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UK Financial Markets and the Foreign Investor
| Author: |
Xiaoyang Zhang
Lecturer of Business Law, The Open University of Hong Kong
|
| Issue: |
Volume 7, Number 1 (March 2000)
|
Contents
- The financial markets in the United Kingdom (UK) may fulfil many economic
functions. However, considering their relevance to foreign investors, their
roles basically ought to be threefold. First, they should facilitate the
raising of capital by foreign investors who resort to external finance to
sustain business. Second, they should provide a place where foreign financial
institutions (banks or other concerns of similar nature) can establish their
corresponding presence in the market and carry out banking business in the UK.
Thirdly, foreign investors (mostly foreign financial conglomerates) can gain
direct access to conducting investment transactions in the market under the
UK's on-going self-regulatory framework. This paper examines the structure and
performance of the above primary roles played by each of the UK financial
markets in foreign investment operations.
- Foreign investors wishing to raise finance in the UK have a number of
options in order to do so. While traditional credit facilities are generally
available by means of bank loans or bond issues, in order to raise medium and
long term capital of a large size, it is generally advantageous to have shares
listed on the International Stock Exchange. This plays a central part in the
UK's capital markets.
- Traditional credit facilities are represented by financing investment
projects by means of various loans or issuance of bonds.
- Loans may be advanced by either a single bank, or where the sum involved
is a large one, by a syndicate of banks. Short term credit may be used to
cover overdrafts, obtain cash advances or bankers' acceptances. These
facilities are typically repayable on demand and may require a fixed or
floating charge over the borrower's assets.
- Medium and long-term loans are also available, especially for the large,
strong borrowers. They normally have a draw down period, a grace period and a
repayment period. In any case, lending institutions expect to be satisfied by
the business plan, cash flows and earning performance of the project as a
source of funds from which the loan will be repaid. In practice, lenders will
invariably require certain forms of security or guarantees for the loan
provided.
- Foreign companies, especially top-quality ones, may issue bonds as medium
to long term debt instruments, usually at a fixed rate of interest. The
structure of a typical bond issue involves, in addition to the issuer, three
significant groups: a. The managers who are responsible for managing the issue
and preparing the relevant documentation; b. The selling group who place the
bonds with outside investors; and c. The underwriters who are large financial
institutions agreeing to purchase any part of the issue not sold by the
selling group.
- Compared with conventional loan arrangements, bond issues are likely to
bring about several benefits. This includes a more favourable interest rate
and a certain publicity to be achieved. This may in turn facilitate subsequent
access to the market, while at the same time the issuers do not deplete the
availability of resorting to the existing banking sources. However, public
bond issues might be more expensive and onerous than directly applying for
loans.
- The objective of raising finance can be well fulfilled by having Shares
listed on the Stock Exchange.
- A full listing may afford a foreign company many advantages. First, an
offer of equity shares to the public is an appropriate way of raising new
funds, since the prestige attached to a full listing may well make it easier
for a company to raise finance from other sources. Second, a floated company
may find its shares become more marketable, therefore realising part of its
investment on flotation and at subsequent times by selling further shares
through the market. Third, there is a considerable degree of high reputation
and publicity in connection with a full listing. This may lead to better trade
terms and wider markets for the company's products and services.
- However, there are corresponding disadvantages as well. First, having a
company listed on the Stock Exchange both in terms of administrative work as
well as loss of privacy is a complicated and costly process. Second, as in
normal circumstances, a minimum percentage of the issued equity share capital
must be in public hands. There is a certain degree of external involvement,
which can incur pressure from outside shareholders for paying dividends and
sometimes an exposure to risk of a take-over bid. The higher the proportion of
the equity in public hands, the more obvious this drawback appears to be. As
the London International Stock Exchange is a recognised exchange for the
purpose of the UK Financial Services Act 1986 (FSA 1986), the official listing
of securities on it is generally dealt with as a separate subject in the Act.
Part IV reflects three EEC directives (namely, Council Directives 79/279/EEC,
80/390/EEC and 82/121/EEC respectively), in view of harmonising and
coordinating various aspects for the admission of securities to official stock
exchange listing throughout the European Union. These lay down minimum
requirements for having shares listed in the Exchange. Moreover, article 9 of
Council Directive 79/279/EEC also requires each member state to designate a
competent authority to decide on the admission of securities to the official
listing on a stock exchange operating within its own territory. By section
142(6) of the FSA 1986, the Council of the International Stock Exchange is
appointed as the competent authority in the UK. This Council has the power to
make listing regulations and rules which are set forth in "Admission of
Securities to Listing", usually referred to as the Stock Exchange's "Yellow
Book". All applications for an initial listing must be submitted to the Stock
Exchange for approval. In fact, the FSA 1986 only provides a broad framework.
The bulk of detailed rules are contained in the "Yellow Book" which in
practice has statutory force as well.
- A foreign company intending to apply for a full listing must have in the
first place a clear understanding of its own suitability for going public. The
requirements that a company has to meet in order to satisfy the Stock
Exchange's criteria for listing can be classified into three main aspects: a.
Market capitalisation; b. Shares in public hands; and c. Trading record. In
theoretical terms, an application for listing will not normally be considered
unless the expected market value of the shares for which a listing is sought
is at least £700,000.[1] In practice however, the Stock Exchange maintains a complete
discretion to adjust the minimum figure. A market capitalisation exceeding
£700,000 by a large margin is likely to be required for ensuring prospective
outside investors that the company to be listed is a high quality one. There
is a further requirement that at least 25% of its shares must be in public
hands,[2] so that the nature of the public company can be guaranteed by
maintaining a reasonable level of external involvement. However, outside
participation is essentially not welcomed by the company to be floated, since
in this case a certain degree of business control will definitely fall into
other people's hands. In practice, a percentage lower than 25% may not be
totally unacceptable if the market will operate properly with a lower
percentage, in view of the large number of shares of the same class and the
extent of their distribution to the public. Thus, this minimum 25% requirement
can become quite a negotiable matter. A company should normally have a trading
record of at least three years and must present audited accounts for the last
three years,[3] hence ensuring that only mature companies will qualify for
admission to listing.
- A company flotation on the Stock Exchange is customarily represented by a
sponsor, which may be a merchant bank and/or a stockbroker. The sponsor's role
is crucial for linking the company with the Stock Exchange. In broad terms,
the sponsor advises the company on all aspects of applying for a full listing,
from assessing the company's initial suitability to the pricing and timing of
the issue itself. Whilst it is reasonable for the company's directors to be
responsible for the accuracy of the information provided for the listing
purpose, the Stock Exchange in practice attaches particular importance to the
role played by the sponsor in satisfying itself that the company is suitable
for a full listing.
- The actual methods of flotation in connection with foreign companies
seeking listing for the first time may normally comprise two major kinds: a.
offer for sale and b. selective placing. The choice of the more appropriate
method depends on factors such as the costs as well as the company's view of
prospective shareholders' profiles that are acceptable to it.
- Offer for sale is usually conducted by the company distributing the
securities that are intended to be offered to the public to an issuing house,
which may or may not be the sponsor itself in the first instance. The issuing
house then invites subscriptions from institutional as well as individual
investors. An offer for sale can be made by way of bearing a fixed price or
arranging a tender.
- The purpose of a sale by tender is to ensure that any excess over the
minimum tender price is made available to the company. This is in contrast to
a fixed-price issue, where if the issue price is pitched too low, short-term
speculators will easily stand to make huge profits. In theory, a tender offer
provides a basis for a more accurate market valuation of the company's shares.
If the issue is small and a large over-subscription is anticipated, this
method will be especially worth trying as the cost incurred by the risk of
failure in this instance would be minimal. In practice however, it has not
always been the case and the company may find it difficult to decide whether
to opt for a straightforward offer for sale or an offer for sale by tender.
- Tender offers are mostly utilised where there is no comparable company
already listed to use as a reference for deciding the company's value. The
uncertainty and complexity embodied in the actual process can discourage
private and small investors. In either case, before an issue of shares is made
to the public, it is usual to insure the success of the issue by having it
underwritten. An underwriter does not guarantee that the public will take up
the shares, but agrees to subscribe for the shares themselves on the happening
of the public's failure to fully purchase. The issuing house would often be
the main underwriter and may find others to sub-underwrite part of the issue.
In a selective placing, new shares are offered to the public selectively by
the sponsor selling the shares to its own client base and finding purchasers
with whom the shares are then placed. A selective placing has two main
advantages. First, it is cheaper to carry out because the advertising costs
are lower and the administrative work involved in handling applications is
less, as the placing is merely conducted within the limited scope of the
sponsor's existing clients. Second, due to the nature of the placing, it is
not necessary to have the issue underwritten so that there may not be any
underwriting expenditure incurred. The major disadvantage of a selective
placing is that investors are deprived of an equal opportunity to acquire the
securities, as the sponsor places securities with their own clients. Thus, the
Stock Exchange imposes strict restrictions in this regard, and only permits
the entire issue to be placed in the case of an initial public offer of £15 million or less.[4]
- One of the most important and time consuming tasks in the entire process
of having shares listed is the preparation of listing particulars which
comprise the "prospectus" required by the Stock Exchange. The listing
particulars serve two purposes. First, they include all information, which the
Stock Exchange requires to be made public to investors on which they are able
to base investment decisions. Second, and of great importance to the company
when shares are being marketed, they describe the company, its business and
prospects, which are designed to promote investment in the company's shares.
Section 146 of the FSA 1986 imposes a general duty of disclosure required
for listing particulars. The company must release all the information with
respect to the assets and liabilities, financial position, profits and losses,
prospects of the issuer of the securities, and the rights attaching to those
securities. This is what an investor and their professional advisers would
reasonably require in order to make an informed assessment.
- However, the more detailed requirements in connection with listing
particulars are set out in the "Yellow Book", covering the following seven
aspects: a) information on the persons responsible for listing particulars,
the auditors and other advisers, including a declaration by the directors
accepting responsibility for the information contained in the listing
particulars, and a statement that the annual accounts for the last three
financial years have been audited; b) information on the shares for which
application is being made, indicating the nature and amount of the issue and
the fixed dates (if any) on which entitlement to dividends arises, and giving
a summary of the rights attaching to the shares; c) general information about
the issuer and its capital, including the legislation under which the issuer
operates and the legal form which it has adopted under that legislation, the
date and country of incorporation, a summary of the principal contents of each
material contract entered in the last two years, the names of persons
exercising control over the company and the names of any persons known to the
issuer interested in 3% or more of the issuer's capital, details of the share
capital of the company and any shares under option, and a summary of the
provisions of the memorandum and articles of association regarding changes in
the capital and rights of the various classes of shares; d) information on the
company or group's activities, including a description of principal
activities, information on any legal or arbitration proceedings, an analysis
of sales by geographical area and category of activity, details of land,
buildings and principal establishments, and information in respect of
development policy, employees and material investments in other companies; e)
information on the issuer's assets and liabilities, financial position and
profits and losses, including consolidated information on the results and
financial position for each of the last three completed financial years, a
statement by the issuer as to the adequacy of working capital, and details of
the issuer's indebtedness; f) information on the company's management,
including directors' details, their services and remuneration, and their
interests in the company's securities; and, g) information on the recent
developments and prospects of the company or group.[5]
- Whilst the rules of the "Yellow Book" generally apply to companies
incorporated in the UK and abroad alike, the Stock Exchange is more flexible
in certain aspects with companies incorporated overseas. They may consider
some derogation from the normal requirement for listing particulars proposed
by such companies. These foreign companies may not need to prepare UK listing
particulars if they have issued a document approved by the competent authority
of another EU Member State. This qualifies for mutual recognition of listing
particulars under the rules introduced by Council Directive 90/211/EEC in
respect of the mutual recognition of a public-offer prospectus as
stock-exchange listing particulars.
- There are three main conditions contained in the "Yellow Book" which have
to be fulfilled by a company to qualify for listing by mutual recognition.
Firstly, the company must have its registered office in another Member State.
If not, it must either be listed on an overseas stock exchange, or the London
International Stock Exchange must be satisfied that it can properly be
regarded as a company of international standing and repute.
- Secondly, the company must have either contemporaneously with its
application, or within three months prior to entry onto the Stock Exchange,
had the qualifying document approved by the competent authority in another
Member State. This must be done as a prospectus drawn up according to the
Public Offers Directive at the time of a public offer in that Member State.
- Thirdly, the qualifying document must contain additional information
specific to the UK market. This includes a description of the tax treatment of
securities holders who are UK residents, names and addresses of the registrars
and UK paying agents for the securities. A statement of how notices of
meetings will be given to UK residents holders of the securities is also
required.[6]
- Foreign banks can establish and carry on banking business in the UK. They
may do this in one of three ways: as a distinct UK subsidiary, as a branch of
the foreign bank, or simply as the bank's representative office. These three
types of institution are entitled to different rights. Only the first two are
permitted to transact in the UK, while a representative office is merely
allowed to promote the interests of the parent institution overseas. Under
such a context, this article is designed to examine the relating legal
regulations and requirements set forth in the UK as parameters for banking
supervision to which foreign banks will be subject if they intend to set up
proper presence there.
- A UK subsidiary of a foreign bank is incorporated in
the UK as a local business entity with separate legal status. Such a
subsidiary must fully comply with the usual minimum criteria of the Banking
Act 1987 (BA 1987), regarding carrying on a deposit-taking business.
Setting up a subsidiary is not easy, but once established it will possess
complete banking functions, which are very close to those of British banks.
- By section 3(1), no person in the UK shall accept a deposit in the course
of carrying on a deposit-taking business, unless that person is an institution
authorised by the Bank of England. To become an authorised institution, a
foreign bank must apply to the Bank of England, which must be satisfied before
granting authorisation that the certain minimum criteria specified in Schedule
3 have been properly fulfilled. The most important of these criteria are
reflected from the Bank's system of prudential supervision, which comprises
three major limbs: a) capital adequacy and liquidity control; b) control of
the bank's controller(s); and c) risk protection control.
- Capital adequacy and liquidity control has the objective of improving
financial stability, which can be enhanced through the supervision of the
strength of financial institutions' capital and liquidity positions. In
relation to capital adequacy, the Bank adopted the proposals put forward by
the Basle Committee representing the "Group of Ten" countries in 1988. The Committee's recommendations provided for banks to hold a
minimum of 8% of capital against their weighted counter-party risks which were
imposed on the UK banks.[7] However, this 8% of capital is a minimum sum and in
reality for most banks the actual figure might be much higher. Additionally,
by paragraph 6(1) and 6(2) of Schedule 3, each bank must have a minimum paid
up capital and reserves of £1 million, which in practical terms may not be so
difficult to satisfy. Concerning liquidity control, while paragraph 4(4) of
Schedule 3 provides that a banking institution should maintain adequate
liquidity, with regard to the relationship between its liquid assets and its
actual and contingent liabilities, the Bank of England does not use liquidity
ratios which should be adhered to by all banks as a standard. They instead
indicate that liquidity management is the responsibility of each bank's
management with the Bank of England seeing that individual bank liquidity
needs are met.[8] In practice, the guideline ratio for the time being is 12%.[9]
- Section 21 prohibits any person from
becoming a controller of an authorised institution incorporated in the UK
unless they have given notice to the Bank and the Bank does not object.
Section 105(3) defines a controller in relation to an institution essentially
as any person in the capacity of managing director, chief executive, or anyone
who is entitled to exercise or control the exercise of 15% or more of the
voting power at any general meeting of the institution, or of another
institution of which the former institution in question is a subsidiary. The
primary purpose of this control is to protect the UK banking sector from
aggressive foreign or other undesirable take-over and from the influence and
control of individuals whose interests may be harmful to those of depositors.
- Risk protection control, based on providing better consumer protection, is
carried out by reporting any large risk exposure and contributing to the
deposit protection fund. Section 38(1) requires an authorised institution to
make a report to the Bank of England whenever it enters into a transaction or
transactions with a single customer with risk exposure of over 10% of its
available capital resources, or proposes to enter into such transactions with
risk exposure of over 25% of those resources.
- In order to give protection to depositors against loss, the BA 1987
continues the Deposit Protection Fund under section 50(1), which was
established by section 21 of the Act of 1979. According to sections 53 to 55,
each institution is required to make an initial contribution to the Fund at
the time of its authorisation. It must then make further or special
contributions subsequently to restore the amount standing to the credit of the
Fund to a minimum of £5 million and a maximum of £6 million if the Fund is
reduced beyond the limit of £3 million. Payments may be made out of the Fund
upon the occurrence of certain specified events which amount basically to the
insolvency of an authorised institution, and are limited to a maximum of
three-quarters of the depositors' protected deposits maintained at not over
£20,000 (sections 58 and 60).
- It is easier for a foreign bank to set up a branch in the UK, which is
equally able to carry on banking transactions. However, a branch does not have
a separate juridical status, and when considering whether it meets the minimum
criteria for authorisation, it will be the whole institution that is to be
considered and not just the branch itself. The parent bank will also be
responsible for all obligations committed to by the branch. Thus the branch
assets alone do not need to meet the minimum capital adequacy and liquidity
requirements. Also, it can be construed from section 38(1) that reporting
large exposures may not be required for a branch whose principal place of
business is outside the United Kingdom.
- The simplest way for a foreign bank to establish business presence in the
UK is to form a representative office. A representative office is not
permitted to conduct a deposit-taking business. Its sole function is to assist
and promote the activity of the institution based abroad. Since it does not
carry on deposit-taking business, there will be no necessity for it to be
authorised under the BA 1987.
- It is likely that the Bank of England might prefer an overseas bank to
establish a representative office which merely does promotion work, thus
protecting the interests of domestic banking sector by controlling foreign
direct participation in the business as subsidiaries or branches. To foreign
banks, especially those that are not quite familiar with the UK's financial
operation system, it would be better to set up a representative office in the
first place. This is used as a stepping-stone for expanding its activities and
becoming a branch or having a subsidiary incorporated later on.
- Furthermore, as part of the developments in
Europe with a view of leading to a single European market, the EC's Second
Banking Co-ordination Directive enables credit institutions incorporated in a
EU member state to enjoy mutual recognition throughout the whole European
Union. This is by virtue of a single authorisation obtained in a member
country.[10] Thus a non-EU bank may take advantage of freedoms under this
single banking licence scheme by establishing itself in the UK.
- Nonetheless, this scheme is carried out under a test of reciprocity
treatment. In the context of article 7 of the Second Banking Directive, a
broad view will be taken of the kind of treatment that EU credit institutions
receive in the given non-EU country by judging whether EU institutions are
given reciprocal treatment. If not, credit institutions from such state will
be denied establishment of their presence in any EU country including the UK.
- Due to the existence of a number of highly developed and efficiently
operated financial markets, it is likely that foreign companies would greatly
benefit if they are able to carry on certain investment businesses in the UK.
The entire investment sector is now administered under the FSA 1986. Central
to this framework is a system of self-regulation, which relies heavily on
market practitioners who can formulate rules that are acceptable to both
market players as well as regulators.
- The Securities and Investments Board (SIB) as the primary regulator has
the appearance of a state agency assuming an overall regulatory
responsibility, whereas the front-line delivery of regulation is made through
a cluster of autonomous self-regulatory bodies which are recognised and
supervised by the SIB. Foreign companies intending to carry on investment
business need to apply for authorisation under this two-tier regulatory
regime, which in turn is intended to ensure that investment business can only
be conducted by those who are fit and proper to do so.
- This article is designed to investigate the principal legal regulations
and requirements to which foreign companies will have to be subject should
they try to conduct investment transactions in the UK's financial markets.
- The FSA 1986, rather than devising an all-embracing definition, introduces
a comprehensive list of investments, which might become the subject matter of
carrying on investment business.
- According to section 1(1), an investment means any asset, right or
interest falling within a statutory list inserted in Part I of Schedule 1,
which widely comprises: a) all types of securities and interests in
securities, such as shares, bonds, notes, debentures, certificates of deposit,
government and public securities, depository receipts, warrants, options, and
units in collective investment schemes; b) currency and other financial
options, options on metals and options on commodity futures; c) delivery-based
futures (but not where the contract is made for purely commercial purposes
other than a recognised investment exchange); d) contracts for differences,
including index-based futures contracts; and e) most long-term insurance
contracts.
- By Part II of Schedule 1, the regulatory framework in general terms covers
all types of investment business conducted in the UK, embracing: a) dealing in
investments; b) arranging deals in investments; c) managing investments; d)
advising on investments; and e) operating a collective investment scheme.
Moreover, under section 1(3), a person carries on investment business in the
UK if they carry on investment business from a permanent place of business
maintained by them in the UK, or engage in investment activity which
constitutes carrying on a business in the UK.
- The statutory definition of various activities constituting carrying on of
investment business is very detailed and complicated. Nevertheless, this
precise definition of investment business essentially serves three important
purposes. First, the FSA 1986 only applies to investment business carried on
in the UK, excluding the activities wholly conducted overseas. The test is
whether the relevant activities are from a permanent place of business
maintained in the UK or amount to the carrying on of a business there from
abroad. As a general proposition, foreign companies having UK clientele can be
counted as carrying on a UK business.
- Second, the definition is used to determine whether there is a real
business involving investment activity. In practical terms, this purpose is of
great significance. It may help to ascertain whether a particular transaction
is an investment activity governed by the FSA 1986, so that in the event of a
transaction, which is excepted from the statutory list, the company concerned
will not be amenable to any disciplinary jurisdiction or statutory liability
under the FSA.
- Third, if the preponderance of a company's activities are excepted from
the statutory list of investment business, certain particular transactions in
which it engages that are statutory investment activities may not be subject
to the provisions of the FSA. This is unless the transactions are sufficiently
numerous and/or continuous to constitute a business with a recurring source of
profit. The purpose of this test is to avoid having essentially non-investment
business entities from being unnecessarily regulated.
- As the objectives of different investors may vary, the kinds of investment
which they choose to meet their varying objectives will differ
correspondingly. The most attractive benefit of carrying on investment
business in the UK lies in the fact that within the financial markets, there
is a wide range of trading arrangements, which are made to locate investors
with whom to carry on transactions. The principal characteristics of
investment markets in the UK can be highlighted by performance of three major
investment exchanges - the London Stock Exchange, LIFFE (the London
International Financial Futures and Options Exchange), and the commodity
markets.
- The London International Stock Exchange is one of the world's best-known
markets for the trading of equities. It brings together those wanting to raise
finance with those who wish to invest. In general, the Exchange offers markets
for buying and selling of four major types of securities: a) British domestic
equities; b) foreign equities; c) UK gilts; and d) bonds or fixed interest
stocks. It has set up a highly developed trading system for market
participants to transact efficiently.
- So far as foreign companies conducting investment transactions are
concerned, the secondary market existing on the Stock Exchange as the place
where securities are traded is of the closest significance to them. The active
secondary market maintained by the Stock Exchange provides foreign companies
numerous opportunities for realising their investment aims. Since the
substantial change to the Exchange's rules in 1986 (i.e. the "Big Bang"), the
separation of members into brokers and jobbers has ceased.[11] All business entities can now become brokers, able to
represent clients in the markets or principals buying and selling securities
on their own account, and are also permitted to register as market makers.[12]
- Created
by the merger of the London International Financial Futures Exchange and the
London Traded Options Market in 1992, LIFFE is now one of the world's leading
exchanges devoted to financial futures and options.[13]
- With unprecedented volatility in the financial markets at the present
time, new opportunities and their associated risks exist simultaneously. Not
only must financial assets be prudently and vigilantly protected against
potential market adversities, but opportunities must also be afforded for
enhanced performances, which are expected to be recognised quickly and
selectively pursued. The result is an environment in which financial futures
and options markets have become a necessity for investors and traders. The
principal benefit of financial futures and options markets lies in the
effective risk protection against adverse movement of financial instruments'
values in question. At the same time, LIFFE transactions can be employed to
implement a range of aggressive and speculative strategies. It provides risk
management and trading chances in fixed income, treasury and equity products
with instruments which encompass both the short and long end of the yield
spectrum, and are denominated by a total of seven major world currencies.[14]
- The commodity markets in the UK are composed of the London Metal Exchange
and the London Commodity Exchange. The function of the London Metal Exchange
is to provide an efficient and orderly market on which transactions take place
in non-ferrous metals. The Exchange's members may act on behalf of their
customers to purchase or sell standard quantities of metals. Bargains are made
either for immediate settlement or for delivery in three months time.
Additionally, member businesses may issue or deal in options to buy or sell
standard quantities of metal for delivery in three months time.[15] The Exchange is a useful place for hedging and speculating,
and primarily concerned with variations in the price of the metals but not
their physical supply. The London Commodity Exchange is Europe's primary
centre for the trading of soft commodity futures and options contracts.[16] Like the Metal Exchange, the Commodity Exchange is a
financial market concerned with price movement and fulfils the same functions
as the Metal Exchange in respect of hedging and speculating. Contracted
commitments by its members are usually closed out by entering into
counteracting forward contracts or by paying differences between the contract
price and the ruling market price at the time of settlement, with very few
physical deliveries.
- In 1981 the UK government
commissioned Professor L.C.B. Gower to inquire into the operation and
effectiveness of the existing law governing investor protection. Based on
Gower's report, the government published its own proposals for new
legislation.[17] The common feature of the Gower proposals and the
government's proposals was the conclusion that the most effective, practical
and economical way to regulate investment markets and activities would be to
combine regulation by the representative organisations whose members are
engaged in various branches of investment business. This would include a
supervisory function and a residual degree of regulation by a government
appointed body acting as an agent of the state.[18] This notion thus formed the basis of the FSA 1986 and also
the SIB's role as the leading regulator.
- A self-regulatory system is now applied under the auspices of the SIB in
the capacity of a government-designated agency responsible for authorising a
series of self-regulatory bodies and overseeing their business operations.
- The role of the SIB can virtually be classified as standard setter and as
supervisor of regulators. Whilst the FSA 1986 provides the legal basis for the
SIB to be empowered to make rules concerning the conduct of business under
section 114, the primary role of the SIB in practice is to formulate and
develop policies which set standards of investor protection and market
integrity. This does not mean that the SIB needs to write more rules in
sophisticated technical terms, but means that it spells out where the goal
posts are. So on the one hand, it provides a benchmark of equivalence to judge
the rules of the second-tier regulators. On the other hand, it ensures that
investors can know what is expected of business entities engaged in investment
activities with which they deal and equally such business entities can know
what is expected of them.
- The role of SIB as supervisor of regulators is crucial to the achievement
of the objective of cost-effective investor protection. Under the two-tier
system, the self-regulatory bodies are the front line regulators with the job
of carrying out day-to-day regulation. They are thereby responsible for the
quality of the relationship between the members and the public and between
their members dealing with each other. However, these self-regulating bodies
have to obtain recognition of the SIB in the first instance. Thus, the SIB's
duty as supervisor of regulators is fulfilled by carrying out recognition or
withdrawal of such recognition so as to guarantee that standards set for
regulating recognised bodies are properly delivered.
- The second-tier regulators, which are of closest relevance to foreign
companies, are self-regulatory organisations (SROs). Under the SIB's
supervision, they are responsible for the regulation and authorisation of
their members, and also have to devise rules that are at least as stringent as
those of the SIB itself. Although the SIB undertakes regular supervision of
them to ensure that they do their jobs properly, the system of the second-tier
regulation runs parallel with that of the direct regulation by the SIB. By
section 8(1) of the FSA 1986, SROs play the role of regulating the carrying on
of investment business of any kind by enforcing rules binding on their
members, who carry on business of that kind. Although the SIB retains ultimate
control, members of SROs are regulated by the rules and constitutions of SROs
themselves, and not directly by the SIB. In practice, most foreign investment
companies need to obtain their authority to carry on investment business
through SRO membership. And a conglomerate conducting a wide range of
investment business is likely to face the prospect of joining more than one
SRO.
- There are currently four SROs recognised by the SIB: Securities and
Futures Authority (SFA), Investment Management Regulatory Organisation (IMRO),
Financial Intermediaries, Managers and Brokers Regulatory Organisation
(FIMBRA), and Life Assurance and Unit Trust Regulatory Organisation (LAUTRO).
SFA is a SRO responsible for regulating business entities that are securities,
and derivative dealers and advisers. Their members are active on the London
International Stock Exchange, LIFFE, and the London Metal Exchange.[19] IMRO principally regulates fund managers and advisers
undertaking management of investments, and trusteeship of collective
investment schemes. Its members are mainly from merchant banks, investment
trusts, pension fund managers, unit trust managers and insurance companies.[20]
- FIMBRA regulates overseas investment advice and services offered by
independent investment intermediaries in life assurance, unit trusts, pensions
and personal equity plans. FIMBRA normally divides its members into one of the
following three categories, depending on whether they handle clients' money
and the type of investment business they do: a) members who do any investment
business regulated by FIMBRA, and are entitled to handle clients' money and
assets; b) members who are involved in any business regulated by FIMBRA except
dealing as principal with clients, and are entitled to handle clients' money
and assets; c) members who are engaged in the same areas of business as those
in category b), but who may not handle clients' money and assets.[21] LAUTRO has its business scope confined to the marketing of
life assurance, unit trust products and other collective investment schemes.
They mainly consist of insurance companies, friendly societies, unit trusts,
and other operators of collective investment schemes.[22]
- Duplication of regulation over a company or a group of companies which has
to join more than one SRO is obviously a potential problem. Many foreign
companies are concerned about the overlapping requirements of different SROs
that they have to join simultaneously due to the wide range of activities
which they want to carry out. To solve this problem, close co-operation
between SROs is essential and any single SRO ought to be willing to share
information with all other counterparts.
- Also, the SROs' responsibilities pertinent to financial surveillance of
the member concerned should be clearly allocated by virtue of expertise to a
specifically designated SRO, which becomes responsible for the member's
business as leading regulator in its own field. Moreover, mergers between
certain SROs equipped with similar and overlapping functions are necessary to
be conducted as well.
- Foreign companies proposing to carry on investment business in the UK need
to apply for authorisation. The FSA 1986 by section 3 prohibits the carrying
on of an investment business without authorisation. There are three main
routes to become authorised: a) application directly to the SIB; b) becoming
authorised by getting approval from a SRO in most circumstances; and c)
becoming automatically authorised as EU-based companies.
- In the first two events, foreign companies must be aware that
incorporation of a subsidiary in the UK through which operation is carried out
is an important pre-condition to be fulfilled. Difficulties in monitoring the
capital adequacy of a foreign company operating on a worldwide basis as a
single entity may lead the SIB or SROs to reject its application for
conducting investment activities in the UK via a branch. This is unless the
home country exceptionally agrees with the UK authority ensuring the
imposition of the necessary supervision with which the UK authority can be
satisfied.
- A foreign company may apply for direct authorisation by the SIB. The
application should include the information as to the investment business
proposed to be carried out, the services provided, and any other information
required by the SIB (section 26(2)). The SIB upon receipt of an application
for authorisation will first of all consider from the information furnished
whether the applicant is a fit and proper person to carry on the investment
business (section 27(2)).
- The fitness and propriety are essentially determined by the applicant's
financial capability, which has to be proved to the satisfaction of the SIB by
fulfilling the financial resources rules set forth by it. However, the
provisions in the FSA 1986 do not reveal any exact amount as to the adequate
level of financial resources required. The SIB makes rules imposing different
financial resources requirements under different circumstances (section
49(2)).
- In addition, the SIB will also consider other factors in making its
decision to grant or refuse an application. For example, information about the
controllers of a company (i.e. directors or shareholders who control 15% or
more of the voting powers at the general meeting, or another body corporate of
which the company in question is a subsidiary), the proposed employees, and
the appointed representatives in question, might additionally be asked for
(sections 27(3)(a) and 207(5)(a)).
- Direct application to the SIB is often based on two reasons. First, in the
case of the company having no permanent place of business in the UK, the SROs
might be very reluctant to grant authorisation to it. Thus there could be no
other alternative but directly applying to the SIB. Second, the intended
investment business might fall within the scope of several SROs and it will be
more convenient if authorisation could be acquired once and for all from a
single source. However, direct authorisation is not easy, nor does the SIB
encourage it.
- The role that SROs are playing is of the utmost importance to the
self-regulating legal structure. Most foreign companies obtain their authority
to carry on a business through membership of and participation in SROs so as
to meet the diverse investment demands to their own advantages.
- Members of a SRO shall be fit and proper persons to carry on investment
business of the kind with which the SRO is concerned. In order to prove their
fitness and properness, they should satisfy the financial resources
requirement and other factors, same as those discussed above in connection
with authorisation by the SIB (paragraph 1(1) and 1(3), Schedule 2).
- Each SRO has rules regarding its own business scope prohibiting its
members from carrying on a kind of investment business which it does not
itself regulate (section 10(3)). The applicant shall ensure that
correspondence does exist between its planned investment business and
categories of the investment scope of the SRO. To avoid conflicts arising from
inconsistencies between the desired activities and the rules of the SRO, the
company intending to participate in a number of separate investment activities
shall join more than one SRO.
- A foreign company becomes automatically authorised to carry on investment
business in the UK if it has established a business entity in an EU member
state other than the UK. Once under the law of that state, it is recognised as
a national, authorised to carry on investment business in that country
(section 31(1)). A foreign company may firstly set up a permanent business
place in an EU member state, where it is likely that they may be subject to
looser administrative control than in the UK, and then carry on the UK
investment business indirectly from their EU base. This method could be used
to avoid or at least minimise the cumbersome procedures for obtaining
authorisation in Britain.
- To become automatically authorised, an EU-based company must ensure that
the law of the member state where their investment business entities are
established affords protection to investors in Britain, at least equivalent to
that provided by the provisions contained in the FSA 1986 (section 31(3)(a)).
Additionally, the provisions of the law under which they are authorised to
carry on investment business shall satisfy the conditions laid down by the
regulations of the Council of Ministers for the European Communities for the
co-ordination or approximation of the laws, regulations or administrative
provisions of member states relating to the carrying on of investment
activities (section 31(3)(b)).
- The FSA 1986 is intended to provide substantial investor protection with
the aim of ensuring healthy, internationally competitive investment markets in
which all investors can have confidence. The rules and regulations with which
each regulator under the two-tier system has to comply are maintained and
enforced by the SIB and the relevant SROs. They principally cover the areas
relative to the conduct of investment business by authorised entities, which
must guarantee that adequate protection can be secured by investors.
- The current two-tier regulatory system provides regulators a substantial
armoury of supervision sanctions concerning the way that foreign investment
companies seek business, regulate insider dealing, and treat investors'
complaints and compensation.
- The marketing of investments is tightly controlled by the FSA 1986.
Misleading advertisements, statements, claims and unsolicited calls to sell
investments are generally prohibited.
- Pursuant to section 57(1), investment advertisements must only be placed
by authorised businesses. In the context of section 48(2)(e), these
businesses, while issuing advertisements must observe the rules made by the
SIB regulating the form and content of investment advertisements. Since
investment advertisements are where investors are very probably at greatest
risk, certain warnings about matters such as the volatility or marketability
of the investments advertised shall be given to prospective investors in
advance. Unsolicited calls to sell investments are normally banned, even by
authorised businesses (section 56(1)). The main exceptions to this are calls
relating to life assurance and unit trusts, where such a cold-call results in
a sale, where the customer normally has a 14-day "cooling-off period". This is
a period in which the rescinding or the withdrawing of offers to enter into
investment agreements are available according to section 51(1)), during which
they can reconsider the transaction and withdraw if they wish.[23]
- To seek business, authorised entities must release appropriate information
to prospective investors. Information about charges, fees and commissions
claimed after doing business with clients is to be provided (section
48(2)(g)). If an authorised business itself has a material interest in a
transaction, conflicts of interest may arise in the course of marketing of
investments. In such a position, the authorised business must timely disclose
the nature of the conflicted interest to investors (section 48(2)(h)). Some
changes have been made to disclosure rules recently. The most important change
is the separation of information into a) key features (vital information to be
given at the time when the product is recommended); b) important information
(to be provided no later than the start of any cooling-off period); and c)
usual information (available on request).[24] These new amendments will mainly affect how intermediaries
who advise on and sell packaged products are to disclose to potential
investors their status and the details of the products offered.
- Insider dealing, the practice of using confidential or
price-sensitive information for personal gain, was rendered a criminal offence
firstly under Part V of the Companies Act 1980. The Companies Securities
(Insider Dealing) Act 1985 re-enacted the earlier legislation with relatively
minor amendments.[25]
- Under sections 1 and 2 of the Insider Dealing Act 1985, insider dealing is
specifically defined as dealing when an individual knowingly transacts in a
security whilst in possession of unpublished price sensitive information
relating to that security. The Act summarises the following 12 categories as
offences of insider dealing:
- primary insider dealing in the securities of the insider's own company;
- primary insider dealing in the securities of a company with which the
insider's company has or is about to enter into a transaction;
- secondary insider dealing in the securities of the informant's company;
- secondary insider dealing in the securities of a company with which
their informant's company has or is about to enter into a transaction;
- dealing in a capacity other than an offeror;
- secondary insider dealing by other than the offeror;
- counselling or procuring a person to engage in insider dealing;
- communicating inside information for the purpose of insider dealing;
- primary insider dealing by a public servant;
- secondary insider dealing on the basis of inside information obtained
through a public servant;
- counselling or procuring a person to deal on the basis of inside
information obtained as or through a public servant;
- communicating inside information obtained as or through a public servant
for the purpose of insider dealing.
- The regulation of insider dealing is in the hands of the Department of
Trade and Industry (DTI), and self-regulatory authorities such as the Stock
Exchange and the Panel on Takeovers and Mergers. Inspectors of the DTI have
wide investigative powers if insider dealing is suspected. The self-regulatory
authorities assist the DTI by duly ensuring release of information and
regulating the conduct of their members. Insider dealers may face severe
punishment. By section 8 of the Companies Securities (Insider Dealing) Act
1985, an individual convicted on indictment of any of the above-mentioned
twelve offences is liable to a term of imprisonment not exceeding two years
and/or an unspecified fine.
- Authorised investment businesses are required to fully investigate and
handle all customer complaints. The proper fulfilment of such obligations is
under the supervision of SROs and the SIB, which have intervention powers that
can be used in the interests of investor protection. The SIB is required to
make proper arrangements for the investigation of complaints in respect of
authorised businesses to be carried out in appropriate cases independently of
the SIB and those authorised businesses (paragraph 4(2), Schedule 7, the FSA
1986).
- The SIB may take further actions including prohibiting the employment of
unfit persons, and applying for an injunction or restitution order to restrict
the business of the authorised entities. SROs may also discipline their
members. However, if the authorised businesses in question express
disagreement with the investors' complaints as well as the disciplinary
measures taken by the SIB or SROs, they may appeal to the Financial Services
Tribunal for judgement.
- The Tribunal is an independent body, which functions to prevent the
possible abuse of power by the SIB against the authorised businesses. The
Tribunal has the authority to investigate a case referred to it, and will
compel attendance of communities or persons in question as well as production
of any documentary evidence (section 98(1), paragraph 5(1) of Schedule 6). It
shall be the duty of the Secretary of State for Trade and Industry to decide
on the matter forthwith in accordance with the Tribunal's opinions (section
98(1)). According to section 54(1), the SIB may make rules establishing a
scheme for compensation of investors who are owed money or other assets by an
authorised business which has become insolvent, either deliberately through
fraud or from poor trading. This provision permits creation of a centralised
compensation scheme, known as "the Investors' Compensation Scheme", applying
to all members of participating SROs and all directly authorised businesses,
under which affected investors have chance to be paid up to £48,000 at
present.[26]
- Generally speaking, as regards foreign investors, the above discussed
three facets in the UK financial markets have assumed fundamental importance.
The highly developed financing facilities provides foreign companies with
opportunities of seeking sources for external fund raising, either through the
traditional credit vehicles or via seeking public listing. In this sense, the
UK's capital markets have an efficient mechanism and are mature enough to
enable foreign companies as borrowers to issue claims which could be properly
arranged to be taken up by those willing to accept.
- Foreign banks may take advantage of the UK's active money markets, foreign
exchange market, financial futures and options market to carry out both
international and domestic banking business, particularly Eurocurrency finance
and foreign exchange transactions. However, setting up representation needs to
be supervised by the Bank of England for safeguarding the interests of
depositors as well as protecting bank counterparts. Due to the existence of
the UK's mature and well-developed investment industries, it is worthwhile for
foreign companies to tap into the various financial markets by carrying on
investment business from the angle that they act as brokers, agents, advisers
or market-makers. The FSA 1986 is intended as a system of regulation relating
to the entire investment sector, from large financial institutions to small
investment advisers.
[1] The Stock Exchange Publication, "Going Public", 1992, p. 5.
[2] Ibid.
[3] The Stock Exchange Publication, "A Listing in London -
Europe's Leading Market-Place", 2nd Edition, May 1994, p. 7.
[4] The Stock Exchange Publication, "Going Public", 1992, p. 9.
[5] The Stock Exchange Publication, "A Listing in London -
Europe's Leading Market-Place", 2nd Edition, May 1994, p. 7.
[6] Ibid, p. 8.
[7] Curwen, Peter, "Understanding the UK Economy", Macmillan,
1992, p. 99.
[8] Pawley, Michael, Winstone, David, Bentley, Patrick, "UK
Financial Institutions and Markets", Macmillan, 1993, p. 45.
[9] Ibid.
[10] Penn, Graham, "Banking Supervision - Regulations of the UK
Banking Sector under the Banking Act 1987", Butterworths, 1989, pp. 157-161.
[11] The London Stock Exchange Publication, "A History of The
London Stock Exchange", 1993, p. 13.
[12] Ibid.
[13] LIFFE Publication, "LIFFE An Introduction", 1993, p. 1.
[14] Ibid, p. 3.
[15] Pennington, Robert R., "The Law of the Investment Markets",
Blackwell Law, 1990, p. 17.
[16] The London Commodity Exchange Publication, "Contract
Specifications: Commodity Futures and Options", 1994, p. 3.
[17] Pennington, Robert R., "The Law of the Investment Markets",
Blackwell Law, 1990, p. 49.
[18] Ibid.
[19] SFA Publication (1993), "An Outline of SFA", p. 2.
[20] Blair, William; Allison, Austin; Palmer, Keith;
Richards-Carpenter, Peter, "Banking and Financial Services Act", Butterworths,
1993, p. 69. Also see Rider, Barry, Chaikin, David, and Abrams, Charles,
"Guide to the Financial Services Act 1986", CCH Editions Limited, 1987, p. 30.
[21] FIMBRA Publications, "Categories of Membership", "How to
join FIMBRA", 1993.
[22] Blair, William; Allison, Austin; Palmer, Keith;
Richards-Carpenter, Peter, "Banking and Financial Services Act", Butterworths,
1993, p. 70. Also see LAUTRO Publication, "A Self-Regulating Organisation",
1993, p. 5.
[23] SIB Publication, "The Background to Investor Protection",
1992, p. 13.
[24] Littlefair, Harry, "Investment and Savings Guide 1993-1994",
Longman, 1993, p. 31.
[25] Rider, Barry, Chaikin, David, and Abrams, Charles, "Guide to
the Financial Services Act 1986", CCH Editions Limited, 1987, p. 99.
[26] Ibid, p. 93. Also see SIB Publication, "The Background to
Investor Protection", 1992, p. 13.
