directly connected to the market. MIFID calls this intermediary investment firm: a company which is licensed to provide investment services. The system is closed for what concerns investment services.

An investment firm must fulfil various requirements, like minimum share capital (at least 2 million euros). The regulator that has to check all these requirement is in Italy bank of Italy and CONSOB. If clients are individual people, we call them retail clients, but there can be even corporations and professional clients.

Most part of MIFID is about investment firms which provide financial services to the public, the object of which is financial instruments → lots of rules about contractual relations between clients and investment firms.

Annexe1:

1.Reception and transmission of orders in relation to one or more financial instruments; Basic investment service: the firm is an intermediary between the client and the market and has to process a specific order to buy or sell a financial instrument that is listed on the market.

3.Dealing on own account;

This is when the bank or the firm sell you an instrument that belongs to them.

You are not trading on the market, but your counterpart is the bank.

Before (in 1 and 2) the intermediary was not your counterpart.

4.Portfolio management;

Clients give money to firm in order to manage this money

5.Investment advice;

Sort of advice provided by the firm on the financial instruments.

Investment advising is licensed: normal companies do not give advice.

It is not a question of taking or managing money. It is detached from portfolio management.

6.Underwriting of financial instruments and/or placing of financial instruments on a firm

commitment basis;

Imagine I am a big corporation issuing bonds and I need to place my bonds on the market. Usually I engage an intermediary (as a bank) that can place them on the public.

This work of placing could be done in two different ways: the bank could place bonds with or without commitment basis.

Without commitment basis means the bank won’t have resp onsibility on how many bonds will be placed effectively. If the bank is not able to place all the bonds, with commitment basis the bank will be obliged to buy all the bonds in excess. If there is not commitment basis, bank will just have to return bonds back to the firm.

7.Placing of financial instruments without a firm commitment basis;

8.Operation of an MTF;

Running a multilateral system is a regulated activity, for which you need to be licensed.

9.Operation of an OTF

Annexe 1, section B: ancillary services

If you can provide financial services, you can even provide ancillary services.

1.Safekeeping and administration of financial instruments for the account of clients, including

custodianship and related services such as cash/collateral management and excluding maintaining securities accounts at the top tier level;

2.Granting credits or loans to an investor to allow him to carry out a transaction in one or

more financial instruments, where the firm granting the credit or loan is involved in the transaction;

3.Advice to undertakings on capital structure, industrial strategy and related matters and

advice and services relating to mergers and the purchase of undertakings;

This is not a financial advice.

4.Foreign exchange services where these are connected to the provision of investment

services;

5.Investment research and financial analysis or other forms of general recommendation

relating to transactions in financial instruments;

6.Services related to underwriting.

7.Investment services and activities as well as ancillary services of the type included under

(5), (6), (7) and (10) of Section C where these are connected to the provision of investment

or ancillary services.

Section C: financial instruments:

1.Transferable securities (valori mobiliari)

Valori mobiliari. If something is a financial instrument, we have to apply MIFID.

We can use the world “negotiation”, to mean that the transfer occurs into the market, while the world “transfer” means something that could happen even outside of the market.

In a face to face transaction, technically meaning, you do not have a negotiation, because it does not happen in the market. When it is just face to face, you can say that it is a transaction.

Security is split in Testo Unico between equity instruments (transferable) and debt instruments (transferable) → shares and bonds.

In order to distinguish between shares and bonds, we could use a proper legal view or a finance view.

All the companies have share capital.

According to which type of capital, you have different minimum level of capital required by law. When we speak about equity we are in the world of shares capital, that can be normal shares → the shareholder is entitled to receive the dividends.

The risk is given by the fact that the value of the shares is connected to the ongoing of the company business. I have two ways to obtain shares: the first is to buy the shares on the market (we are talking about listed company). The second way is to give money when new shares are issued. Otherwise, the bonds represent a credit that the subscriber holds towards the company. Convertible bond: when the investment period is going to end, the convertible bond can be converted into a share, after the life of the bond.

Italian Testo Unico Finanziario: Articlo1: definition of financial instruments (strumenti finanziari) → this definition is not in the MIFID, as in the MIFID we just have the list.

Here instead we have a definition: “gli strumenti finanziari sono prodotti finanziari e ogni altra forma di investimento di natura finanziaria” → Financial products are financial instruments and any other form of investment of financial nature.

For “valori mobiliari” we mea n types of securities which could be negotiated into a capital market. Transferable means broadly “which could be negotiated on a capital market”.

A share that is not listed, generally could be listed and negotiated, so it is transferable.

Even if a specific bond is not listed, but could be listed and negotiated, it is transferable.

Take for example a contract of sale of commodities, executed over the counter or face to face.

The contract itself is not listed, and therefore it is not transferable, according to MIFID.

The first meaning of transferability is the possibility for a given instrument to be negotiated into the market, that is the multilateral system.

What are transferable securities for Italian Testo Unico?

a)Azioni di società (company shares)

b)Bonds (obbligazioni)

c)Whatever securities negotiated