Assess The Value Of Standard Documentation In Int. Finance Markets And The Extent To Which This Can Act As A Substitute For Oversight and Regulation.
1. Introduction
The second half of the 20th century up until the beginning of the global financial crisis in 2008 it is undeniably regarded as being the most debatable era in the International Finance Law and regulation community[1]. More accurately, after World War II (mainly in the late 1970’s), due to rapid technological development, it has been noted an intense swift towards global deregulation and liberalisation of financial markets and banks, resulting in a “chaotic” regulatory environment[2]. Despite some supranational actions to achieve uniformity and legal predictability (i.e FSMA regime(UK)[3], Basel II, MAD, EMIR, CRD) a notable part of the wholesale and the Over-The-Counter markets remain in their strict sense, unregulated[4].
The present study to evaluate the significance and function of standard documentation utilized in undisciplined International Financial markets and the subsequent extent to which these pre-printed forms, as an inseparable part of self-regulatory regimes, can act as a replacement for Public official regulation (comparative analysis). It has to be noted, that financial practitioners, academia and regulatory/supervisors constitute crucial players in this advancement.
2. International Financial Markets: Definition and Subdivisions
The generic term Financial Market encapsulates the notion of an environment in which institutions and individuals can trade and invest on financial assets and manage risk in a sophisticated way[5]. Financial markets provide a well-defined and vigilant habitat for various types of organized transactions, enabling a legal formulation of agreements through contracts and claims. Reflecting the complexity of modern economic theory in a global environment, Financial Markets operate on various levels and are naturally subdivided on a wide range of types[6].
A predominant distinction arises between Capital and Money Markets. Capital Markets allow large-scale institutions to obtain capital through various mechanisms of long term financing such as issuing and trading securities, namely equity and debt[7]. These are further subdivided into primary (issuance) and secondary (trading) markets. The former enable organisations to issue transferable debt mechanisms, available to other investors within the market. Within the latter, such investors have the opportunity to claim and trade these securities and acquire profit or loss depending on their value fluctuations. Money Markets are wholesale markets within which financial corporations maintain liquidity in their larger scale transactions, acting as catalysts for short term financing[8]. Money markets are also divided into primary and secondary.
Another type of market, of crucial importance for international finance, is that of financial derivatives. The financial derivatives market provides a means of facilitating and managing risk through the exchange of derivatives such as swaps, options, forwards and futures, which can be classified as over the counter (OTC) and in exchange derivatives, the former accounting for the vast majority (84%) of the market[9]. A further option providing safety against credit risk are Credit derivatives, which did not appear before the late 1990’s[10]. In addition, Insurance markets provide further options for risk management including pensions and liabilities, creating a safer environment for customers and institutions[11].
Currency markets are wholesale markets which permit individuals and banks on a global scale, to buy and sell different currencies[12]. With the City of London being at the heart of international currency exchange, currency markets are responsible for approximately US$5 trillion worth of day to day transfer of credit[13]. Eurodollar markets constitute one of the most important types of international financial markets. Institutions are able to issue debt and credit in a currency not indigenous to that of issuance, often resulting in beneficial regulation for the financial product on hand (usually in the form of Euro bonds and Euro loans)[14].Finally, the Gold and Commodities Markets allow for the buying and selling of gold and commodities (oil, cotton, cocoa etc.) respectively.
3. Standard Documentation and its Significance
3.1 Standard documentation as a rule-maker
Standard documents are issued mainly by International bodies defined as Self-Regulation Organisations (SROs) to regulate. Even though no definition of self-regulation is approved globally, according to ICSA Committee “A SRO is a private non-governmental institution which performs industry, regulatory or public interest functions by establishing, monitoring compliance with[15], and enforcing rules in a particular financial market and the conduct of the SRO's members under the Securities regulatory authority”.[16] International Trade Associations as a “hybrid” type of SRO[17] provide self-compliance non-binding rules through their standard-based documentation terms attempting an integral legal framework especially for unregulated and OTC derivatives Markets, acting a “quasi-regulator”[18].SROs are still subject to government-imposed regulation up to a certain point[19]. Various International Trade Organisations have generated standard documents setting the main-skeleton corresponding to the needs of each different type of financial product.
As far as International loan market is concerned, the Loan Market Association(LMA) has published the Multicurrency term facilities, a pre-printed form related to Syndicated loans and leveraged finance loans[20]. Bonds issues are standardized by International bond and market association(ICMA) as emerged after ISMA and IPMA 2005[21]. The International Stock Lending Association (ISLA)[22] issued Global Markets Stock Lending Agreement (GMSLA), in order to unify stock lending markets. Regarding repurchase agreements (repos) and reverse repurchase transactions, the Securities Industry and Financial Markets Association (SIFMA)[23] created the Global Master Repurchase Agreement (GMRA) in 2000 setting the basic form for these transactions. The British Bankers Association (BBA) in collaboration with the Foreign Exchange Committee (FEC) have set standard rules for currency trading in international foreign exchange markets through the International Foreign Exchange and Currency Option Master Agreement (IXFCO)[24]. The most remarkable[25] among all is the International Swaps and Derivatives Association (ISDA)[26], which has established the bespoken ISDA Master Agreement[27] to standardise OTC derivatives trading[28]. It counts approximately 800 members in 56 countries and poses the highest standard in OTC globally[29]. According to many scholars it represents the best paradigm of what may constitute the new Lex mercatoria[30].
3.2 Assessment of standard documentation
Privileges for the parties as a result of the widespread use of standard documentation[31] include among others reduction in transaction costs and default risk, legal certainty and predictability, lower negotiation and drafting fees, as well as uniformity since traders due to its common use, are quite familiar with its terminology, hence speed and liquidity are promoted. This was the main idea when drafters shaped a structure so stern and flexible at the same since continuous modifications are possible in order to reflect the market practice.
3.2.1 Legal Safety, Predictability and Uniformity
While there is no official regulatory framework, the aforementioned trade associations equip the transactions in the relevant markets with uniformity through standard documents, thereby market confidence is achieved[33] and conflicts of laws due to regulatory discrepancies in different national systems are abolished[34]. They have been well thought and structured[35], therefore the transactions will be legally safer, as they do not give rise for individual considerations and at the same time essential variations are discouraged[36]. More specifically, predetermined terms provide predictability in the execution of the contracts. For instance, the parties will know in advance what are the legal and economic subsequences of the terms since they are identified, and even further they can predict the outcome of a trial if a dispute arises (legal certainty). The extended use of standard pre-printed set of rules will undoubtedly lead to more judicial decisions related to them and therefore more predictability, interoperability and consistency are ensured.[37]
3.2.2 Liquidity and Familiarity
For the financial markets to “thrive”, the securities that are to be traded must be liquid[38]. Liquidity means that securities keep on trading in a constant volume. Nevertheless, in the absence of unified terms, especially those related to rights and obligations[39] while having regard to the tremendous volume of business and speed of transactions as an inherent characteristic of financial Markets[40], parties will be detracted from trading certain types of securities[41] since they will not be able to transact them easily with legal safety and make a margin[42].
3.2.3 Costs-Time Saving and Risk Management
Financial contracts are complex, which means that their drafting is a costly, complicate and expensive process especially when peculiar financial instruments such as exotic derivatives or interest rate swaps are engaged[43]. In a non-uniformed legal environment, the parties are likely to explicitly negotiate every single term in the contract in order to better attain their individual needs. Negotiations and drafting mean that more lawyers are recruited, which is not efficient both in terms of costs and time for traders. Nevertheless, standard documents by setting a common legal environment, enable parties to fulfil standard terms without being required to conduct extensive elaboration, therefore they can deal in a more cost-efficient and fast way[44]. This uniformity subsequently leads to a massive saving of time and expenses taking into consideration that the parties don’t have to negotiate contracts from scratch.
The main purpose of the parties in the use of standard-based contracts, especially in the OTC unregulated markets, is to identify and allocate the associated risks underlying their transactions.[45] It has to be noted, that in case where peculiar instruments are traded there is an inherent unknown risk (systemic)[46] which cannot be identified and possible divergent terms incorporated in different documents would subsequently lead to unequal allocation of losses or even worse the whole may collapse. Nevertheless, the uniformity that standard documentation provides entails risk reduction since the similar terms agreed by the market participants, would lead to an equivalent exposure to the losses sustained[47]. The most prominent paradigm is the Master Agreement contract[48] which mitigates credit[49] and default risk[50] (insolvency) through the close-out netting[51] clauses by establishing a common framework within parties can terminate their contract as quickly and painlessly as possible[52]. However, it is crucial to bear in mind that standard documentation, no matter how well-drafted it is, deemed impossible to fit and cover every peculiar differentiation[53]. There is always a call for revision in order to reflect the market practice and the subsequent changes in novel products.
4. Oversight of Standard documentation
In recent years, market explosion and the subsequent demand for uniformity in financial cross border transactions have raised a significant debate as to whether self-regulatory rules could provide an efficient legal framework accommodating certainty and uniformity[54]. According to the IOSCO official report, the vast majority of market participants recognized than only those who are truly engaged with the trade usages should be eligible to provide sufficient rules or principles on financial regulation through the issuance of standard documentation[55]. It is worth noting, that self-regulatory rules occurred way before statutory legislation[56]. Nevertheless, the role of the SROs has been condemned by scholars and academics due to inherent lack of transparency, which is opposite to the public interest and their anti-competitive effects as part of their “lobbying” idiosyncratic feature[57].
4.1 Cost and Competence
Taking into consideration the complexity that financial market entails, specialized personnel is needed to efficiently regulate them. Subsequently, the process might turn out to be very costly, especially in complicated fields (such as derivatives trading) which cannot be obtained by an official governmental body[58]. Governments do not have neither such personnel nor the resources to hire them. Conversely, SROs can more cost-efficiently accomplish this task hence their members are sophisticated market players (industry professionals), who have already expertise and overview over the market practices[59]. Accordingly. since members are used in the process of formulating as well as interpreting the standard terms of the documents in question, the SRO as a “regulator” do not need to incur additional costs to acquire this technical knowledge, but this is not the case for governments. That being the case, enforcement and monitoring expenses are diminished and at the same time since their rules are not formal in their strict sense, compared to those issued by governmental entities, costs are even more reduced including those inferable to delay[60]
4.2 Adaptability and Continuous Revision
The International Financial markets, especially OTC markets, are constantly and rapidly changing, fact that raises questions as to whether public intervention in the rule-making process can act in a sufficient way. On the opposite, SROs as the front-line quasi-regulators are considered much more responsive and more capable of spotting and embedding new trends and innovations in these markets[61], because their members have a continuous overview over them[62], as they are market participants. Furthermore, the revision of a contract is practically easier and faster than the review of an official regulation[63], especially in a global level where different, often controversial jurisdictions involved thereby making harmonization almost impossible. However, the efficiency of this integration heavily depends on the conflicting interests between the SROs’ members, as they might want to promote their individual agenda[64]. Subsequently, this could lead to unexpected results, such as non-integral rules or even worse the frustration of a potential revision.[65]
4.3 Voluntary Adoption and Transnational Effectiveness
SROs through standard documents set rules governing a specific market, but they are not considered strictly a source of law therefore lacking legitimacy[66]. Their adoption depends on the intention of the parties to adopt these rules, raising questions regarding the uniformity and integrity of the markets. Conversely, the adoption of an official rulebook is difficult to be achieved because of the reluctance of national authorities to coordinate leading to unregulated regimes. Nevertheless, SROs through the participants’ voluntary compliance to the rules, uniformity is achieved, because the participants have a strong inventive to apply these rules, as they are more flexible and responsive to their needs[67]. Even more, the absence of a central and public rule book have led to the formation of rules coming from SROs, but it cannot be ensured that more than one recognized and well-respected organisations are not going to publish standard documentation for the same market or instruments, such as ICMA and SIFMA[68] for the international repos market, causing even more non-uniformity and endangering the stability of the markets.
5. Conclusion
Questions have been raised about how efficient self-regulation as a private regulator can be ensuring Market uniformity and interoperability since a number of morality scandals globally led to extended condemnations against the regime[69]. The absence of legitimacy, the lack of transparency and that of public accountability are only some of the reasons indicating that if self -regulation is used, vital decision should be made regarding the range of SROs’ powers and responsibilities as well as their surveillance and composition[70]. A possible solution could be the “model of cooperative solution”[71] between Governmental Authorities and SROs, namely a “shared scheme” to the regulatory system by maintaining an appropriate balance as regard the independence of SROs to develop their own schedule and their effective supervision[72]. Otherwise all the privileges associated with their operation will be abolished. It is hard to say where the line should be drawn.
6. References
[1] Ron Dixon and Phil Holmes, Financial Markets: An Introduction, (1st edn, Chapman & Hall, 1992) 2-3
[2] Morten Balling and Ernest Gnan, 50 Years of Money and Finance - Lessons and Challenges, (1st edn, SUERF 50th anniversary volume, 2003) ch 5, 157-158
[3] George Walker and R. Purves, Financial Services Law, (2nd edn, Oxford University Press, 2008) ch 16
[4]George Walker, International Financial Markets and Finance Law (Unpublished 2016) para 1.83
[5] Ibid para 1.62
[6] Peter Howells and Keith Bain, Financial markets and institutions (5th edn, Prentice Hall/Financial Times 2007) 262-264
[7] William M. Clarke, How the city of London Works (7th edn, Sweet & Maxwell 2008) 42-43
[8] Walker (n 3) para 1.62
[9] Deutsche Borse Group, The Global Derivatives Market: An Introduction (White Paper, 2008) <https://www.math.nyu.edu/faculty/avellane/global_derivatives_market.pdf
[10]Janet M. Tavakoli, Credit Derivatives and Synthetic Structures: A Guide to Instruments and Applications (2nd edn, John Wiley & Sons 2001) 10
[11] Clarke (n 6) 22
[12] Walker (n 3) para 1.56
[13] Monetary and Economic Department of Bank for International Settlements, Triennial Central Bank Survey: Global Foreign Exchange Market Turnover in 2016 (2016) Table 1 <https://www.bis.org/publ/rpfxf16fxt.pdf
[14] Clarke (n 6) 76
[15] The SRO Consultive Committee of IOSCO, Model for Effective Regulation 3 (2000), 6
< https://www.iosco.org/library/pubdocs/pdf/IOSCOPD110.pdf
[16] International Council of Securities Association, ICSA Emerging Markets Committee report: Improving the Regulatory Impact Analysis across Emerging Market Countries(2017)<https://icsa.global/research-documents
[17] Global Capital Markets Department of the World Bank, Self Regulation in Securities Markets, (Policy Research Working Paper 5542, 2011) 9 <https://siteresources.worldbank.org/FINANCIALSECTOR/Resources/WPS5542_Self_Regulation_in_Securities_Markets.pdf
[18] Julia Black, ‘Decentring Regulation: Understanding the Role of Regulation and Self-Regulation in a “Post-Regulatory” World’ (2001) 54 Oxford 103, 121 <https://search.proquest.com/openview/a57fa6050c908b239b6f4cf6c0253a89/1?pq-origsite=gscholar&cbl=2032116&casa_token=7qVjpf2lE_4AAAAA:NeEK60dMFaTdHiubTiG4LcR2VFPvFvWm0CmRPbVbqL0T-xCkdddgwjuzxA7IR_Pv6TytDaCQtcQ
[19] The SRO Consultive Committee of IOSCO (n 15) 4
[20] Loan Market Association, A Loan Market Association Guide: A Guide to Syndicated Loans & Leveraged Finance Transactions(2013)<https://www.lma.eu.com/application/files/1614/7749/3386/LMA_Guide_to_Syndicated_Loans.pdf
[21] ICMA Group <https://www.icmagroup.org/resources/icma-documentation/
[24] Alastair Hudson, The Law of Finance (1st edn, Sweet & Maxwell 2009) 934-935
[25] Swedbank AB v. Lehman Bros. Holdings Inc., No.10-cv-04532 (NRB)
[27] S. Henderson, Henderson on Derivatives (2nd edn, LexisNexis UK 2010) 803.
[28] This list is not exhaustive.
[29] Geoffrey Fuller, The Law and Practice of International Capital Markets (3rd edn, LexisNexis 2012) 66
[30] K. Berger, The Creeping Codification of the New Lex Mercatoria (2nd edn, Alphen aan den Rijn: Kluwer Law
International, 2010) 61
[31] Titan Steel Wheels Ltd v Royal Bank of Scotland plc.
[32] Alastair Hudson, The Law of Finance (2nd edn, Sweet & Maxwell 2013) 542
[33] Philip Wood, Law and Practice of International Finance (University edn, Sweet & Maxwell 2008) 440
[34] Maria Chiara Malaguti, ‘Private-Law Instruments for Reduction of Risks on International Financial Markets: Results and Limits of Self-Regulation’ (2000) 11 Open Economies Review 254 <https://link.springer.com/article/10.1023/A:1008325911275#citeas
[35] Rasiah Gengatharen, Derivatives Law and Regulation (Illustrated edn, Kluwer Law International 2001) 64
[36] Wood (n 32) 441
[37] Ibid
[38] Howells (n 6) 40
[39] Specific obligations, representations, events of default and termination events are settled through the common terms.
[40] Wood (n 32) 438
[41] Especially those which price is easily negatively affected as a result of a delayed response in Market’s changes (i.e commodities)
[42] International Monetary Fund, Monetary and Exchange Affairs Department Working Paper: Measuring Liquidity in Financial Markets (2002) 11
[43] Howells (n 6) 278
[44] Ibid 281
[45] Berger (n 29) 64
[46] Wood (n 31) 440
[47] Ibid
[48] For the structure of “single agreement” see Alastair Hudson, The Law on Financial Derivatives (4th edn, Sweet & Maxwell 2006) 1116
[49] Fuller (n 28) 67
[50] Morris v Rayner Enterprises Inc [1997], Stein v Blake [1996]
[51] Wood (n 32) 438
[52] Alastair Hudson (n 47) 439
[53] Miller G, Gafaggi F & Andreoti T, The Governance and Regulation of International Finance, 1st edn (Elgar 2013) 121
[54] SIA, Comments on CESR Draft Statement on Consultation Practices, (Nov. 19, 2001), available at https://www.sia.com/2001_comment_letters/pdf/CESR.pdf
[55] The SRO Consultive Committee of IOSCO (n 15) 8
[56] Caroline Bradley, ‘Private International Law-Making for the Financial Markets’ (2005) 29 Fordham International LawJournal<https://ir.lawnet.fordham.edu/cgi/viewcontent.cgi?referer=https://www.google.co.uk/&httpsredir=1&article=1999&context=ilj
[57] Dombalagian Onnig H., ‘Self and Self-Regulation: Resolving the SRO Identity Crisis’ (2007) Volume 1, Brooklyn Journal of Corporate, Financial & Commercial Law Journal, 320
[58] Global Capital Markets Department of the World Bank (n 17) 17
[59] Schwarz S, ‘Regulating Complexity in Financial Markets’ (2009) 87 Washington University Law Review , 243
[60] Ibid
[61] Sean Flanagan, ‘The rise of trade association: Group Interactions within the International Swaps and Derivatives Association’ (2001) 11 Harvard Negotiation Law Review 212, 261
[62] Despite their effectiveness CDOs are not appropriately settled.
[63] The SRO Consultive Committee of IOSCO ( n 15) 5
[64] Imad A. Moosa, Good Regulation, Bad Reguation: The Anatomy of Financial Regulation (Palgrave Macmillan Studies in Banking and Financial Institutions, 2015) 41
[65] Gabriel V. Rauterberg and Andrew Verstein, ‘Assessing Transnational Private Regulation of the OTC Markets: ISDA, the BBA and Future of Financial Reform’ (2013) 54 Virginia Journal of International Law 10, 43<https://web.law.columbia.edu/sites/default/files/microsites/law-economics-studies/assessing_transnational_private_regulation_of.pdf
[66] The SRO Consultive Committee of IOSCO (n 15) 5
[67] Ibid 7
[69]Global Capital Markets (n 17) 13
[70] Ibid 15
[71] Ibid 14
[72] Moosa (n 61) 45
Author: Gkikas Panagiotis-Lawyer
Date: 4/12/2018
'ALL RIGHTS RESERVED'