Capital Markets Overview

Capital Markets

• Capital is anything with value to its owner, vital for companies and economies
• Types of Capital:
  • Economic capital: monetary and non-monetary resources boosting growth
  • Business capital: money and productive assets for growth
  • Working capital: daily operational funding
  • Equity capital: value creation funding
  • Debt capital: short-term/long-term, sometimes project funding
  • Trading capital: regulatory minimum fund requirement
• Capital markets are venues where funds are exchanged (equity, bonds, etc.)
  • Suppliers and users of capital include households and institutions
• Primary market: new securities (stock, bonds) are issued and sold.
• Secondary market: existing securities are traded.
• Public market: securities are offered/traded to the public (most liquid).
• Private market: restricted offering/sale/trading (private placements).
• Liquidity: ability to provide the lifeblood of economies/companies (availability of capital), market for speed of sale, financial for meeting obligations.
• Large public markets boost security liquidity.

History of Capital Markets

• Early in Netherlands (14/15 cen), US (18th cen)
• "Robber Barons" = wealthy industrialists. "Bucket Shops"= no underlying securities.
• WWI boom, New Deal/WWII growth, energy/inflation crises, 2000s market fluctuations/illiquidity.

Securities Laws

• Securities Act of 1933: regulates sales to issuers.
  • Main objectives to ensure investors have all material (average investor would find relevant) information before investing and prevent fraud.
• Registration requirements for public offerings, disclosure/registration process detailed.
  • Foreign companies issuing in foreign markets and PIPEs (private investment in public equity) aren’t subject.
• Prospectus: investment report in public offerings (often with “red herring” preliminary form).
• Private placements: securities sales outside public markets, do not need SEC registration, but still need to follow anti-fraud provisions.
  • Materiality definition can be different in private placements.

Securities Act of 1934

• Regulates trading on secondary markets
• Created the Securities and Exchange Commission (SEC).
• Increased public company disclosures.
• Covers proxy solicitations and tender offers.
• SEC role: regulates market conduct, registers and regulates players (brokerages, custodians, SROs), disciplines entities, requires reporting.
• Public reporting companies: made a registered public offering, certain assets/investors, listed securities requirements.

Other Acts

• Investment Company Act of 1940: regulates companies investing in securities.
• Investment Advisers Act of 1940: registers investment advisors.
• Trust Indenture Act of 1939: debt securities offered to the public need a trust indenture.
• Sarbanes-Oxley Act of 2002: enhanced corporate responsibility, disclosure, and accounting oversight.
• Dodd-Frank Act of 2010: comprehensive financial regulation overhaul.
• JOBS Act of 2012: reduced regulation for business access to public capital markets.

Regulations

• Regulation D: Rule 504 (microcaps, up to $10m), 506 (established issuers, unlimited but pre-existing relationship or accredited investors).

• Rule 504 ($10 million in any 12-month period, sold to any investor type, microcaps)

• Rule 506 (unlimited amount, to unlimited accredited but 35 other non-accredited investors)

• Regulation A: "mini-IPO" (public sale of securities, less disclosure, fastest route to the public markets).

• Rule 144A: resale of unregistered securities to Qualified Institutional Buyers (QIBs), exclusively for QIBs, no trading prohibition.

• Regulation S: offshore offerings not subject to U.S. registration requirements, when it is not subject to '33 Act

• Interplay of Reg S and Rule 144A: facilitates global offerings, private placements in the U.S., concurrent use, fungible (one can be exchanged for the other identical thing)

• ADRs (American Depository Receipts): negotiable certificates representing ownership in non-US company shares, traded in US dollars, cleared through US systems

  • Levels I, II, and III have differing SEC requirements.

• GDRs (Global Depository Receipts): similar to ADRs, trade internationally.

Cases: Brazil and The Lost Decade

• Brazil: Instruction 169 and Constitutional changes accelerated foreign investment.
• The Lost Decade (1980s):
  • Emerging markets heavy reliance on bank loans (restrictive foreign investment laws).
  • "Country risk" was underestimated initially.
  • Flight capital reduced potential capital return.
  • Rising interest rates and devaluing currencies complicated loan payments.
  • Banks had "cushions" but loans and interest grew to exceed cushion size.
  • Mexico's moratorium triggered a cascade of defaults.
  • Restructuring agreements (Baker, Brady plans): new loans, structural reform, but no debt forgiveness.
  • Brady bonds: reduced and exchanged loans for liquid bonds, collateralized/US government backed.
  • Challenges to sovereign debt restructuring:
    • No tribunal to enforce agreements.
    • Difficult to get full consensus due to holdouts, no collections mechanism.
  • Argentina defaulted to commercial debt, wanted to write off 75% and faced lawsuits.