FINANCIAL LAW AND LEGAL REASONING

UNIT 1.5

EU Sources are striving for harmonization

1. Cross Sector Issues: go beyond traditional banking, securities market and insurance and would be
the banking union or capital markets union. Banking Union is the idea to create a levelled playing
field for banks operating in the EU no matter where they are located. The same goes for the capital
markets union but contrary to the banking union, the capital markets union is much less developed.
It deals with anti-money laundering, financial crime prevention, shadow banking (there are players,
particularly in the securities area, that will carry out bank like activities but are not licensed as such
which leads to challenges in this area such as regulatory arbitrage. It will also cover international
areas such as European Supervisory Authorities.
2. Financial Institutions: focus on banking institutions, particularly regulatory capital but also bank
structural aspects meaning Basel framework (capital requirements directives CRD and capital
requirements regulation CRR). We also will address insurance, occupational pensions, financial
conglomerates.
3. Financial markets: in the broader sense with a focus on securities regulations, specific regulations
such as the one dealing with credit rating agencies but there will also be in the area of a much
broader securities regulations, the so-called markets in financial instruments directives (MIFID) or
MIFIR. In general terms, all the structural aspect that we find in the banking side in the CRD, CRR,
will be covered on the securities side in MIFID and MIFIR. They have also dedicated frameworks
that restrict or prevent short selling and we also have product targeting regulations such as the one
targeting investment funds (UCITS). In the area of financial market infrastructure, we have the
EMIR (European market infrastructure regulations) which helps when dealing with derivatives
structures.
4. Consumer Aspects: everything that addresses the retail client (the one that is in need of investor
protection, is not knowledgeable and does not operate on a professional basis). It will also address
payment services, deposit guarantee schemes or investor compensation schemes. All these points
are EU initiatives to harmonize consumer services so that consumers/investor would not be
differently treated in different EU countries.
5. Financial Growth: broader economic incentive to regulate in relation to long term financing,
infrastructure financing (alternative means of financing like crowd funding as well).

When talking about banking and financial law, EU defines banking and financial law as being the business of
lending money and raising fund from the public (core bank activities). In order to contract banking
activities, you have to have a license and this license is important for insuring that the bank or financial
institution has the necessary qualifications to contract the service (distribution of financial products to the
public) and insures a monitoring exercise to prevent any threats to the financial stability. Regulated activity
is the core, from birth to death of an institution.

In the beginning each MS may or may not have had domestic rules which contradicted the principles of EU
financial market, namely there was no homogeneous application of the rules and EU law was only applied
in small, highly regulated markets. It took a while to get all MS willing and accepting that EU law was not
only superseding domestic law but also a EU market was for their respective benefit.

First EU directive dealing with banking law was in 1977, but it was not precise enough in terms of content
yet and therefore MS had the possibilities to circumvent the rules.
12 years after was the Second Banking Directive which was a game changer because it introduced the
“European Passport”. The European Passport is a key principle in EU law in banking and securities
regulation in the area of investment funds, so it is easy to distribute an investment fund in another MS as
long as the passport requirements are met.

Only certain activities can be passported! Activities that are regulated hence licensed in various MS. We
need to have a minimum regulatory level in each MS and the willingness of MS to recognize MUTUALLY
those domestic regulations. If we have comparable regulations between the states that want to apply this
passporting, ideally on the basis of EU law, there is the likelihood that national competent authorities in the
host country and home country MUTUALLY recognize the regulatory standards.

Basically 2 things, only certain activities can be passported:

 Dedicated activities which are subject to mutual recognition and are REGULATED
 Activities which are: acceptance of deposits or other repayable funds ▪ lending, including (inter alia)
consumer credit, mortgage credit, factoring, with or without recourse, financing of commercial
transactions (including forfeiting) AND MORE

Example: three conceptual pillars

We have to have the requirement that there’s a dedicated activity which is regulated. Second one, this
activity is mutually recognized.

Austrian entity will approach Austrian regulator with the request of distributing a product in Ireland.
Austrian Regulator will be in communication with Central bank of Ireland for the intent of passporting a
fund. Cooperation between home and host country authorities. If requirements are met, Irish authorities
will approve the request, unless serious concerns for the operations or risks, then there may be revocation
of license.

Austria must regulate investment funds and the same must apply in other countries. If everything is
properly regulated, Austria will distribute the fund while also controlling its operations and carrying the
liability for it (if an accident happens it is the Austrian who will deal with the issue or Ireland can stop them
from further distributing the product via banks etc.). We always have authority communication.

Distributing a product in another country: opening a branch or an office in the other country.

In order to achieve this level of harmonization, we have regulatory frameworks that apply. Some of these
initiatives is the Lamfalussy report (and after the de larosière report):

 This framework still shapes the EU regulatory: the 4-level process

 Level 1: General regulatory framework: can regulate hedge funds, can be in the area of AML, can
regard capital requirements. As the name indicates, it talks about a framework, so it is based on a
co-decision process (EU commission, parliament, etc) and it’s the start of a compromise.
 Level 2: typically, delegated regulations or delegated directives which means they help to
implement the technical details within the set-out framework. (Specificities in a framework).
 MS transpose level 1 and level 2 into domestic law.
 Level 3: the European Banking Authority further calibrate the standards derived by the regulatory
framework (further harmonization)
 Level 4: joint regulatory actions to make sure that EU law is more effectively enforced across MS.
This is important because it shows how the other levels relate to each other.

De Larosière Report
Ater the financial crises, a High-Level Group provided a report to assess and review regulatory frameworks
for the EU and they came up with the 3 Step Approach:

 Reshape the regulatory agenda: more regulation in place, stronger supervision, trigger for the
establishment for the European Supervisory Authorities (ESA), effective crisis management
procedures.
 Creation of the European System of Financial Supervision (“ESFS”) which consists of European
Banking Authority (EBA) - European Securities and Markets Authority (ESMA) - European Insurance
and Occupational Pensions Authority (EIOPA) plus European Systemic Risk Board (ESRB)
 Regulations better than Directives (no more recommendations because not everybody adheres to
that)

From the De Larosière Report we have a new architecture called the Single Supervisory Mechanism (SSM),
which targets practical paradoxes meaning on one hand, thanks to the passport, we have a somewhat
integrated market for credit institutions (you can easily cross the border) but on the other hand we have
the difficulty that supervision per se remains fragmented within the boundaries of each MS.

Consequently, the Austrian Supervisor can only supervise in Austria.

This is seen as a paradox.

The SSM was born to harmonize Supervision. To do so we have differentiated between significant
institutions (SIs) and less significant institutions (LSIs). SI are the large banks while the LSI are the mid-small
banks. This is important because the SIs are directly supervised by the European Central Bank (ECB) and not
the Austrian supervisor, so there are the same supervisory standards applied.

The LSI are supervised by the national competent authorities (FMA in Austria, CSSF in Lux).

SSM is part of the “Banking Union” (WE START TALKING ABOUT A BANKING UNION) which also includes the
Single Resolution Mechanism (SRM) (the winding down of a bank) and the Common Deposit Guarantee
Scheme (CDGS). SSM is still an ongoing implementation.

Institution is considered a SI based on the following criteria:

 total value of assets exceeds EUR 30 bn

 or the total value of assets exceeds 20% of the national GDP and the total value of assets exceeds
EUR 5 bn
 or the national supervisory has notified the ECB that the credit institution is significant in terms of
the country’s national economy and its significance has been confirmed by the ECB
 moreover, a credit institution can also be classified as an SI by the ECB based on its significant cross
border activities
 any receipt of direct assistance from the ESFS or the European Stability Mechanism (ESM) leads to a
classification as an SI
 the largest three banks in every Eurozone-MS are classified as Sis

UNIT 2

INTRO TO CAPITAL MARKETS

Capital markets are important because when we are talking about financial regulations, we are covering
banking and securities markets and a general intro to capital markets.
Capital markets are important for financing needs, speculative activities, investments conducted via capital
markets and most importantly capital markets are a sub segment of the financial market. PROMOTES
ECONOMIC GROWTH. We differentiate between money market and capital market and credit market: the
capital market is mid term nature which means its not necessarily always covering super liquid assets on
capital markets.

Various types of financial instruments: securities (the most widespread asset traded on capital markets).

Advantages of securities: they tend to be liquid, easy to transfer, we can easily determine the value of a
respective security because we talk about securities traded on stock exchanges or any sort of market
infrastructure (transparent securities, nothing exotic and nothing speculative).

We talk about equities, bonds, derivatives, money market instruments and units of investment funds.

From a regulatory perspective, a financial instrument is not always a security, but a security is always a
financial instrument.

Securities and Market Regulation:

Banks and insurance companies are active on capital markets but are treated as market participants in this
sub segment. This is important because there are specific rules for banks when they act on capital markets
for ex portfolio management activities, same thing for insurance companies and pension funds (there are
additional protective measures in place to ensure retail clients are well protected).

How capital markets emerge: with stock markets, an aggregation of buyers and sellers of stocks ▪ on a stock
market typically securities (that are listed) are traded (publicly). Everyone can buy and sell there.

Difference between stock market (which is a general aggregation) and liquidity stock exchange (which is the
place or organization by which stock traders typically companies or people can trade stocks). From a
regulatory perspective we focus on the stock exchange because in order to run one you need a license.

Trading stocks means transferring money for the respective stock, easy to transfer either physically or
electronic.

Participants can be retail investors, institutional investors and publicly traded corporations, insurance
companies, pension funds therefore the regulatory concept is to create a fair, level playing field between all
the participants.

From a regulatory perspective, it is important to understand stock market as a trading venue:

 facilitates the exchange between demand and supply of transferable securities (see MiFID
framework)
 increase the liquidity of market
 quality of exchange – professionalism (incl. authorisation of dealers)
 regulated exchange (incl. authorisation of traded instruments), special approval needed

Everything traded is captured by regulations.

The regulation of stock exchanges came into the spotlight of EU legislation because it was considered
inefficient that each member state would have a stock exchange and they wanted to harmonize it under
the general dogma of the free movement of capital. We have integrated EU Regulatory Framework but
there is still Domestic Supervision.

ART 44 MiFID II: stresses that regulated market as part of the stock exchange would be a reserved activity
therefore a licensing requirements exists. Without the approval of the regulator, you cannot conduct
business. The domestic country has full responsibility in assessing company structure, the system that are
in place, the organization structure, and regulations would specifically rule the operations and organization
of the operator.

Responsibility of the operator: responsible for the correct functioning of the market and has to have
continuous oversight; have the authority to withdraw authorization and needs to have good reputation,
knowledge and skills to perform his job (fit and proper). Liability: the operator needs to ensure that only
admitted financial instruments are listed and traded and is traded fair, orderly and in an efficient manner
and freely negotiable.

Any financial instruments which are publicly listed require the Prospectus.

Prospectus: document which has the task of disclosing any characteristic of the financial instruments and
gives you a non-technical manual which provides you with the insights of the respective security or financial
instrument.

The Prospectus is a legal document and therefore has an EU Directive which deals with the content of the
Prospectus, the liability, etc. This is important for 3 reasons: making sure the investor has all the
appropriate info, should put the investor in the position of taking an informed decision, all the info is laid
out there as it is a means of consumer protection.

Pressure on the issuer of a security to provide accurate and correct info for the prospectus otherwise you
can be sued.

There are other means of transparency such as Key Info Documents and fact sheets, etc. All of them can be
used but all of them have to relate back to the Prospectus: full consistency between these documents and
the prospectus. If there are any significant changes you are obliged to amend the prospectus accordingly.

The admission to a stock market is a complex thing:

The company needs to take the decision to take the company public because from a corporate law
perspective you have to get necessary legal approvals to move to the listing process.

Financial entities are the ones that are facilitating the listing: investment banks, law firms, accounting firms
which are there to support the issuing of the security and the admission to the stock market. They are
acting as arrangers.

Arrangers make sure securities are listed on the regulated market and drafting of the prospectus and its
subsequent submission to the authority for approval.

(financial) activities of arranger: “underwriting”: the activity of helping the respective company to go public.
There are different kinds:

 firm commitment underwriting: the underwriter (typically the investment bank) would purchase
the securities from the issuer for an agreed price.
 best efforts underwriting: underwriter makes best efforts (promises) to sell securities of the issuer.
 standby underwriting: issuer offers securities, with the commitment of the underwriter to purchase
remaining securities which are not purchased.

The admission to the stock exchange and offering of securities to public has been subject to harmonization
at EU level for almost 40 years.
The EU Regulatory framework tends to follow a granular or evolving approach: there is one regulation that
covers everything and it gets updated when necessary, depending on the necessities of the market.

Listing Particulars Directive: the admission of securities to official stock exchange listing and on information
to be published on those securities.

Prospectus Directive: prospectus to be published when securities are offered to the public or admitted to
trading.

Transparency Directive: secondary

Listing Directive: refers to the listing process, therefore we have a minimum standards how the listing of
securities has to be conducted on a domestic level, EU framework; no other admission to official listing on
any stock exchange in the MS and requirement that all issuers of securities to be admitted to official listing
are subject to the Directive.

Shortcomings of the Listing Directive: when it comes to liability we are not fully harmonized and tort law
remains national law, so specificities of liability regimes are subject to MS contract law.

Prospectus Directive: essential. Duty to duly inform the public about the financial instruments, either for
shares or bonds, and ensuring that investor is duly informed about the specific risk. Prospectus is important
because the more information available, the closer to fairness are the prices of securities, more realistic.

From a legal perspective, the Prospectus is the document that ensures the proper level of investor
protection and the Prospectus has to contain all information which, according to the particular nature of
the issuer and of the securities offered to the public or admitted to trading on a regulated market, is
necessary to enable investors to make an informed assessment of the assets and liabilities, financial
position, profit and losses, and prospects of the issuer and of any guarantor, and of the rights attaching to
such securities.

The Prospectus is a contract.

The Info that the Prospectus should contain has to be brief manner and in non-technical language,
convey[s] the essential characteristics and risks associated with the issuer, any guarantor and the securities,
the language in which the prospectus was originally drawn up. Whatever you put in a Prospectus has legal
implications, the information needs to be correct otherwise you would be liable.

It is standard practice to have an investment advisor.

Exception when you do not need a prospectus: professional investors because they act in a professional
capacity anyway, so you do not need to explain the basics anyway, or if offer of securities whose
denomination per unit amounts to at least € 100,000 because it means the person knows what they are
doing.

Two cases always require a prospectus:

 actual promotion of an offer of transferable securities to the public (“offer to public” as trigger
which is wider than “contractual offer”).
 admission of transferable securities to an EEA regulated market (European economic area).

If we do not meet these criteria, then criminal law applies.

Prospectus has an EU Passport: we can issue a security in Austria and distribute it and offer it to an investor
in Germany, German Authorities will ask for the respective Prospectus plus any other domestic
requirements which need to be added (often in terms of Tax law).
The Dogma of Market Integrity: when talking about financial markets, we have different interests that we
have to cover.

Retail investors need protection while professional ones do not.

You commit a crime when you commit insider trading: capitalizing (ACTING for your own benefit) on insider
information not available to the general public or dealing with market manipulation which means that you
are trying to influence the development of the stock price. Both are considered crimes; therefore, criminal
law is involved.

Market manipulation: fake news (information based, public exposure needs to be done through lawyers
when you are an important and powerful person) or large order, etc. (transaction based).

Market Abuse Regulations are always trying to be up to speed with the new developments of the markets.

 “insider” as any person who possesses that information as a result of a) being a member of the
administrative, management or supervisory bodies of the issuer; b) having a holding in the capital
of the issuer; c) having access to the information through the exercise of an employment,
profession or duties; or d) being involved in criminal activities
 “inside information” is information “of precise nature” which has not been made public and that
relates “directly or indirectly, to one or more issuers or to one or more financial instruments” Info
that may have an impact on a financial Instrument

Purpose of disclosure of inside information: guarantee that “inside information is made public in a manner
which enables fast access and complete, correct and timely assessment of the information by the public”

UNIT 3

CONSUMER PROTECTION

Consumer protection is linked to providing information and we tend to exclude certain groups from certain
market segments. We have a combination of various tools: if we exclude already certain participants, then
we do not have to worry about them burning their hand in a particular market segment but if they are
allowed to operate in another market segment, there info available so they can inform themselves.

Categorizing clients is essential: study background and certificates possessed, work experience, funds
available (what is the overall portfolio of the individual, if they have 1 million and they want to invest it all
clearly we can assume they have the means and are in a position to invest), from a regulatory perspective
we take a quantitative threshold where we assume that even if a qualified retail investor with disposable
income can read the prospectus and can act in their self-interest.

Notion of consumer protection is multi-faceted, and we are trying to apply tools to protect the different
categories of investors and market participants in a different set up.

Who takes care of the respective needs/protection? We have an average investor: fictional!! With
minimum requirement such as having standard education, reading, writing, basic math, understand some
charts. From a regulatory perspective, the average investor is who you could be expecting as a
customer/investor. From this you build specific documents and Info such as Prospectuses. In addition to
this, to protect the investor, financial institutions have the obligation to categorize the clients (bank,
insurance company, investment firm, etc.). They will ask you some general question and based on the info
provided they will have a first assessment. In addition, according to EU regulation, financial institutions are
possibly liable for any miss-selling of financial instruments.

For a standard retail investors, only certain categories of products are available.

In order to avoid a lawsuit as an advisor or fiduciary, you have to have written proof that you have
educated the investor properly and they have signed off the documents stating they were aware of the
risks, you may be off the hook.

Advantages:

 right of customer to disclose information so that they can make the best possible educated decision
 higher reputation (trust based), demonstrate you care about your clients

Disadvantages:

 not opening product range for a certain type of investor and tend to harmonize the products with
the same features for a type of client (diversification not much?)
 administrative: higher costs (creation of prospectus, administrative system behind)
 no guarantee that with the respective level of protection we prevent future crises

Regulatory Concept of Consumer Protection

Professional Institution who has a business relationship with the client (contract law is the starting point
since we have 2 parties, seller and buyer).

Principle of party autonomy (“free choice what and with whom to contract”) but also caveat emptor → “be
aware, purchaser” (purchaser must investigate, check terms of conditions of sales contract), make sure as a
client that you know what you are getting into.

Financial Regulation intervenes and regulates (restricts) the freedom to contract.

Protect the weak: the consumer who is more exposed to the risk, mitigate such risk.

Regulatory concepts in place:

 Unfair terms Directive: avoid the use of unfair terms, terms that the weaker party might not
understand and that can be used to the detriment of the consumer.
 Markets in Financial Instruments Directive (MiFID): applied in EU financial markets. 2 MIFID
frameworks: the first one is the original MIFID I framework which had been transposed into
domestic law in 2007 and after global crisis it got completely revised which led to the MIFID II
framework. MiFID framework as comprehensive EU framework in consumer protection because it
applies to banks (banking law), encapsulates capital markets law and also deals with insurance
distance.
 PRIIPS framework: Packaged Retail Investment and Insurance based Product: distributed to retail
public where we have any kind of insurance underlying. It is important because it’s a framework
that tries to improve information delivery by requiring basic information document (Key
Information Document) for such retail investment and insurance-based products (mutual funds,
structured products, insurance policies) so that consumers know what its all about.

In most set ups there are bargaining power imbalances: the bank or investment advisor, broker has a better
knowledge than the client, which is where the Unfair Terms Directive comes from. The first step is always
to identify the consumer.
Based on contract law we can end up in a situation where the consumer is unduly and detrimentally
affected by the contractual structure. The consequence is to make the term not binding on the consumer,
provided that the consumer has not individually negotiated (this proves power and If not individually
negotiated it proves a power imbalance since there was no influence from the consumer on contract).

Consequence: a term is not binding upon the consumer provided the term has not been individually
negotiated and it is “contrary to the requirement of good faith” while, in its wake, “it causes a significant
imbalance in the parties’ rights and obligations arising under the contract, to the detriment of the
consumer”.

The Unfair Terms Directive was important also because it laid the ground for core objective assessment of
contracts, the means of interpretation of contracts (language of contract shall be plain, intelligible and
when interpreted in the most favorable way for the consumer).

Unfair term leads to non-binding provisions.

Aside from negotiations where supplier and consumer are physically present (i.e. bank branch), the
consumer may end up in a more delicate position ending up in “distance” negotiations: frameworks in
place to protect the customer.

 MIFID II: first EU regulatory framework that in a broad manner goes beyond pure contractual
means and into consumer protection (the Unfair terms Directive did not perfectly match the
challenges of Investment products that are complex in nature, and you cannot define without
complex words)
 Investment Services Directives: before MIFID, had shortcomings, generic terminology

With MIFID II we categorization of clients:

 professional clients (those that have experience, knowledge and expertise to make their own
investment decisions and able to properly assess the risks, regulatory confidence they can take care
of themselves, can fall back to retail, expand your product range at your OWN RISK)
 retail clients (standard client, MAXIMUM LEVEL OF PROTECTION AVAILABLE)
 eligible counterparty (intra bank business, no level of protection)

We also have a very strong focus on the organizational and governance structure of Investment firms (still
in capital markets) and the consumer protection regulation requires minimum organizational and
institutional requirements such as:

 capital requirements (enough resources, domino effect in terms of liquidity shortages should be
reduced)
 management requirements / internal control system / documentation (typically comprising of at
least 2 directors, 4 eye principle)
 principle of proportionality (you have to find an organizational structure appropriate to the product
that you are selling, the complexity of the operation and size of your business)

If you set up your company according to corporate law requirements (joint stock company, limited liability
company, etc.), you have to have a managing director to apply a duty of care.

The activities that these Investment firms can conduct are called investment services. Another means of
protection is to specify what these entities are allowed to do:

 list of services that can be offered, particularly portfolio management, this way authorities can
intervene appropriately.
 they have to obtain licensing requirements
Rules how to treat clients:

Investment firm has to act “honestly, fairly and professionally in the best interest of its clients”.

Yu have to prove that you acted in a fair manner and in the best interest of the client.

If you misconduct you are confronted by a liability claim: you may be sanctioned by the regulator and/or
get a fine. You may also be confronted by lawsuits with reputational issues, monetary impacts (dealing with
attorneys is expensive), revocation of license.

Information to clients has to be “fair, clear and not misleading” (example: if you take a chart of historical
data of a good period, it may be misleading on the actual performance of the product).

We also could have conflicts of interest: they emerge in every trade or transaction; the interest of the seller
is to get the highest price while the buyer wants the cheapest price. Some products may be pushed more
than others.

investment firms have to identify conflicts of interest, manage them and – if necessary – disclose them
because in the end investment firms have to “best execute” the instructions of the client so that his
interests cannot be affected (reg. costs, prices, timely execution etc.)

MiFID II has a particular emphasis on product governance and the target market for the product: I issue a
structured product and say my target market is the retail client. I have to demonstrate that the feature of
the product meets the requirements of the general public or the level of consumer protection.

UNIT 4

Whenever we talk about banking business, there are a few developments that shaped the banking
business. First, in ancient times, even as far as the Bible, there is a section of money changes. Whenever we
talk about Finance there is a link to industry or trading balance (commercial and trading activities). In Italy
the most powerful banks are linked to the church. Finances of the roman catholic church paved the way for
modern finance.

Banks face challenge of insolvency since they only hold a fraction of the sums received in deposit available
for retrieval by depositors. So, we have more money outstanding than in hold and therefore the biggest
threat for any banking institution if there is a major influx of clients wanting to withdraw big sums of money
(that would be called a bank run).

To balance out this problem there are 2 requirements: 1. What is the sufficient level of capital that the bank
has to hold (12 to 14% now) and proper risk management in place.

The more risks the more granular the risk management.

Distinction between risk and uncertainty: something is not considered a risk but only as un uncertainty until
it happens in which case it shifts closer to the mean in the probability distribution and is therefore
calculated as a risk. Plus banks in different countries are interconnected (the banking business).

Risk of bankruptcy: first you capitalize on whatever is left, basically liquidating everything that is left.

Banks are doing credit business so that is why the bank is a credit institution: through peoples savings
account they are able to lend, providing liquidity: liquidity transformation, maturity transformation, credit
transformation.
Even conservative money (pension money) is regulatory captured by very strict rules to avoid falling into
traps.

Granting a loan is a significant risk for a bank, therefore the risk for the bank (the credit default, where the
banks experiences a loss or even liquidity constraints) translates in assessment of each loan on the basis of
a comprehensible risk analysis.

If bank does not grant the loan: crowd funding or crowd investing. There is also crowd funding regulation in
order to protect investor. If not crowd funding, then capital markets.

Banking activities are regulated and if they conduct banking business without such permissions or without
care for the regulatory framework, that becomes a criminal offense. A bank also has capital requirements
to be ready in case of a default or another crisis. They also need to have a variety of assets: there is a
minimum required of liquid assets (stocks and anything related to the money market). LOLR (land of last
resort): last resort for a commercial bank, Central bank bails you out but not always like Lehmann brothers.

Banks and other financial institutions have to get insurance coverage against potential losses meaning if
you deposit some of your money, you are granted insurance that you will get your money back: you pay
more to make sure you will be able to get your money back. Law of large numbers: if one person cannot
pay, you use the insurance premium to bail them out.

Finish UNIT 4 AND PART OF UNIT 5

UNIT 5

BANKING SUPERVISION

The Single Supervisory Mechanism (SSM) includes the Single Reservation Mechanism and Common Deposit
Guarantee Scheme. The function is to create transparency and harmonization and (simplify) in the EU
Banking. Apply same supervisory measures across the EU.

BANKING INSOLVENCY

Central banks of countries don`t always have the power to bail out a commercial bank. The concept too big
to fail concept needs to be reassessed such as the case with Lehman Brothers. But sometimes the country
cannot afford a big institution to fail.

Domestic laws apply to insolvency laws in MS, but an Austrian bank going bankrupt may cause spillovers to
other banks in other MS; protect and support banking institutions is the objective for every state in case of
bank insolvency.

It is a court decision that sends a bank into insolvency, regulator does not have the competences to send
an institution into insolvency. Numerous cases in the financial sphere where courts denied bailout. No
means to deal with them. Central banks of countries don`t always have the power to bail out a commercial
bank. The concept too big to fail concept needs to be reassessed.

3 pillars of insolvency framework

The EU response was to introduce a new framework: BRRD (Bank Recovery and Resolution Directive): New
framework introduced by EU, on a cross border basis where they have introduced insolvency procedures
for financial institutions (we can deal with spillovers, one bank failing affecting banks from other countries;
new ways to wind down institutions (SRM); Deposit guarantee scheme! There is also the Single Resolution
Mechanism (SRM) where we have a standard mechanism of how to wind down a financial institution. There
Is also the Deposit Guarantee Scheme.
BRRD foresees that the national authorities (and in the case of the SRM, the SRB) are empowered to
intervene both by taking proactive action in respect to the credit institution, and by reacting when the
actual failure occurs.

BRRD should stave off any future likelihood that banks will fail in a disorderly manner. We are dealing with
macro prudential regulations: meaning continuous oversight of financial institutions in terms of systemic
risk. That´s why we have risk dashboards in place that are granular.

BRRD is aimed to safeguard the essential services and protect certain shareholders (contrary to the
traditional rule of maximizing creditor’s value). Avoid as much as possible to spend tax-payers money to
bail out speculators: tools in place to protect shareholders and stake holders.

BRRD applies to credit institutions, investment firms (subject to CRD legislation) and financial holding
companies in the EEA.

BRRD HAS 3 MAIN PILLARS

1. Recovery and Resolution Plans: is intended to work as a manual or guideline in case an institution is
failing (first you have to know what kind of business you are doing, different rules for different
businesses). With this kind of plan you are prepared for the various scenarios. You have to have a
document with the recovery plan to your specific situation and to submit it to the national
competent authority who then has to approve it. If the event is triggered then both you and the
NCA know what to do. Plan activated only in emergency. There also needs to be a consultation with
the resolution authority: they need to approve every step and they need to guide you through the
recovery. You are not taking any measure without the approval of the resolution authority
otherwise you are under the risk that you become liable for not considering the interests of the
stakeholders.

Banking supervision, Capital Market supervision, Insurance Supervision and Resolution authority.

2. If the situation deteriorates then Early Intervention Measures kicks in: the resolution plan also has
to include intervention measures that can only be triggered upon approval of the resolution
authority (this means the resolution authority has to classify you as a significantly deteriorated
institution). If this is the case Early Intervention Measures kicks in. Resolution Authority is cautious
about making public announcements in case it triggers a bank run and everyone panics and tries to
pull out their money from the deteriorated institution.
Selling off business units, make money wherever they can to avoid insolvency, fire management
and put trustees in their place (senior managers), the resolution authority looks for replacement
(they are part of the NCA). Make money wherever you can.
3. If measures prove to be ineffective, more extreme measures should be taken and Resolution and
Resolution Tools kick in: - the appointment of a “special manager” taking over the institution’s
management - the sale of the business or the shares of the institution without the prior approval of
the BoD or the shareholders, to a private sector purchaser - a measure whereby the assets and/or
liabilities of the institution at stake are transferred to an alternative entity - transfer of non-viable
assets to a “bad bank” - application of the “bail-in tool” (i.e. Conversion of unsecured claims into
shares or write-off) (transfer debt into equity (creditor turns shareholder), recapitalize the
institution). Good bank is a bridge institution where you transfer the liquid assets while the bad
bank is where you transfer the non-viable assets. Band bank is a separate legal entity.

PROTECTION OF THE DEPOSITOR

Deposit Guarantee Scheme: the depositor, the person who is putting money in the accounts in the bank, if
it adds 500 euros to the account it is not speculating. We have to make sure the financial institution
remains credible and trustworthy and every person who puts money in their accounts is assured to get it
back. The DGS is structured as a fund so it has to have the respective financial resources in place to cover
such default.

PROTECTION OF INVESTOR

Contrary to the protection of the depositor, the protection of the investor is treated differently. Investors
follow a different system than depositors, they are willingly taking a risk by investing. The regulations are
not a safe haven as with depositors.

UNIT 6

INVESTMENT FIRM (player in capital markets)

Is an operator of investment services and investment activities in relation to financial instruments. All needs
to be done in the context of financial instruments: stocks, bonds, derivatives, money market and
investment funds: they are all SECURITIZED (very strong securities component, real estate not a financial
instrument).

MIFID framework and IFD, IFR. They also have to have licenses.

Consequently, we're just operating in different areas in banking or capital markets dealing with securities
but at the end of the day they behave more or less in a similar manner line with the regulatory frameworks
namely that they have to adhere to CRD or MIFID framework and they have to obtain a license meaning like
obtaining authorization by a naturally competent authority. They have in both cases dedicated activities
and can cooperate on cross boarder level (they have the passport).

This is an aera with interplay between banking and investment business. The main infrastructure
investments are made through capital markets: pension funds, venture capital, direct investment, debt
financing, institutional investors, private equity. Everything is invested in capital markets.

MIFID framework is the regulatory oversight of investment firms. Behave in the interest of the client etc…

Everything that is distribution of a financial product is regulated.

Investment fund: all investors differ only in terms of units they are holding, pool of money collected from
different people then the fund manager invests the money according to the Prospectus and is responsible
for the pool of money. Investors do not have a say. Fund manager = Fiduciary, acts in the best interest of
everyone who invested and the pool of money.

If an investor does not like the investment style of the manager, he can get out and he gets back his initial
investment plus any increase made during, minus management fees and performance fees. THIS IS AN
OPEN-ENDED FUND (liquid fund so called security fund, can get out whenever you want AND IS EASILY
TRANFERABLE). (In a hedge fund you can get out maybe once a year for ex.) (that's why real estate is not a
security fund because YOU CANNOT EASILY TRANSFER IT.)

You store a security in a broker account electronically (easy to store).

Evolution of capital markets due to new technologies (high frequency trading, trading in nanoseconds), new
financial products (crypto assets like NFTs) and innovative forms of organization.

Core regulatory frameworks: MIFID or MIFIR which define investment firm as: “any legal person whose
regular occupation or business is the provision of one or more investment services to third parties and/or
the performance of one or more investment activities on a professional basis (increased duty of care, right
and orderly manner)”.

“Investment services” are services carried out by the investment firm in the interests of the client
(brokerage business) while “Investment activities” are carried out by investment firm in its own interest.

In terms of “portfolio management” you have to distinguish between

▪ individual portfolio management is the contractual relationship between a customer and a professional
(i.e. Investment firm) where the latter uses its expertise as an investment advisor for the investment of
securities and money of an individual customer.

▪ collective portfolio management: the investment firm acts as manager to a fund whose units belong to a
plurality of investors.

Investment Firm under MiFID are created similarly as a credit institutions when it comes to regulatory
requirements when it comes to Initial Capital and Authorization Process meaning an investment firm has to
hold minimum capital to ensure that the business has sufficient financial buffer to accommodate losses as
referenced to CRD.

Banking Union based on the Single Rulebook that gathers all the regulations that apply to all MS, to
minimize risks, harmonize. Banks have to adhere to such rules. Supervise banks across the EU and Eurozone
countries. Single Supervisor: ECB then NCAs, DGS, BRRD. Banking Union encompasses banking rules
applicable across EU.

investment firm needs a license, capital, minimum of 2 managers with the correct expertise, passport for
cross boarder activities (you need dedicated activities, mutually recognized)

REGULATORY FRAMEWORK FOR INVESTMENT FUNDS

Investment funds are “financial instruments”.

functioning of an investment fund

 cash contributions by (several) investors. Collecting funds from investors by an offer to the general
public (that’s why they are referred to as public funds), offer based on Prospectus and Fund rules:
gives you info on the manager, the risks limit, depository. It is a contract with the investor.
 investments are reflected in respective units/shares of the fund and investor becomes shareholder.
 fund invests the money in assets according to the fund rules which lay out the investment
strategies.
 investment conducted by professionals (i.e., licensed management company /ManCo).

Largest markets for Investment funds are Luxembourg and Ireland.

Public fund: thousands of investors so investors cannot influence decisions at all, that’s why there are fund
managers acting in a Fiduciary capacity.

Private fund: may have a single or low number of investors, investor can choose their preferred strategy
and dictates how fund should be managed., that’s why the fund manager acts as advisor.

2 professionals/managers: MANCO (management company) who has to have a contract with a custodian
because it cannot hold the funds itself and DEPOSITORY BANK (or custodian) who holds the assets in
custody. They ensure management and safekeeping of the assets.
UCITS (Undertakings for Collective Investment in Transferable Securities: collective investment, transferable
securities. These are securities funds and cannot invest in other assets other than securities. Traditional
investment funds and open ended funds (you can enter and exit the fund on a daily basis), very liquid
funds, suitable to retail investors. It needs to have a significant level of diversification as to minimize risk as
much as possible. It has the Manco and the depository bank (under Austrian law, both hold a banking
license, so they are credit institution). The relationship between MANCO and Depository needs to be
transparent vis a vis communication.

If MANCO becomes insolvent it is not a problem for investors: it manages money and not assets of the fund
company.

If custodian becomes insolvent, the shares are given back to the investor but cash is difficult to separate
from the cash of the depository bank or other cash buckets so it becomes an issue in case of insolvency.

Shares I can identify the ownership and cash I cannot.

Many changes during the years, constant updates.

AIF Alternative Investment Fund Manager Directive: same principles as UCITS, we have a manager
(alternative investment manager) and a custodian. The difference is that AIF go beyond traditional
investment funds meaning they cover also real estate, private equity, hedge funds. It goes beyond a
traditional securities fund. AIF is close ended funds (only quarterly or yearly redemptions meaning you
cannot enter and exit whenever you want but in specific times during the year). AIF are eligible for a limited
number of investors, so not exactly public funds. Higher level of risk and complexity. Before the GFC they
were not regulated so they are a result of the GFC, they realized after that they were a threat to the
financial stability. Contrary to UCITS, they have manager regulations: the regulator wants to know about
the institution that is managing the fund whereas in UCITS the product is the focus (because of all the
consumer protection). In AIF regulations refer to the financial stability instead. More reporting
requirements. AIFMD has to be seen in the context of related regulatory regimes: EuVECA (EU Venture
capital funds), EuSEF (EU Social Entrepreneurship funds), ELTIF (EU Long term investment funds). These are
important for the regulatory perspectives because you have to adhere to the basic EU regulation. ELTIF
here to fund infrastructure.

Authorization Procedure for the AIFM: different authorizations for different funds (ex different procedures
for EuVECA and ELTIF).

AIFM can make use of “EU Passport” but only for AIFs targeted at institutional investors.

Different target of investors: AIF can also be distributed to retail investors but targets more professional
investors.

UCITS and AIF are mutually exclusive meaning a fund can be one or the other but not both.

UNIT 8

Custody and Transfer of Money and Securities: banks have transformed their business models from
moneychangers to deposit-takers. Deposit-taking means accepting the monies from the public for purposes
of custody. Taking deposits is granting them to different accounts, electronically. There is no need anymore
for physical storage however we have Data protection issues, cyber security issues.

Claims of money depositors rank pari passu (which today typically means “equally without preference”).

 depositum regulare (“regular deposit”): deposits for safe keeping

  depositum irregulare (“irregular deposit”): deposits into a current account

From a legal perspective, they have different property rights. If you deposit assets in a bank, the bank does
not own the assets, but the bank can use the money. A bank holds your assets, but they are still your
assets. The bank will use your assets though so il faut a guarantee that you can get them back at any point
(with limits, you might not be able to get everything back at one time otherwise the bank may default).
Return equivalent property: you deposit 50-euro bill but you will not get back that exact 50 euro bill you
deposited: SAFEKEEPING FUNCTION; value you deposit will be kept the same.

how is your asset kept quality wise?

When holding securities in custody, the respective security will be returned with the same property rights
as it already belongs, without mixing them with others. In case of insolvency the securities will be returned
to who they belong to.

When it comes to money it is a bit different since you are putting all the money into one cash account (co-
mingling, put in one basket when for securities you have a separation of assets depending on who owns
them).

For money there is also money that belongs to the credit institution (there are requirements when it comes
to insolvency, they cannot separate their own assets from client assets so cash will be typically included in
the estate and the individual only has a claim against the estate meaning they get back only a fraction of
what they deposited).

They have been trying to harmonize custody laws, within MIFID and CSDR are trying to capture it, but it is
still a work in progress. So, it does not solve the issue, so we need to be aware of the risk.

You can have a chain operation when it comes to securities and money: in a securities custody chain with
multiple financial intermediaries between the client and the CSD, multiple laws may apply.

There are different sources of omnibus accounts (they may have UCITS in different omnibus accounts and
AIF in different omnibus accounts).

Separation is the most important thing: MIFID states the firm needs to make proper arrangements to
safeguard a clients assets.

Investment firms are not allowed to hold cash on behalf of clients other than cash in connection with the
provision of investment services.

Property law regulation is left to the discretion of the MS: different domestic laws, different domestic
regulatory framework.