FINANCIAL MARKETS AND EXCHANGES LAW SECOND EDITION FINANCIAL MARKETS AND EXCHANGES LAW SECOND EDITION Edited by MICHAEL BLAIR QC GEORGE WALKER STUART WILLEY Great Clarendon Street, Oxford, OX2 6DP, United Kingdom Oxford University Press is a department of the University of Oxford It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide Oxford is a registered trade mark of Oxford University Press in the UK and in certain other countries © Oxford University Press, 2012 The moral rights of the authors have been asserted First Edition published 2007 Second Edition published 2012 Impression: All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, by licence or under terms agreed with the appropriate reprographics rights organization Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above You must not circulate this work in any other form and you must impose this same condition on any acquirer Crown copyright material is reproduced under Class Licence Number C01P0000148 with the permission of OPSI and the Queen’s Printer for Scotland British Library Cataloguing in Publication Data Data available ISBN 978–0–19–960165–3 Printed in Great Britain by CPI Group (UK) Ltd, Croydon, CR0 4YY Links to third party websites are provided by Oxford in good faith and for information only Oxford disclaims any responsibility for the materials contained in any third party website referenced in this work PREFACE In the five years since the first edition of this book, there has been a great deal of change in the field that it covers We hope therefore that this second edition will be welcomed by all of its readers and users A substantial proportion of this development is attributable, directly or indirectly, to the financial crisis of 2008 and its after-effects For example, the new emphases on macro-prudential matters and on ‘resolution’, while mainly concerned with financial banking and trading institutions of systemic importance, not leave untouched the ways in which the organized markets themselves now operate Financial regulators globally have identified a new key policy objective with the desirability of minimizing and containing contagion and systemic risk This objective has created a heightened interest in ‘infrastructure’, including not only clearing houses, but also payments systems and other market service providers Indeed, the focus of regulation has, over the time since our first edition, moved to some extent away from organized markets and the clearing and settlement systems that support them, and new changes are in place or proposed to reduce the risks now identified in the less intensively supervised trading environments in in-house trading systems and in over-the-counter (OTC) markets In both editions of this work, we have taken a broad interpretation of ‘markets and exchanges’ to include not only formal and informal markets, but also systems for market support, including those for making and recording payments, as well as the clearing, settling, and reporting of securities transactions As to informal markets, the treatment of the OTC market has been expanded in this second edition Trade reporting, which has now become an important aspect of the oversight of the less formal trading arrangements, now features in this edition in its own right The arrival of an EU Directive on Payment Services has meant that the new edition gives an account of the reorganization of this area at the European and UK levels Readers will also find a new treatment of the management of the public debt in the UK and an enhanced coverage of global custody Finally, the fact that the role of credit rating agencies has come under closer scrutiny since the financial collapse has also meant that this element of the financial infrastructure and its regulation now feature in this work for the first time In the UK, the financial crisis of 2008 has led directly (albeit also with a change in government) to proposals to reorganize fundamentally the financial regulatory structure itself At the time of writing, the Financial Services Bill is still before Parliament and its final effects are not yet fully clear However, one clear conclusion is that the Bank of England will emerge at the centre of this structural reorganization with an even more substantial and extended role Its remit is significantly enlarged and the oversight functions that it lost in 1997–2001 are being returned as part of an even wider supervisory responsibility This is the main purpose of the Bill, even if prudential powers relating to specific institutions are to be operated through a subsidiary and not, as before, directly, albeit with some answerability to a partly external supervisory board within the Bank In this edition, we have sought to recognize these changes by offering a new chapter early in the book devoted to the Bank of England in its new and forthcoming landscape Structural change has not been limited to the UK In the European Union as a whole, the central institutions concerned with the policy content and effectiveness of financial regulation have been refashioned and their powers have been substantially extended again The financial crisis has given impetus to the establishment of three influential new European Supervisory Authorities (ESAs) These bodies also have been given nascent powers of direct intervention in financial markets, as well as new legislative powers Here, too, we offer a chapter describing this process of change and its effect At the time of the first edition, the Markets in Financial Instruments Directive 2004 (MiFID) was about take effect through transposition into the law of the member States It represented the first phase, building on the early work in 1992 with the Investment Services Directive, in embedding the European principles of fair and open access and equal treatment in the field of financial services The application of MiFID and of others in its wake on different aspects of securities trading has led to changes in practice and in the marketplace itself Two apparently conflicting developments—that is, first, the arrival of new market entrants, bringing competition between different types of trading venue, and, second, the process of consolidation among established exchanges in the search for greater efficiency—have both been noticeable in this period In this context, we also include a new chapter on the still relatively recent group of Financial Services Authority (FSA) rule modules affecting securities, especially those that are listed or admitted to trading on UK regulated markets This area has been overhauled as a result of several key EU directives on prospectuses, transparency, and market abuse, and now receives detailed treatment in this work We give some account of these developments on the ground, and, in relation to the Directives themselves, we devote a chapter to this general area of EU law, contributed by colleagues from Switzerland (a non-EU country) Only five years on, a new initiative is under way to overhaul and expand the footprint of MiFID Accordingly, in the UK, there is currently in progress a double process of adaptation and reform— that is, in the Financial Services Bill and also in the European legislative arena Where relevant, the individual chapters of this work seek to give an account of both proposed and likely future developments in each area The international reach of the book has also been reconsidered and enlarged The chapters on international institutions show how the pace of modernization has not slackened worldwide And we are also happy to have been able to include new chapters on two of the most important international financial markets: New York and Hong Kong Most of the chapters in the previous edition of the book remain, but each of them has been revised so as to cover the developments in the relevant areas over the last five or six years We would like to record our most grateful thanks to three persons working in the Oxford University Press without whom this edition would never have seen the light of day: Rachel Mullaly, Lucinda Yeates, and Faye Judges Editors are fortunate indeed to be supported by such able and untiring colleagues Michael Blair QC George Walker Stuart Willey August 2012 SUMMARY CONTENTS Table of Cases Table of Legislation Table of Treaties and Conventions List of Abbreviations List of Contributors PART I FINANCIAL MARKETS Financial Markets and Exchanges George Walker Exchange Review, Regulation, and Evolution George Walker UK Central Banking and Financial Stability Guy Morton and Andrew Marsh PART II UK SECURITIES MARKETS Recognized Investment Exchanges (RIEs) and Recognized Clearing Houses (RCHs) Bob Penn The Listing, Prospectus, and Disclosure and Transparency Rules Will Pearce and Antonia Kirby Multilateral Trading Facilities (MTFs) Bob Penn Transaction Reporting David Lawes PART III UK MONEY, DEBT, AND DERIVATIVES MARKETS London Money Markets: Legal and Regulatory Framework Joanna Gray UK Government Debt Management and the Gilt Market Sarah Ellis 10 UK Derivatives and Commodities Markets Edward Murray PART IV UK PAYMENT AND SETTLEMENT 11 UK Payment Systems Laura John 12 UK Settlement Madeleine Yates PART V EUROPEAN MARKETS AND EXCHANGES 13 The European System of Financial Supervision Stuart Willey 14 Regulation and Consolidation of European Markets and Exchanges Markus Kaempf and Peter Nobel 15 European E-Commerce and E-Money David Toube PART VI INTERNATIONAL MARKETS AND EXCHANGES 16 The Architecture of International Financial Regulation Eva Hüpkes 17 International Settlement Madeleine Yates 18 Global Custody Madeleine Yates 19 Credit Rating Agencies Charlotte Eborall 20 US Equity Market Structure Edward L Pittman 21 Hong Kong Markets and Exchanges Douglas W Arner and Berry FC Hsu 22 Islamic Securities Exchanges: Principles and International Developments Amr Marar, Nik Norzrul Thani, and Lily Adelina Hashim Index DETAILED CONTENTS Table of Cases Table of Legislation Table of Treaties and Conventions List of Abbreviations List of Contributors PART I FINANCIAL MARKETS Financial Markets and Exchanges Introduction Origin and development Securities and exchanges Restructuring and competition Electronic trading and internal order books Regulatory challenge Scandal and crisis Global financial crisis Financial markets and instruments Capital markets Money markets Eurodollar markets Currency markets Financial derivatives markets Gold market Commodity markets Insurance markets Markets and exchanges Financial markets and exchanges Securities and claims Primary and secondary markets Market operation Market structure Market function Market trading Market orders Financial crisis and financial reform Financial crisis stages Financial crisis response UK regulatory reform The Bank of England The Financial Policy Committee The Prudential Regulation Authority The Financial Conduct Authority The Financial Services Bill Financial evolution Exchange Review, Regulation, and Evolution Introduction UK markets London Stock Exchange (LSE) London International Financial Futures Exchange (Euronext.LIFFE) London Metal Exchange (LME) ICE Futures Europe PLUS Stock Exchange SIX Swiss Exchange OMX Alternative trading systems CREST London Clearing House (LCH.Clearnet) Gilt and cheque clearing Exchange regulation, structure, and operation Exchange regulation Exchange recognition Exchange function Exchange structure and ownership Exchange governance Exchange conduct Market and exchange evolution Digital competition Financial innovation Capital role and private investment Financial security Financial stability Financial integration and global contribution UK Central Banking and Financial Stability The Bank of England Brief history of the Bank and its functions The Bank’s constitution The Bank as banker Banking operations Note issue Cash ratio deposits The Bank and Monetary Policy The Bank of England Act 1998 The Monetary Policy Committee Setting Bank Rate and its effects Quantitative easing and its effects The Bank’s money market operations The use of repo transactions ‘Normal’ operations for monetary policy purposes The current system of monetary policy money market operations Money market operations for liquidity insurance purposes 105 A ‘large trader’ is defined as a person, whether or not based in the US, which effects transactions on behalf of itself—or accounts over which it exercises investment discretion—in an aggregate amount equal to exceeding: (i) million shares or US$20 million during any calendar day; or (ii) 20 million shares or US$200 million during any calendar month A non-US entity that engages in trades of NMS securities may be required to register as a large trader, even if the trades of NMS securities are executed outside of the US 106 Various provisions under the Rule address who must file when dealing with holding companies, affiliates, and trades performed on behalf of mutual funds 107 The SEC emphasized at the time that it adopted the Rule that the information provided in Form 13H will remain confidential and non-public 108 See para 20.30 109 The DTC holds securities through its nominee, Cede & Co 110 See SEC, Concept Release on the US Proxy System (July 2010, Exchange Act Release No 3462495), available online at (discussing the US system for registered and beneficial ownership of shares) 111 On T+1, NSCC releases the results of trade comparisons and matching to its participants NSCC releases transaction summaries on T+2 to broker-dealers listing compared trades and providing net amounts due for settlement The Basic Law of the Hong Kong Special Administrative Region of the People’s Republic of China Adopted on April 1990 by the Seventh National People’s Congress of the People’s Republic of China at its Third Session, Article D Arner, B Hsu, and A Da Roza, ‘Financial Regulation in Hong Kong: Time for a Change’ (2010) 71(5) Asian Journal of Comparative Law 71–114 (2010) Subject to the broad provisions of the Exchange Fund Ordinance (Cap 66), especially s BIS, Locational Banking Statistics (June 2012), available online at Measured respectively by consolidated claims of reporting banks on individual countries and total external positions of banks in individual reporting countries in all currencies Hong Kong Monetary Authority (HKMA), ‘The People’s Bank of China appoints clearing bank for RMB business in Hong Kong’, 24 December 2004, Press release, available online at There are transaction limits in each case: HKMA, ‘Hong Kong banks to conduct personal renminbi business on trial basis’, 18 November 2003, Press release, available online at World Economic Forum, ‘Hong Kong tops Financial Development Index for the first time’, Press release, available online at Hong Kong and Singapore each permitted public issuance in the mid-1970s, some forty years after Thailand and the Philippines See P Lejot, D Arner, and L Qiao, Asia’s Bond Markets: Reforms to Promote Activity and Lessen Financial Contagion (May 2004, Hong Kong Institute of Economics and Business Strategy Working Paper 1090), available online at 10 HKEx, Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited (revised March 2012) (‘Main Board Listing Rules’), Ch 37, available online at 11 OECD, Insurance Regulation and Supervision in Asia (December 1999) 121 12 Financial services is included as one of the four key industries in the Hong Kong economy, alongside trading and logistics, tourism, and producer and professional services For the latest statistical information, see Hong Kong Census & Statistics Department data available online at 13 Following its accession to the WTO, China was to open up its insurance market to qualified foreign insurers by end of 2004 In particular, a foreign insurer is qualified for a licence if it has more than thirty years of experience in a WTO member country, has a representative office established in China for two consecutive years, and has global assets of over US$5 billion Qualified foreign insurers and insurance brokers can operate and provide services in Shanghai, Guangzhou, Dalian, Shenzhen, Foshan, Beijing, Tianjin, Suzhou, Chengdu, Chongqing, Fuzhou, Xiamen, Ningbo, Shenyang, and Wuhan As for life insurance, foreign insurers can now provide individual insurance to foreign and local clients By the end of 2004, foreign insurers were to be able to provide health, group, and pension/annuities insurance to foreign and local clients Also, 50 per cent foreign ownership is allowed: EnglishPeople.com (2001) ‘China unveils WTO details on opening insurance market’, 23 November, available online at 14 See n 14: Mainland and Hong Kong Closer Economic Partnership Arrangement (CEPA), 29 June 2003 15 ‘Editorial’, Oriental Daily, 11 August 2005, B3 16 Basic Law, art 109 17 SRC, Report on the Operation and Regulation of the Hong Kong Securities Industry (June 1998) 18 T Ujejski, ‘Securities regulation’ in The Law in Hong Kong 1969–1989 (Hong Kong University Press, 1989) 299–300 19 SFC, A Consultation Paper on a Draft for a Composite Securities and Futures Bill (April 1996), available online at 20 E Yiu, ‘Securities Law Still in Grip of Bitter Bickering’, South China Morning Post, December 2000; E Yiu, ‘SFC Calls for Reform to Battle Coming Challenges’, South China Morning Post, 28 December 2000 21 CEPA provisions on Financial Services Cooperation: Banking sector under CEPA I service sectors with further liberalization under CEPA II, implemented from January 2004 On the banking measures, see 22 OECD, Principles of Corporate Governance (revised May 2004), available online at 23 World Bank, Principles and Guidelines for Insolvency and Creditor Rights System (April 2001), available online at ; United Nations Commission on International Trade Law (UNCITRAL), Legislative Guide on Insolvency Law (June 2004), available online at The International Monetary Fund (IMF), World Bank, and UNCITRAL were cooperating to produce a single standard 24 International Financial Reporting Standards (IFRS) 25 International Standards on Auditing (ISA) 26 Financial Action Task Force on Money Laundering (FATF), International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation: The FATF Recommendations (February 2012), available online at