1. Legal Aspects of Finance Slide Set 5 Investment Firms - Legal Standards on Customer Relations - Other Regulation of Investments Firms Matti Rudanko

2. Legal Aspects of Finance 5 2 Legal Basis DIRECTIVE 2004/39/EC OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC (Markets in Financial Instruments Directive / MiFID) COMMISSION DIRECTIVE 2003/125/EC of 22 December 2003 implementing Directive 2003/6/EC of the European Parliament and of the Council as regards the fair presentation of investment recommendations and the disclosure of conflicts of interest (Commission Investment Recommendations Directive)

3. Legal Aspects of Finance 5 3 Legal Basis, cont. Act on Investment Services (14.12.2012 / 747) Repeals: Act on Investment Service Companies (2007) FSA Standard No 1.3: Reliable Administration and Arrangement of Activities FSA Standard No 2.1: Standard on code of conduct for the provision of financial services. FSA Standard No 2.3: Standard on financial services agreements FSA Standard 2.4: Customer identification and customer due diligence. Prevention of money laundering, terrorism financing and market abuse FSA Standard 5.5: Investment recommendations and accepted market practices

4. Investment Firms 1 Banks Finance and credit card companies Investment companies Invest in shares or real estate. Special credit institutions Municipality Finance, Finnvera, Finnish Export Credit owned by the public sector carry risks that a private financier does not want to assume. Legal Aspects of Finance 5 4

5. Investment Firms 2 Mutual funds Mutual Funds Act and the EU UCITS (Undertakings for Collective Investment in Transferable Securities) directive Insurance institutions Securities brokers manage securities transactions based on their customers’ orders to buy or sell In October 2004 there were 47 investment service businesses in Finland Legal Aspects of Finance 5 5

6. Financial Organizations Federation of Finnish Financial Services Merger of The Finnish Bankers’ Association, Federation of Finnish Insurance Companies and The Finnish Finance Houses Association The Advisory Office for Bank Customers The Finnish Securities Complaint Board The Finnish Association of Securities Dealers The Finnish Association of Mutual Funds The Finnish Venture Capital Association. Legal Aspects of Finance 5 6

7. 7 Customer Relations Act on Investment Services (AIS) Ch. 10 A securities intermediary shall conclude a contract on the provision of investment services in writing. The liability to conclude a contract in writing shall, however, not apply to a securities intermediary when he provides investment services to a professional investor. (Sect. 3) AIS Ch. 1 Sect 18, Ch.10 Sect. 1: professional / non-professional investors, eligible counterparties (Ch. 1 Sect. 19, Ch.10 Sect. 11) Investor compensation fund: only non-professional investors Classification of clients and agreements on it; information to be given to the client on the status as an investor Register by the FSA on professional investors Eligible counterparties: exceptions from certain intermediary duties In a contract relating to the provision of investment services, a securities intermediary may not employ a term that is contrary to proper practice or otherwise unconscionable for the client.

8. Eligible Counterparties An Eligible Counterparty (ECP) is an entity that is authorised or regulated to operate in the financial markets that is not given investment advice and belongs to one of the following categories: Investment firms, Credit institutions, Insurance companies UCITS and their management companies National governments and their corresponding offices, including public bodies that deal with public debt Central banks and supranational institutions If such clients are provided with investment advice, they will be treated as Professional Clients instead. ECPs receive the lowest level of protection under MiFID. Legal Aspects of Finance 5 8

9. 9 Customer Relations, cont. “Know your customer” (AIS Ch 12 sect. 3) the financial resources and experience Information on services suitable for the client Prevention of money laundering and funding of terrorism A securities intermediary shall execute his orders carefully and in the best interest of the client without undue delay. A securities intermediary shall aim at avoiding situations involving conflict of interests and, upon their occurrence, treat the client in accordance with proper practice. A securities intermediary shall treat his clients equally.

10. Legal Aspects of Finance 5 10 Systematic internalisers Advance announcement to the FSA They shall publish a firm quote in those shares admitted to trading on a regulated market for which they are systematic internalisers and for which there is a liquid market. In the case of shares for which there is not a liquid market, they shall disclose quotes to their clients on request. Investment firm which,on an organised, frequent and systematic basis, deals on own account by executing client orders outside a regulated market or an MTF

11. Legal Aspects of Finance 5 11 Systematic internalisers 2 Systematic internalisers shall execute the orders they receive from clients in relation to the shares for which they are systematic internalisers at the quoted price at the time of reception of the order. Systematic internalisers shall be allowed to decide, on the basis of their commercial policy and in an objective nondiscriminatory way, the investors to whom they give access to their quotes. To that end there shall be clear standards for governing access to their quotes. Systematic internalisers may refuse to enter into or discontinue business relationships with investors on the basis of commercial considerations such as the investor credit status, the counterparty risk and the final settlement of the transaction.

12. Legal Aspects of Finance 5 12 Post ‑ trade disclosure by investment firms Investment firms which, either on own account or on behalf of clients, conclude transactions in shares admitted to trading on a regulated market outside a regulated market or MTF, shall make public the volume and price of those transactions and the time at which they were concluded. Declaration of suspicious transactions to the FSA (SMA Ch. 14 Sect. 5) –Transactions suspected to include insider trading or market manipulation

13. Legal Aspects of Finance 5 13 Investment services Purchase, sale, transfer and subscription of investment targets in one’s own name on behalf of another; brokerage on or execution of orders for investment targets (securities brokerage) submission and publication of binding bids and offers in investment targets continuously or on request under a contract concluded with a marketplace or an issuer; public trade in one’s own name based on such contracts (market making ) submission of binding bids and offers in investment targets, their publication and notification to investors and trading in them on one’s own account (securities dealing )

14. Legal Aspects of Finance 5 14 Investment services, cont. management of investment targets under a client-by- client contract in which decision- making power has been granted to the contractor (asset management) Investment advice Issue of subscription commitments in connection with the issue of a security or the conclusion of a derivatives contract (emission guarantee) acquisition of subscribers for investment targets or arrangement of their subscriptions (emission arrangement)

15. Corporate Finance services relating to issues of securities: Emission arrangements / guarantees venture capital mezzanine instruments: preferred stock, subordinated loans, options, convertible bonds company restructuring syndicated loans securitization Arranging long term financing Legal Aspects of Finance 5 15

16. Securitization http://www.investopedia.com/terms/s/securitization.asp http://www.investopedia.com/terms/s/securitization.asp An issuer creates a financial instrument by combining other financial assets and marketing different tiers of the repackaged instruments to investors. The process promotes liquidity in the marketplace E.g. mortgage-backed securities: –combining mortgages into one large pool –dividing the large pool into smaller pieces based on each individual mortgage's inherent risk of default –smaller investors can purchase shares in a larger asset pool (portions of a mortgage) as a type of bond. Without the securitization of mortgages, retail investors may not be able to afford to buy into a large pool of mortgages. Legal Aspects of Finance 5 16

17. Legal Aspects of Finance 5 17 Mezzanine and restructuring Mezzanine –subordinated loans –options, option loans –convertible bonds –preferred stock Restructuring –mergers –diffusions –share / asset deals, takeovers –LBO, MBO

18. LBO (Figure from Wikipedia) Legal Aspects of Finance 5 18

19. LBO, cont. A leveraged buyout (LBO) is when a company or single asset (e.g., a real estate property) is purchased with a combination of equity and significant amounts of borrowed money, structured in such a way that the target's cash flows or assets are used as the collateral (or "leverage") to secure and repay the money borrowed to purchase the target-company/asset. Since the debt (be it senior or mezzanine) has a lower cost of capital (until bankruptcy risk reaches a level threatening to the lender[s]) than the equity, the returns on the equity increase as the amount of borrowed money does until the perfect capital structure is reached. As a result, the debt effectively serves as a lever to increase returns-on-investment.seniormezzaninecost of capitalbankruptcycapital structure (Wikipedia) Legal Aspects of Finance 5 19

20. MBO A transaction where a company’s management team purchases the assets and operations of the business they manage. A management buyout (MBO) is appealing to professional managers because of the greater potential rewards from being owners of the business rather than employees. MBOs are favored exit strategies for large corporations who wish to pursue the sale of divisions that are not part of their core business, or by private businesses where the owners wish to retire. The financing required for an MBO is often quite substantial, and is usually a combination of debt and equity that is derived from the buyers, financiers and sometimes the seller. (Investopedia) Legal Aspects of Finance 5 20

21. Basics about Finance Equity, Debt capital, Mezzanine (e.g. capital loan, preferred stock) Forms of finance differ in four respects: Right to control Owners: yes – preferred stock, capital loan and other creditors: no Mandatory yield Equity and capital loan: No - debt capital: Yes Determination of yield Debt and capital loan: fixed - equity: variable Position in the order of payment in liquidation 1) creditors – 2) capital loan creditors – 3) owners Legal Aspects of Finance 21

22. Investment Firms 3 manage share issues, acquisitions, mergers, and general accounting and financial consultation. Investment banking fixed-term, equity-based investment in SMEs not listed on the stock exchange but with good growth potential. convertible bonds, bonds with warrants and mezzanine financing at the end of the term, the venture capitalist’s investment is realised: selling his or her shares to other company owners / acquiring new owners / listing the company on the stock exchange. Venture capital investors Legal Aspects of Finance 5 22

23. Legal Aspects of Finance 523 Investment banking Emission arrangement services relating to issues of securities Emission guarantees subscription commitments (underwriting ) asset management decision making power with the contractor

24. Legal Aspects of Finance 5 24 Roles of an investment firm issuer Issue of securities InvestmentfirmInvestmentfirm subscriber emission arranger emission guarantor roles agent financier

25. Legal Aspects of Finance 5 25 Emission arrangement Issuer investors Emission arranger No contractual relations (if authority from the issuer)

26. Legal Aspects of Finance 5 26 Liability norms relating to the roles Authorized agent of the subscriber (contractor) norms on commission contract (agency) (KK Ch. 18) Emission arranger norms on disclosure duties on securities markets contract law norms on commission contract Emission guarantor liability norms on the contractual relationship

27. Legal Aspects of Finance 527 Syndicated loans / emissions Managing underwriter –concludes the contract with the issuer as an agent of the group divided syndicate contract –responsibilities of the members selling group –marketing

28. Legal Aspects of Finance 528 Contracts Emission arrangement / syndicate the arranger is responsible for following the official norms contents of contracts –mutual liabilities –indemnity: exemption of the agent from e.g. disclosure liability SYNDICATE