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

2. Legal Basis
DIRECTIVE 2014/65/EU OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 15 May 2014
on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU
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)
REGULATION (EU) No 600/2014 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 15 May 2014
on markets in financial instruments and amending Regulation (EU) No 648/2012
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3. FSA Standard No 2.3: Standard on financial services agreements
Legal Basis, cont.
Act on Investment Services ( / 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
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4. Investment Firms 1 Invest in shares or real estate. 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.
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5. Insurance institutions
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
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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.
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7. Act on Investment Services (AIS) Ch. 10
Customer Relations
Act on Investment Services (AIS) Ch. 10
A securities intermediary shall conclude a contract on the provision of investment services in writing. The liability to conclude a contract in writing shall, however, not apply to a securities intermediary when he provides investment services to a professional investor. (Sect. 3)
AIS Ch. 1 Sect 18, Ch.10 Sect. 1: professional / non-professional investors, eligible counterparties (Ch. 1 Sect. 19, Ch.10 Sect. 11)
Investor compensation fund: only non-professional investors
Classification of clients and agreements on it; information to be given to the client on the status as an investor
Register by the FSA on professional investors
Eligible counterparties: exceptions from certain intermediary duties
In a contract relating to the provision of investment services, a securities intermediary may not employ a term that is contrary to proper practice or otherwise unconscionable for the client.
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8. MiFID main reforms and amendments
Taking care of investor needs and rational decisions
Prevention of criminal acitivities
Know your customer and give information
Professional / non-professional clients
Eligible counterparties
Classification of customers
E.g. systematic internalizers
Classification of investment firms / their business
Regulated markets / MTF’s / OTC’s
Classification of marketplaces
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9. Regulated market means a multilateral system
Regulated markets
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 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
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10. Multilateral trading facility (MTF)
Multilateral trading facility or ‘MTF’:
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 accordance with non-discretionary rules
in a way that results in a contract in accordance with Title II of this Directive
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11. Organised trading facility (OTF)
Organised trading facility’ or ‘OTF’
a multilateral system
which is not a regulated market or an MTF
in which multiple third-party buying and selling interests in bonds, structured finance products, emission allowances or derivatives are able to interact
in a way that results in a contract in accordance with Title II of this Directive
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12. Direct electronic access to a trading venue
An investment firm that provides direct electronic access to a trading venue shall have in place effective systems and controls which ensure
a proper assessment and review of the suitability of clients using the service,
that clients using the service are prevented from exceeding appropriate pre-set trading and credit thresholds,
that trading by clients using the service is properly monitored and that appropriate risk controls prevent trading that may create risks to the investment firm itself or that could create or contribute to a disorderly market
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13. Conflicts of interests
Investment firms shall take all appropriate steps to identify and to prevent or manage conflicts of interest
between themselves, including their managers, employees and tied agents, or any person directly or indirectly linked to them by control and their clients
or between one client and another that arise in the course of providing any investment and ancillary services, or combinations thereof,
including those caused by the receipt of inducements from third parties or by the investment firm’s own remuneration and other incentive structures.
Where organisational or administrative arrangements are not sufficient the investment firm shall clearly disclose to the client
the general nature and/or sources of conflicts of interest and the steps taken to mitigate those risks before undertaking business on its behalf.
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14. Best Execution
Investment firms shall take all sufficient steps to obtain, when executing orders, the best possible result for their clients
taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order.
Nevertheless, where there is a specific instruction from the client the investment firm shall execute the order following the specific instruction.
Obligation to execute orders on terms most favourable to the client (Best Execution rule)
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15. 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.
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16. 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.
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17. 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
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18. 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.
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19. Post‑trade disclosure by investment firms
Investment firms which, either on own account or on behalf of clients, conclude transactions in shares admitted to trading on a regulated market outside a regulated market or MTF, shall make public the volume and price of those transactions and the time at which they were concluded.
Declaration of suspicious transactions to the FSA (SMA Ch. 14 Sect. 5)
Transactions suspected to include insider trading or market manipulation
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20. 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)
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21. 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)
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22. Arranging long term financing
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
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23. Basics about Finance Forms of finance differ in four respects:
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
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24. Mezzanine and restructuring
subordinated loans
options, option loans
convertible bonds
preferred stock
Restructuring
mergers
diffusions
share / asset deals, takeovers
LBO, MBO
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25. Securitization http://www.investopedia.com/terms/s/securitization.asp
An issuer creates a financial instrument by combining other financial assets and marketing different tiers of the repackaged instruments to investors.
The process promotes liquidity in the marketplace
E.g. mortgage-backed securities:
combining mortgages into one large pool
dividing the large pool into smaller pieces based on each individual mortgage's inherent risk of default
smaller investors can purchase shares in a larger asset pool (portions of a mortgage) as a type of bond. Without the securitization of mortgages, retail investors may not be able to afford to buy into a large pool of mortgages.
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26. LBO (Figure from Wikipedia)
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27. LBO, cont. Legal Aspects of Finance 5
A leveraged buyout (LBO) is when a company or single asset (e.g., a real estate property) is purchased with a combination of equity and significant amounts of borrowed money, structured in such a way that the target's cash flows or assets are used as the collateral (or "leverage") to secure and repay the money borrowed to purchase the target-company/asset.
Since the debt (be it senior or mezzanine) has a lower cost of capital (until bankruptcy risk reaches a level threatening to the lender[s]) than the equity, the returns on the equity increase as the amount of borrowed money does until the perfect capital structure is reached. As a result, the debt effectively serves as a lever to increase returns-on-investment. (Wikipedia)
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28. MBO
A transaction where a company’s management team purchases the assets and operations of the business they manage.
A management buyout (MBO) is appealing to professional managers because of the greater potential rewards from being owners of the business rather than employees.
MBOs are favored exit strategies for large corporations who wish to pursue the sale of divisions that are not part of their core business, or by private businesses where the owners wish to retire.
The financing required for an MBO is often quite substantial, and is usually a combination of debt and equity that is derived from the buyers, financiers and sometimes the seller. (Investopedia)
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29. Investment banking; venture capital
manage share issues, acquisitions, mergers, and general accounting and financial consultation.
Cf. Commercial banking:
deposit and credit business
transfer of payments
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
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30. Emission arrangement Issuer Emission arranger No contractual relations
(if authority from the issuer)
investors
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31. 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
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32. Syndicated loans / emissions
Managing underwriter
concludes the contract with the issuer as an agent of the group
divided syndicate contract
responsibilities of the members
selling group
marketing
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33. 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
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