Securities Regulation & Responsible Investments PDF

Giorgia D’Alessandro SECURITIES REGULATION AND RESPONSIBLE INVESTMENTS - Nicoletta Ciocca Lecture 1: 18/09/2023 Securities regulation in the United States is the field of U.S. law that covers transactions and other dealings with securities. It refers to the body of laws and regulations that govern...

Giorgia D’Alessandro SECURITIES REGULATION AND RESPONSIBLE INVESTMENTS - Nicoletta Ciocca Lecture 1: 18/09/2023 Securities regulation in the United States is the field of U.S. law that covers transactions and other dealings with securities. It refers to the body of laws and regulations that govern the issuance, trading and management of securities in financial markets. When we consider securities, we are referring to bonds, shares/stocks, ABS, derivatives, units of collecting investment funds… Key elements: 1. ISSUERS 2. FINANCIAL INSTRUMENTS (SECURITIES) 3. TRADING VENUE (exchange markets) 4. INTERMEDIARIES between issuers and customers Intermediaries in the context of financial markets are indeed specific professionals or entities that act as intermediaries between buyers and sellers of financial assets. These intermediaries facilitate the matching of supply and demand for various financial instruments. Two common types of intermediaries are: - Banks - Investment Funds, including mutual funds, exchange-traded funds (ETFs) and hedge funds which are investment vehicles that pool together money from multiple investors to invest in a diversified portfolio of financial assets. These intermediaries help bridge the gap between investors who have funds to invest and those who need capital for various purposes, such as businesses looking to expand or governments financing public projects. They are heavily regulated by the European Union. Main pillar of U.S. system: DISCLOSURE Companies and entities issuing securities are often required to register with regulatory authorities and provide detailed information about their financial health, business operations and risks associated with their securities. This information is made available to the public in the form of prospectuses or offering documents. Disclosure is crucial because it allows investors to make informed decisions about buying or selling financial assets. It is fundamental to market efficiency because it ensures that relevant information is widely disseminated and incorporated into asset prices. This, in turn, helps prevent information asymmetry, where some market participants have more information than others. Intermediaries in financial markets, such as banks and investment firms, benefit from disclosure in several ways. By having access to comprehensive and up-to-date information about issuers and their securities, intermediaries can offer better advice to clients, make more informed investment decisions and manage risks more effectively. This knowledge can also enhance their credibility and reputation. 1  Giorgia D’Alessandro However, because incentives for voluntary disclosure can be insufficient, regulatory standards are necessary to ensure a minimum level of information is made available to all market participants, promoting fairness and efficiency in financial markets. "Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman." - U.S. Supreme Court Justice Louis Brandeis (1913) This quote means that when actions, decisions, or processes are exposed to public scrutiny and transparency, it helps to deter wrongdoing, corruption, or unethical behaviour. Balancing individual self-interest with the common good is a central challenge in economics and public policy. Negative externalities often result from the unchecked pursuit of self-interest. Responsible investments and regulatory measures are attempts to align individual interests with broader societal and environmental goals. Second pillar of U.S. system: SUSTAINABILITY The year 2018 marked a significant turning point when it comes to setting boundaries. The challenge lies in finding the right balance: adjusting the rules to align financial resources and directing them towards specific objectives. The starting point for this regulatory effort dates back to the 1929 financial crisis. The Brundtland Report, officially titled "Our Common Future," was published in 1987 by the World Commission on Environment and Development (WCED). The report was named after Gro Harlem Brundtland, the former Prime Minister of Norway, who chaired the commission. The Brundtland Report is a landmark document in the field of sustainable development and environmental policy. It introduced and popularised the concept of sustainable development, which it defined as "development that meets the needs of the present without compromising the ability of future generations to meet their own needs". ESG stands for Environmental, Social, and Governance. It is a framework used to assess and measure the sustainability and ethical impact of an investment or business. Each component of ESG represents a different aspect of an organisation's performance: 1. Environmental (E): This aspect evaluates how a company or investment affects the natural environment. It includes considerations such as a company's carbon footprint, energy efficiency, water management and efforts to reduce pollution and waste. 2. Social (S): The social component looks at how an organisation impacts society and its stakeholders. This can include assessing labour practices, employee relations, community engagement, diversity and inclusion, human rights and consumer protection. It’s based on the ethical aspects and the impact on the community. 3. Governance (G): Governance focuses on the internal structure and management of a company. (For example the parity between men and women). It assesses factors such as board composition, executive compensation, shareholder rights, transparency and 2  Giorgia D’Alessandro adherence to ethical business practices and legal standards. This is less considered than the other two aspects. ESG criteria are used by investors, financial institutions and businesses to make informed decisions about investments, asset management and corporate practices. Companies that perform well in ESG assessments are often seen as more sustainable, responsible and attractive to socially conscious investors. Additionally, ESG considerations are increasingly integrated into investment strategies and corporate governance to promote ethical and sustainable business practices. Sustainability and ESG are often used as synonyms, even if they are not the same. Relevance in Economic Industries: - Reputation: Companies that prioritise sustainability and ESG are often viewed more favourably by consumers, investors, and the public. A strong commitment to these principles can enhance a company's reputation and brand value. - Production-Related Problems: Unsustainable production practices can lead to various problems, such as resource depletion, environmental degradation and harm to local communities. Addressing these issues through sustainable practices can mitigate such problems and reduce long-term risks. - Regulatory Compliance: Many governments and regulatory bodies are implementing stricter environmental and social regulations. Failing to comply with these rules can result in legal and financial penalties. Adhering to sustainability and ESG standards helps businesses remain compliant. - Business Continuity: Sustainability is increasingly seen as a critical factor in business continuity. As concerns about climate change and resource scarcity grow, industries that do not adapt to sustainable practices may face disruption or even extinction. - Environmental Impact: Industries often rely on infrastructures and processes that can be environmentally harmful. Sustainability initiatives aim to reduce the negative impact on the environment by promoting cleaner technologies, resource efficiency, and responsible waste management. In summary, sustainability and ESG considerations are highly relevant in economic industries due to their potential to impact a company's reputation, risk management, regulatory compliance, and long-term business viability. Embracing sustainability practices and adhering to ESG standards can not only enhance a company's ethical standing, but also contribute to its overall resilience and competitiveness in an evolving global landscape. 3  Giorgia D’Alessandro Lecture 2: 19/09/2023 Not only the issuers are the ones who need to disclose information, but also customers. Sustainability is relevant because it is a source of risks, related to the insight of the corporation. Example The automotive industry is a prime example of an industry where sustainability is critical. Concerns about greenhouse gas emissions, air pollution and resource use have driven the need for more sustainable practices. Electric vehicles (EVs), improved fuel efficiency, and alternative fuels are among the innovations aimed at reducing the industry's environmental impact. The European Union has been at the forefront of sustainability efforts, particularly in terms of regulatory standards and environmental goals. Initiatives such as emissions targets, renewable energy mandates and stringent environmental regulations have pushed industries within the EU to adopt more sustainable practices and technologies. THE EUROPEAN BODIES The European Commission, the European Parliament, and the Council of the European Union are three key institutions within the European Union (EU). Each of them plays a distinct role in the EU's governance and decision-making process: 1. European Commission: executive branch. Its primary role is to propose and implement EU legislation and policies, manage the day-to-day affairs of the EU, and represent the EU in international matters. Independent body. - Composition: The Commission is composed of one representative from each EU member state, known as a Commissioner. 2. European Parliament: is the directly elected legislative body of the EU. It shares legislative power with the Council of the EU. It represents EU citizens and has the authority to debate, amend, and pass legislation in collaboration with the Council of the EU. - Composition: Members of the European Parliament (MEPs) are elected by EU citizens every five years. The number of MEPs from each member state is proportional to its population. The Parliament's President is elected by MEPs. 3. Council of the European Union: represents the member states' governments. It is responsible for making decisions on EU legislation, foreign policy and other important matters. - Composition: The Council's composition varies depending on the issue being discussed. For example, when discussing agricultural policies, the Agriculture and Fisheries Council meets, consisting of the relevant ministers from each member state. The European Commission plays a crucial role in shaping and proposing policies and documents related to sustainability. However, the Commission itself may not have the 4  Giorgia D’Alessandro capacity to directly implement these policies. Instead, its role often involves setting the direction and framework for action. To ensure that financial resources are redirected toward sustainable activities, there’s the need to create incentives for sustainable investments, implementing regulatory frameworks that favour long-term sustainability and collaborating with financial institutions to promote responsible investment practices. "Foster Long-Term Investments" can be seen as a guiding principle or motto in official documents. It emphasises the importance of encouraging investments with longer time horizons, especially in the context of sustainability. Some scholars argue that many negative externalities result from a predominant focus on short-term gains. When investments prioritise short-term returns without considering long-term consequences, negative externalities may arise. This underscores the need to balance short-term and long-term interests. The choice between short-term and long-term investments depends on various factors, including the nature of the investment opportunity and the preferences of the investor. Some projects may require longer time frames to yield benefits, while others may be more suitable for short-term gains. Efforts should be made to orient financial markets toward the long term, promoting sustainable investment practices that consider environmental, social and governance (ESG) factors. This alignment can contribute to more responsible and sustainable financial decisions. The quote "In the long run, we are all dead" attributed to economist John Maynard Keynes, reflects a perspective that emphasises short-term considerations. However, it should be balanced with the recognition that long-term sustainability and responsible investments are crucial for the well-being of future generations. While promoting long-term investments is important, a balance must be found. Short-term investments also serve important economic functions and different circumstances may require different investment horizons. The key is to encourage responsible and sustainable decision-making in both the short and long term. Directives and Regulations Directives and regulations are both types of legislative acts used in the European Union (EU) to establish legal standards and regulations. They are both laws and not suggestions. 1. Directive: set out goals or results that EU member states are required to achieve. They provide a framework for member states to develop their national laws and regulations in a way that achieves the specified EU objectives. Directives allow member states some flexibility in how they implement the EU law. They can adapt the directive to their specific legal and administrative systems while achieving the intended outcome. Directives are binding on member states, not individuals or businesses directly. Member states are obligated to take the necessary measures to ensure the directive's objectives are met. Directives typically provide member states with a specified period of time to write their national rules and laws to comply with the directive. This allows for a gradual adaptation to the EU's goals and objectives. The period allowed for transposing directives into national laws provides member states with time to understand, evaluate and adapt the EU's goals to their specific circumstances. 5  Giorgia D’Alessandro 2. Regulation: are more detailed and specific than directives. They are used when a uniform application of the law across all member states is necessary. Regulations are typically used for matters that require a high level of harmonisation across the EU. Regulations create uniform rules and standards that are directly applicable and enforceable in all EU member states without the need for further national legislation. Regulations are binding on both member states and individuals or businesses within the EU. Unlike directives, regulations do not require member states to pass additional national legislation. They become part of the national legal system automatically. Regulations offer clear boundaries and standardised rules that member states must follow without much room for interpretation. The choice between using a directive or a regulation is not based on specific topics, but is a preliminary decision made at the EU legislative level. This decision determines whether member states will have flexibility in implementation (directive) or strict uniformity (regulation).The adoption of directives and regulations involves decisions made jointly by the European Commission and the Council of the EU. In the realm of finance, EU legislation often combines both regulations and directives. This mixture allows for a balance between harmonisation and flexibility in the financial sector, addressing various aspects of financial regulation and supervision. EU's sustainable finance agenda main actions: 1) TAXONOMY REGULATION 2) BENCHMARKS 3) DISCLOSURE Taxonomy Regulation and its significance in classifying environmentally friendly industries and businesses within the European Union (EU). The Taxonomy Regulation plays a central role in classifying and defining which economic activities and industries can be considered environmentally friendly or "green." This classification is essential for promoting sustainability within the EU. To determine whether an industry or business qualifies as environmentally friendly, the Taxonomy Regulation provides a system for verification and scoring. This system assesses whether the necessary criteria and requisites are met for sustainability and environmental responsibility. The Taxonomy Regulation addresses the need for transparency and disclosure in the financial sector. It ensures that businesses and financial institutions accurately represent their environmental credentials, allowing investors and the public to make informed decisions. The Taxonomy Regulation serves as a guide for directing investments towards sustainable and environmentally responsible activities. It helps ensure that financial resources are channelled in a way that aligns with EU sustainability goals and objectives. In promoting the transition to a more sustainable economy, the Taxonomy Regulation provides essential instruments and guidelines. These instruments aid businesses, financial institutions and investors in making the necessary shifts towards sustainability. 6  Giorgia D’Alessandro The Taxonomy Regulation was enacted in 2020, marking a significant milestone in the EU's efforts to create a standardised framework for environmentally friendly activities and investments. Benchmarks serve as reference points that allow investors to measure and compare the performance of investments. In the realm of sustainability, benchmarks are crucial for measuring the environmental impact of investments. They provide a standardised framework for evaluating how much a particular investment contributes to or mitigates carbon emissions and other environmental factors. Some aspects of impact, such as carbon emissions reduction or social benefits, are not naturally measurable in monetary terms. Benchmarks provide a structured way to assess and compare these non-financial aspects, making it easier to compare different investments and assess their performance consistently. The importance of disclosure in the financial industry, particularly in the context of regulatory frameworks, is represented by MiFID (Markets in Financial Instruments Directive) and MiFID II.They place an emphasis on reinforcing disclosure practices and require financial intermediaries to provide investors with comprehensive and relevant information about financial products and services. Investors often rely on financial intermediaries, such as banks and investment firms, to make informed investment decisions. These intermediaries play a crucial role in providing information and guidance to investors. MiFID and its successor, MiFID II, are regulations aimed at standardising rules for financial markets and services across the European Union. MiFID II, introduced in 2014, added new rules and requirements to the original MiFID framework. It introduced rules governing how financial institutions must interact with customers and what information they must provide. These regulations aim to ensure that customers receive fair treatment and have access to essential information. MiFID II expanded on the concept of disclosure by introducing additional layers to ensure that customers are not only provided with information but are also actively questioned to understand their needs and risk profiles better. The ultimate goal of these regulations, including MiFID II, is to ensure that customers receive all the necessary information to make informed investment decisions. This helps direct investments in a way that aligns with the customers' financial goals and risk tolerance. The Sustainable Finance Disclosure Regulation (SFDR) and its relevance to financial intermediaries, investment funds, and asset managers. SFDR is a regulatory framework that requires financial intermediaries, including asset managers and investment funds, to disclose their sustainability policies and practices. It aims to enhance transparency and prevent "greenwashing," where investments are falsely marketed as environmentally friendly. - Investment Funds: are vehicles that pool money from multiple investors and are managed by professionals. They can take various forms, including specialised investment funds that focus on specific asset classes or strategies, and index-tracking funds that replicate market indices. 7  Giorgia D’Alessandro - Asset managers: are responsible for making investment decisions on behalf of investment funds and their clients. They play a critical role in defining the investment strategies and portfolio compositions. SFDR requires financial intermediaries to clearly define their investments, including specifying whether they invest in government issuers or other types of assets. This helps investors understand the nature of the investments they are exposed to. SFDR includes provisions to prevent greenwashing, which is the practice of exaggerating or misrepresenting the environmental benefits of an investment. By forcing disclosure of sustainability policies and practices, SFDR aims to ensure that environmental and social criteria are genuinely considered in investment decisions. It establishes specific parameters and requirements for the disclosure of sustainability-related information. This ensures that the information provided is consistent and comparable across financial intermediaries. In the world of finance and securities markets, there is a complex network of participants that includes issuers, intermediaries, and customers. Here's an overview of each of these key players: 1. Issuers: are entities that issue securities to raise capital. These entities can be corporations, governments, or other organisations seeking to raise funds for various purposes. Issuers issue various types of securities, including stocks (equity securities) and bonds (debt securities), which investors can purchase. 2. Intermediaries: are financial institutions or professionals that facilitate the buying and selling of securities in the financial markets. They act as intermediaries between issuers and customers. Common types of intermediaries include investment banks, brokerage firms, stock exchanges, and asset management companies. Intermediaries play various roles, such as underwriting securities, providing brokerage services, managing investment funds, and offering investment advice. Intermediaries provide liquidity to the market, ensure compliance with regulations, and assist customers in executing trades. 3. Customers: also known as investors or traders, are individuals, institutions, or entities that buy and hold securities for investment purposes or engage in trading activities. Customers can include individual retail investors, institutional investors (such as pension funds and mutual funds), and corporations. Customers invest in securities to achieve various objectives, including capital appreciation, income generation, portfolio diversification, and hedging against risk. The interaction between these three groups forms the foundation of the securities market. Issuers raise capital by selling securities to investors through intermediaries, who facilitate the buying and selling of these securities. Customers, in turn, make investment decisions based on their financial goals and risk tolerance. The roles and relationships among these participants are governed by regulatory frameworks, stock exchange rules, and industry standards, all of which contribute to the efficient and transparent functioning of securities markets. 8  Giorgia D’Alessandro Pre-2018: Before 2018, certain companies were already obligated to disclose additional reports about sustainability and non-financial information. These requirements went beyond traditional financial reporting and aimed to provide stakeholders with insights into a company's environmental, social, and governance (ESG) practices. The obligation to share non-financial sustainability reports was initially limited to a small sample of companies. This meant that only a subset of issuers was required to disclose this type of information. Transition Period: Currently, we are in a period of transition regarding sustainability reporting requirements. This transition involves expanding and standardising the disclosure of non-financial information by a broader range of companies. Corporate Sustainability Reporting Directive 2022: The Corporate Sustainability Reporting Directive (CSRD) is a significant development. It is expected to come into effect in 2022 and will expand the scope of companies obligated to disclose non-financial information. Under the CSRD, more companies issuing securities will be required to provide comprehensive sustainability reports. The goal of these evolving regulations is to enhance transparency and accountability in corporate sustainability practices. By obliging a wider range of companies to disclose non-financial information, investors and stakeholders can make more informed decisions and assess a company's ESG performance. These reporting requirements are in line with global sustainability goals, such as the United Nations Sustainable Development Goals (SDGs) and the Paris Agreement. They encourage companies to integrate ESG factors into their business strategies and decision-making processes. Lecture 3: 20/09/2023 Primary Market: is where the issuance of new securities takes place for the first time. It is the market for the initial sale of securities by issuers to investors. IPO: An IPO is a common event in the primary market. It involves a company's first-time sale of shares to the public, allowing it to raise capital by becoming a publicly traded entity. In the primary market, issuers raise fresh capital by selling newly created shares or bonds directly to investors. These transactions help companies finance their operations and expansion. Secondary Market: is where previously issued securities are bought and sold among investors. It does not involve the issuing company directly. While an IPO may be structured with the intention of eventually trading on a stock exchange like Borsa Italiana, the secondary market is where these securities are traded after the initial offering. It is the market where investors buy and sell shares or bonds of existing companies. Stock exchanges are regulated markets where securities are bought and sold. Listing on a stock exchange involves announcing to the market that a company's securities are available for trading on that exchange. Listing on a stock exchange does not always occur immediately after an initial public offering (IPO). While it's possible to list directly after an IPO, there may be a time gap between the 9  Giorgia D’Alessandro two events. The announcement of listing can vary in intensity. It may be a formal announcement made to a broader audience or a more targeted communication to a specific group of investors. Whether an offering qualifies as an IPO depends on various factors, including the number of addresses or potential investors. If an offering is addressed to a sufficient number of addressees, it is considered an IPO. Regulatory authorities often establish thresholds and rules to determine when an offer is considered to be made to the public. Once these thresholds are reached, specific regulations and disclosure obligations come into play. Being listed on a stock exchange triggers additional disclosure and regulatory obligations for the issuing company. These obligations are put in place to ensure transparency and investor protection. Every listing assumes that there has been an IPO, but not every IPO immediately leads to listing. Listing represents the company's presence on a stock exchange, while an IPO marks the initial sale of shares to the public. PRIMARY MARKET → IPO → LISTING IPO → PROSPECTUS Prospectus sections: 1. Summary: - The prospectus often begins with a summary section that provides an overview of the document. It may include details such as the total number of pages, the organisation of chapters or sections, and a brief summary of key information. 2. Issuer Information: - The issuer section provides comprehensive information about the company issuing the securities. This includes details about the company's history, operations, industry, competitive positioning, and future plans. The goal is to ensure that investors are well-informed about the issuer's background and prospects. 3. Offer Information/Characteristics of Shares: - This section covers the specifics of the offering itself, including the type and quantity of securities being offered. It may include details about the offering price, any discounts or underwriting fees, and the proposed stock exchange where the securities will be listed. Certainly, the "issuer" is the entity or company that creates and legally owns the securities being offered. The "offeror" is the party or entity making those securities available to investors under specific terms and conditions. These two roles can be different, and it's important for investors to understand both when considering an investment opportunity. An offer, in the context of securities or financial products, typically refers to the solicitation made by a company to sell its securities to potential investors. A prospectus is a legal document that provides detailed information about the company and the securities being offered. It is intended to inform potential investors about the investment opportunity.It's common for financial documents to adhere to specific legal formats and terminology to ensure compliance with regulations to ensure consistency and comparability among different issuers (companies offering securities), regulators often provide templates or guidelines that issuers must follow when creating their prospectuses. This helps investors easily compare different investment opportunities and make informed decisions.The primary purpose of a 10  Giorgia D’Alessandro prospectus is to provide full and fair disclosure of relevant information to potential investors.Prospectuses play a crucial role in this process by providing comprehensive information to investors in a standardised format. This helps investors make informed decisions and promotes confidence in the financial markets. ISSUER 1. Types of Issuers: Issuers can be categorised as financial or non-financial. Financial issuers typically include banks, insurance companies, and other financial institutions. Non-financial issuers encompass companies from various industries, such as manufacturing, technology, healthcare, and more. 2. Model: type of organisation (private/public). Corporate law can vary significantly from one country to another. The regulations governing disclosure requirements, corporate governance, and issuer classifications may differ at the national level. These differences can impact how companies are categorised and what information they must disclose. 3. Capitalization and Company Size: The capitalization of a company is a measure of its size and financial strength. It's typically calculated by multiplying the number of outstanding shares by the market price per share. Companies can be classified as large, middle (mid-cap), or small (low-cap) based on their capitalization. This classification is used to gauge the company's relevance and market presence. There may be varying disclosure requirements for companies of different sizes. Larger companies often have more extensive disclosure obligations due to their greater impact on the market and investors. Over time, disclosure requirements have evolved to better meet the needs of investors and the changing business landscape. Regulators may adapt these requirements to ensure that investors receive relevant and meaningful information for making investment decisions. In stock exchanges, companies are often classified into various indices or categories based on their industry, size, and other factors. These classifications help investors and analysts track and compare companies within specific sectors or groupings (sample companies in the Stock Exchange). ISSUERS AND INVESTORS Financial markets rely on a complex network of participants, including issuers seeking capital, investors seeking returns, and financial intermediaries like banks and investment firms that facilitate the flow of capital between the two. Banks often raise funds from the public through various deposit and savings products. They use these funds, along with their own capital, to provide loans and finance various activities, including investments in securities. This is a core function of traditional banking. Banks and investment firms offer placement services where they help issuers find investors for their securities. This involves marketing and distributing the securities to potential buyers. These services are typically available only to qualified financial intermediaries. Placement, also referred to as placing, is a financial service provided by banks and investment firms to assist issuers (usually companies or entities) in raising capital by selling 11  Giorgia D’Alessandro their securities to investors. This service involves the process of marketing and distributing these securities to potential buyers, which can include individual and institutional investors. In Italy, SIMs are authorised to provide various financial services, including helping issuers place securities with investors. Gatekeepers, such as regulatory authorities and professional oversight bodies, help maintain the integrity of financial transactions and protect the interests of all parties involved. Auditors are professionals or auditing firms responsible for examining a company's financial statements and providing an independent assessment of their accuracy and compliance with accounting standards. They play a crucial role in verifying the reliability of financial information. Auditors are often considered gatekeepers because their certification enhances the credibility and transparency of a company's financial statements. Rating agencies, such as Moody's, Standard & Poor's, and Fitch Ratings, assess the creditworthiness and risk associated with various financial instruments, including bonds and securities. They assign credit ratings to these instruments, which help investors gauge the level of risk involved. These are all entities that are doing formal checking and are formalised organisations. UNDERWRITING AND FIRM COMMITMENT In the context of securities offerings, such as initial public offerings (IPOs) there are two common methods used in the issuance and distribution of securities: 1. Underwriting: - Underwriting involves a financial institution (the underwriter) purchasing all or a substantial portion of the securities being offered by the issuer before the offering is made to the public. - In this scenario, the underwriter assumes the full risk of purchasing the securities from the issuer, regardless of whether they can find investors to purchase the securities later. - The underwriter commits to purchasing the securities at a predetermined price, which is usually set in advance, and then they take on the responsibility of reselling the securities to investors. - If the IPO or securities offering is successful, the underwriter may profit from the difference between the purchase price and the resale price. However, if the offering is not successful, the underwriter bears the financial loss. More expensive than firm commitment. Placing is expensive and the service is between the issuer and the placer. It has an indirect effect on the investor. 2. Firm Commitment: - Firm commitment underwriting is a specific type of underwriting in which the underwriter agrees to purchase the entire issue of securities from the issuer, regardless of whether they can resell them to investors. - The underwriter essentially guarantees the issuer a fixed amount of funds for the securities upfront, which provides certainty to the issuer. 12  Giorgia D’Alessandro - The underwriter takes on the risk of any unsold securities. If they are unable to find investors to purchase the securities at the agreed-upon price, they must absorb the loss. - This method provides more assurance to the issuer but places a significant risk on the underwriter. The placer does not subscribe, he just looks for investors. Binding commitment to buy at a later stage. Risk of success is on the placer. INVESTORS Types of Investors: 1. Retail Investors: individuals who invest their personal funds in financial markets. They may have varying levels of knowledge and experience in investing. Regulations often provide special protections for retail investors due to their potential vulnerability. 2. Professional Qualified Investors: These are investors who meet specific criteria set by financial regulations. They typically possess a certain level of knowledge, experience and financial capacity. As qualified professionals, they may have access to a wider range of investment opportunities and fewer regulatory protections than retail investors. - Eligible Counterparties: In the context of the Markets in Financial Instruments Directive (MiFID), eligible counterparties are entities such as financial institutions, investment firms, and other professionals. They are considered to have sufficient knowledge and experience to participate in financial markets without the same level of regulatory protections as retail investors. Final Addressee: The concept of the final addressee relates to who is the intended recipient of specific financial information or regulatory requirements. It can vary depending on the context and the type of financial transaction: 1. Spontaneous Sharing: This term typically refers to the sharing of financial information or investment opportunities with individuals or entities who are considered highly knowledgeable, experienced and capable of making informed investment decisions on their own. They may not require the same level of regulatory protection as less experienced or less qualified investors. 2. Mandatory Disclosure of Prospectus Regulations: In certain situations, such as public offerings of securities, regulations may mandate the disclosure of a prospectus. This prospectus is a comprehensive document that provides detailed information about the securities being offered. The final addressees, in this case, would include both retail and qualified investors. Retail investors are provided with mandatory disclosures to ensure they have the information needed to make informed decisions and are protected by regulatory requirements. 13  Giorgia D’Alessandro Private placement: - Clarity of Bond Quality: Private placements involve the sale of securities, such as bonds, to a select group of investors rather than the general public. In these transactions, it's important that investors can easily assess the quality and risk associated with the bonds being offered. - Mandatory Disclosure: Disclosure requirements in private placements may vary depending on the jurisdiction and the type of investors involved. Mandatory disclosure is essential when there's a need to provide investors with information to make informed investment decisions. Security Reaching the Public: - New Disclosure Requirements: If securities originally offered through a private placement are later resold to the public, additional mandatory disclosure may be necessary. This ensures that investors in the secondary market have access to relevant information. Issuer and Offering: in some cases, the issuer of the securities in a private placement may be the same entity making the offering. This can occur when a company wishes to raise capital by selling bonds directly to a specific group of investors. There are often thresholds that determine when an issuer is obligated to prepare and distribute a prospectus. These thresholds may vary by jurisdiction and are typically based on the size of the offering. Prospectus: a prospectus is a comprehensive document that provides detailed information about securities being offered to the public. It involves a process of writing, obtaining regulatory approval, and publishing for potential investors. - Writing - Approval - Publishing In Europe, including Italy, regulatory authorities like CONSOB (Commissione Nazionale per le Società e la Borsa) play a crucial role in supervising financial markets, ensuring disclosure, and promoting transparency. While there is a regulatory framework at the European level (e.g., ESMA - European Securities and Markets Authority), the supervision of prospectus requirements and disclosure typically falls under the jurisdiction of national regulators. Each member state of the European Union may have its own authority responsible for these matters. There isn't a single European entity responsible for checking prospectuses; instead, it's done on a national basis. This reflects the principle of subsidiarity in European regulation, where responsibilities are allocated to the lowest effective level of government. 14  Giorgia D’Alessandro Lecture 4: 25/09/2023 The Prospectus Regulation (EU) 2017/1129 is a piece of legislation that was initially enacted on June 30, 2017, as the original version of this regulation.Over time, amendments were made to the original text of the Prospectus Regulation. These amendments can result from various factors, such as changes in the regulatory environment, the need for updates, or feedback from stakeholders.When amendments occur, the EU typically creates consolidated versions of regulations. These consolidated versions integrate the changes made through amendments into the original text and the purpose of consolidated versions is to provide a single, up-to-date document that reflects the current state of the regulation.This consolidated version would have included the original text along with any new additions or changes made through amendments up to 2018. The Initial Public Offering (IPO) doesn't require immediate listing, but any listed company should have undergone an IPO. Regulatory speaking the two cases are detached. This suggests that there are separate regulations for these processes. The regulation is enacted by the EU and applies within the EU. It does not regulate outside of it, even if overcoming digital barriers is relatively easy, but the regulation itself is strict, and there is no overlapping with other regulations. Article 1: Requirements and Distribution of the Prospectus: creation, approval, revision and publishing of prospectuses. Scenarios Requiring a Prospectus: 1. When Securities Are Offered to the Market: This means that if a company or entity is making a public offering of securities, they are generally required to provide a prospectus to potential investors. This document provides essential information about the securities being offered. 2. Offer to the Public: In the context of securities regulation, an offer to the public refers to making securities available for purchase by a wide range of potential investors. This could include various types of investors, such as retail investors. Exemptions from Prospectus Requirements: a. Value of the Security: the value or denomination of the security being offered may determine whether a prospectus is required. Some regulations may exempt smaller offerings from the prospectus requirement. b. Qualification of the Addresses: the nature of the addresses (the intended audience). For example, certain sophisticated or institutional investors may not require the same level of disclosure as retail investors. c. Thresholds for Small Offers: in some jurisdictions, if an offer does not reach a certain threshold in terms of size or value, it may be considered a small offer and, therefore, exempt from the requirement to publish a full prospectus. In essence, the regulation of prospectuses is designed to strike a balance between providing investors with essential information to make informed decisions and allowing flexibility for 15  Giorgia D’Alessandro smaller or specialised offerings. The concept of regulation on a regulated market is a process that entails dialogue. It’s more difficult to understand when we have an offer to the public: ex. social media. We have to define the boundaries, it’s where we have exemptions or exclusions. 12-Month Criterion: To accommodate both one-shot and tranche (multiple-stage) scenarios for public offers, the regulation considers a 12-month period. This means that the criteria for whether a prospectus is required are assessed over a 12-month period to capture various offering scenarios. Paragraph 3 of the regulation imposes a strict obligation for offers below 1 million euros. It essentially prohibits both EU member states and national authorities from requiring a prospectus for offers below this threshold. In other words, no prospectus can be requested for offers under 1 million euros, regardless of national rules or regulations. The term "gold plating" refers to the practice of a member state imposing stricter rules or requirements than what is required by EU law. In this context, the EU aims to prevent member states from imposing additional or stricter prospectus requirements for offers below 1 million euros. The EU wants to ensure uniformity and prevent individual member states from making the rules more stringent. Thresholds for Prospectus Requirements: - Below 1 Million Euros: No prospectus is required, neither on the basis of EU regulations nor national rules. (It’s a sort of prohibition) - In between 1 and 8 Million Euros: Member states have the freedom to set either more strict or less strict prospectus requirements depending on their discretion. This allows member states some flexibility within this range. - Above 8 Million Euros: An obligation for the prospectus applies, and issuers are required to prepare and provide a prospectus for offerings above this threshold. Nobody can set any obligation to impose a prospectus. The criteria for determining when a prospectus is required under the EU Prospectus Regulation. 1. Overall Measure of the Offer (Amount of Euros): the total amount of euros (denomination) involved in the securities offer. If the offer exceeds a certain threshold, typically defined in the regulation, a prospectus is required. This criterion is straightforward and objective, as it is based on a specific monetary amount. 2. Quality of the Investors (Qualified): is more subjective and pertains to the quality or qualification of the investors participating in the offer. To avoid triggering the prospectus requirement, the issuer needs to demonstrate that the investors meet certain qualifications or criteria. If the issuer cannot substantiate the qualification of investors as required by the regulation, there may be consequences. 3. Number of Investors: considers the number of investors participating in the offer. While there are no specific limitations on the type of investors, there is a boundary set in terms of the number of investors involved. If the number of investors exceeds a certain threshold, 16  Giorgia D’Alessandro which is often set at 150 natural or legal persons per Member State, a prospectus may be required. A detailed explanation of the concepts related to the denomination, par value, and market value of securities, as well as the criteria used for selecting investors under the EU Prospectus Regulation. Denomination per Unit (Par Value): The denomination per unit, often referred to as the par value, represents the nominal or face value assigned to each individual security, such as a share or bond. It is essentially the formal value that is initially set by the issuer. For example, if a company issues shares with a par value of $1 per share, each share is initially worth $1 according to the company's records. Market Value: The market value of a security is the actual value of that security in the open market. It is determined by supply and demand, investor sentiment, company performance, and various other factors. Market value can fluctuate and may be higher or lower than the par value. For example, a share with a par value of $1 may have a market value of $20 if the company is performing well and investor demand is high. Efficient financial markets are characterised by market prices that generally reflect the actual or intrinsic value of securities. In such markets, the market value closely aligns with the actual value of the security, making it an efficient mechanism for pricing assets. Under the EU Prospectus Regulation, there are specific criteria for selecting investors and these are two relevant ones: a. Denomination per Unit: The denomination or par value per unit of the security is one criterion used to determine the type of investors who can participate in an offering. b. Consideration (Price) per Unit: A threshold of 100,000 units has been chosen, which means that investors who wish to participate must meet this threshold in terms of the number of units they are purchasing. Additional exemptions (paragraph j) under the EU Prospectus Regulation, specifically regarding credit institutions (banks) issuing bonds. It's clear that these exemptions have evolved over time. In the past, credit institutions, such as banks, were granted a broad exemption from the obligation to publish a prospectus when issuing bonds. This exemption was based on the belief that bonds issued by banks were inherently secure and safe for investors. As a result, banks were not required to provide a prospectus for bond offerings. Over time, there was a reevaluation of this exemption and changes were introduced to specify the conditions under which banks could be exempt from publishing a prospectus for bond offerings. The exemption is now limited to a specific scenario: - Type of Security: The exemption applies to "non-equity securities," which typically include bonds. - Issuer: The issuer must be a bank. 17  Giorgia D’Alessandro - Offering Nature: The securities must be issued in a continuous and repeated manner. - Size Limit: The total value of the securities offered must not exceed 75 million euros. To benefit from this exemption, the non-equity securities issued by banks must meet specific criteria: - Non-Subordination: The securities must not be subordinated to other obligations. - Non-Exchangeability: They must not be exchangeable for other securities. - Non-Tradability: They must not be tradable in secondary markets. - Non-Convertibility: They must not be convertible into other financial instruments. The exemption now requires that the securities issued by banks be "plain-vanilla" or very simple in nature. This shift is likely due to concerns about the complexity and potential risks associated with certain types of structured or derivative-like bonds. This change reflects a more cautious approach to investor protection and transparency in financial markets, especially in the context of complex financial instruments. Paragraph k → Crowdfunding is a method of raising capital that utilises the internet to connect investors with businesses or projects seeking funding. It is primarily regulated at the national level because crowdfunding activities often involve local businesses and investors. Italy was one of the early adopters of specific regulations to facilitate crowdfunding. The main financial regulation in Italy, known as TUF (Testo Unico della Finanza), regulated crowdfunding, allowing certain private companies to use crowdfunding platforms up to 8 millions (around 2012). Italy's approach aimed to support crowdfunding as an opportunity for businesses. The EU enacted a detailed regulation on crowdfunding to create a common framework across member states. This regulation, known as the Common European Framework, sets specific rules and thresholds for crowdfunding activities within the EU. The trade-off discussed likely relates to how crowdfunding (M2: amendment inserted in the regulation in 2020) activities intersect with the requirements for prospectus disclosure. The EU regulation sets a threshold for crowdfunding offers, stating that if the amount offered does not exceed 5 million euros, a prospectus is not required. The concept of "safe harbour" (= exemption following guidelines) in this context likely means that if the issuer of crowdfunding offers complies with the EU regulation's requirements, they are exempt from having to prepare and publish a full prospectus. Non-compliance with the EU regulation on crowdfunding may result in various consequences: - Criminal Consequences: This could lead to penalties, including potential jail time, for individuals or entities involved in serious violations. Focuses on punishment and deterrence through legal action. - Administrative Sanctions: Non-compliance may also lead to administrative fines imposed by regulatory authorities. Involves regulatory penalties to enforce compliance. - Civil Consequences: Those who have suffered damages due to non-compliance may seek compensation through civil proceedings. Aims to compensate victims and remedy damages. The damage must be restored and to demonstrate. 18  Giorgia D’Alessandro If the obligation of the prospectus stands, there can be criminal, administrative or civil consequences but the goals are totally different. The primary goal of these consequences, whether criminal, administrative, is to protect the public interest and maintain the reliability of the financial market. Deterrence is an important aspect to discourage violations. Offering securities to the public An offer to the public can be made through various means, as mentioned in Article 2, paragraph d. This can include methods such as social media, pigeon (perhaps humorously referring to unconventional means), billboards, or any other form of communication. The key is to provide sufficient fundamental information about the quantities and terms of the offer to enable potential investors to make an informed decision. In order to have a recognizable offer, we have to read it on the basis of a general middle man, making an assessment on its own. The definition of securities can be broader than just traditional shares and bonds. It may include units issued by investment funds, warrants and certain types of derivatives. The exact definition may vary depending on legal and regulatory frameworks. MiFID (Markets in Financial Instruments Directive): Article 4, point 44 of MiFID likely elaborates on what is considered a "security". Qualified investors are typically individuals or entities that meet specific criteria allowing them to participate in certain types of investments, often with fewer regulatory protections. These criteria can vary by jurisdiction. A circular offering is a standardised and repeated manner of making offers. It may not be legally required, but is often used for convenience, especially in cases where similar offers are made repeatedly. In the context of the European Union's prospectus regulation, when an issuer wishes to offer securities in multiple EU member states, it designates one member state as the "home member state" where it undergoes the regulatory approval process. Once approved in the home member state, the issuer can use a "passport" to offer the securities in other EU member states without having to follow separate procedures for each. (paragraph m) Some issuers, especially in specific sectors of the bond market, may choose to select a different member state as the home member state if they prefer that member state's legal framework over their own. This exemption is designed to provide flexibility to issuers. 19  Giorgia D’Alessandro Corporate law is typically a matter of national regulation, while prospectus regulation follows a different approach that considers the concept of a home member state and allows for EU-wide passporting of prospectuses. London and Luxembourg: markets for bonds. The notion of security is a bit longer than shares and bonds. It included units issued by funds, it may include warrants, derivatives (certain types). Find the MIFID (in the folder on TEAMS), article 4, point 44. What does the notion of security include? Does this notion include only traditional, simple securities, convertibles? Lecture 5: 27/09/2023 MiFID, page 15, point 44: ‘Transferable securities’ Transferable: 1. Circulate 2. Negotiability: capital markets Transferable: the ability of a financial instrument to circulate and be negotiable, primarily on capital markets. It's important to note that being transferable doesn't necessarily mean the instrument has to be listed. The definition remains open-ended because financial practices can change over time. In essence, it signifies the instrument's capability to be traded, especially on capital markets. While transferability is a key aspect, there can be limitations on the ease with which a security can be transferred. These limitations can vary depending on the issuer's country of origin and the regulatory framework governing corporate law. Penalties for non-compliance may vary accordingly. It's worth emphasising that the name or label of a security (e.g., 'Donald Duck' bonds) is irrelevant in this context. What truly matters is the structure of the security and its characteristics. Transferable securities can include shares or equivalent instruments, bonds or equivalent instruments, warrants, and convertible bonds. The key feature is that they can be acquired or sold. It’s like an exchange between a current and a future one. Conversion can be one method to acquire security: exchange with another security. Reverse Convertible Bonds Reverse convertible bonds are intriguing financial instruments, often considered a hybrid because they combine features of both bonds and derivatives. These financial products are 20  Giorgia D’Alessandro structured as bonds when initially issued, but their performance is closely tied to the price movements of specific underlying assets, typically the shares of a particular company. Here's a more detailed look at how they work: - Bond Structure: At the outset, a reverse convertible bond is delivered to investors as a bond, which means it has a fixed face value and pays periodic interest to the bondholder. - Underlying Asset: However, what sets reverse convertible bonds apart is that they are intricately linked to the performance of an underlying asset, usually a certain stock or group of stocks. Specifically, if the price of the underlying asset remains above a predetermined threshold during the bond's tenure, the bondholder will receive their principal back in cash at maturity. Crucially, if the price of the underlying asset falls below this predetermined threshold, the bondholder does not have the right to receive the face value in cash at maturity. Instead, they may receive the underlying asset itself. From a financial perspective, reverse convertible bonds exhibit characteristics of bonds when the underlying asset performs well, as the investor receives cash at maturity. However, if the performance is unfavourable, it may resemble a derivative, where physical delivery of the underlying asset occurs. These bonds are often considered exotic financial instruments because their performance is tied to the outcome of a specific event, in this case, the performance of the underlying asset. “Securities” Securities: financial instruments → Economic scholars pov In the context of MiFID (Markets in Financial Instruments Directive), it's crucial to define the term "securities" precisely. This definition has significant implications for regulatory purposes: MiFID intentionally excludes certain financial instruments from the category of securities, and this exclusion is by design. Specifically, instruments of payment, such as cash, credit cards, debit cards, and electronic payment methods (e-cards), are not considered securities under MiFID. The exclusion of payment instruments is logical as these instruments primarily serve as mediums of exchange or means of payment rather than investment vehicles. Shares used as a form of payment, for example, resemble a barter system rather than a traditional investment. MiFID narrows its focus to financial instruments that are typically used for investment purposes rather than day-to-day financial transactions. This ensures that the directive is tailored to regulate securities and related financial activities effectively. Cryptocurrencies and Regulatory Challenges: Cryptocurrencies (ex. Bitcoin and Etherum) have introduced a new dimension to the financial world. They are not subject to traditional securities regulations and MiFID (Markets in Financial Instruments Directive) because they represent a novel form of investment. 21  Giorgia D’Alessandro The world of crypto assets is incredibly diverse, and this diversity poses a significant challenge in terms of how to regulate them. Each cryptocurrency may have unique characteristics, use cases, and features. In response to the challenges posed by crypto assets, the European Union (EU) has introduced a new set of regulations known as the Markets in Crypto-Assets (MiCA) framework. MiCA is tailored to address the specific characteristics and issues surrounding cryptocurrencies within the EU. The existing regulatory frameworks like the Prospectus Regulation and MiFID were not designed to address the complexities of cryptocurrencies. They do not provide the clarity needed for the regulation of these digital assets. MiCA was introduced to address the regulatory gaps in the crypto asset space. It aims to provide a comprehensive and consistent framework for crypto assets, ensuring consumer protection and market integrity while fostering innovation. The definition of a "security" in traditional financial regulation is quite distinct. Cryptocurrencies challenge this notion, as they do not neatly fit into the existing categories of securities or payment instruments. Cryptocurrencies were originally conceived as a means to decentralise financial transactions, reducing the reliance on traditional intermediaries. Ironically, a significant portion of cryptocurrency trading occurs on centralised platforms hosted on the web. It's important to note that cryptocurrencies are often treated as instruments of payment, and they are typically excluded from the scope of securities regulation. However, this distinction can be complex, as some cryptocurrencies may also have investment attributes. The concept of what constitutes a "security" in the context of cryptocurrencies remains a dynamic and evolving one. ‘Middle man’: financial intermediaries. Article 5 - Subsequent resale of securities The regulation isn't limited to primary markets but extends to secondary markets as well. It stresses the need to distinguish between an offer to the market and a safe harbour in the secondary market, with a focus on assessing whether reselling securities constitutes a public offer. The crucial question is: Are we making an offer to the market, or are we within the safe harbour? There is no inherent distinction between the primary and secondary markets in this context, but a careful assessment is necessary. This assessment primarily centres around the concept of an offer, its public nature, and the exemptions that might apply. Example - CIRIO Bonds (https://www.dirittoegiustizia.it/#/documentDetail/9149515) When it comes to reselling securities, the critical question is whether it amounts to a public offering or not. This determination should have been made with consideration of Article 5. Italian banks, for instance, began reselling these bonds without necessarily consulting legal experts. This was because the reselling process was structured as a bilateral negotiation between the bank and individual clients. From a technical standpoint, this wasn't seen as a resale to the public since it wasn't presented to all clients collectively. However, the tricky 22  Giorgia D’Alessandro part of applying Article 5 in such scenarios is that it wasn't a single, unmistakable public offering. If it had been, there would be no ambiguity about its classification. Article 5 aims to address this complex scenario by reminding us that the obligation under the prospectus regulation is not limited to the primary market. Whenever there's an inkling that the public might be involved, heightened awareness is essential. The key question arises: What constitutes the resale of securities? Is it a one-time, definitive offering, or can we view reselling securities as an ongoing process? From the issuer's standpoint, after the initial issuance of securities, they may no longer be directly concerned with their subsequent resale. However, the issuer and the offeror may be distinct entities, adding complexity to the situation. Ultimately, the goal of the prospectus regulation is to ensure transparency and investor protection in the market. It encourages careful consideration and legal expertise in determining whether securities reselling actions fall within the regulatory framework. Article 6 - the Prospectus Article 6 of this regulation delves into the essential elements that must be included in a prospectus, emphasising the importance of providing investors with material information required to make informed assessments. 1. Comprehensive Information: Article 6 underscores that a prospectus should encompass critical information necessary for investors to make informed judgments. 2. Clarity and Comprehensibility: The article also emphasises that the information presented in the prospectus should be written and structured in a manner that is easily understandable, concise, and analyzable. 3. Composition of the Prospectus: Article 6 provides flexibility in how a prospectus can be structured. The issuer, offeror, or entity seeking admission to trading on a regulated market can choose to compile the prospectus as a single document or as separate documents. It's important to understand the rationale behind this obligation, as it aims to strike a balance between transparency and practicality: 1. Materiality Emphasises Relevance: Materiality ensures that the information provided in a prospectus is directly relevant to investors' decision-making processes. Including only material information prevents the prospectus from becoming overly burdensome and ensures that investors can focus on the critical factors influencing their investment choices. 2. Avoiding Bureaucracy: The regulation aims to avoid unnecessary bureaucracy and excessive administrative burdens on issuers. Requiring that information be material means that issuers do not have to inundate potential investors with every detail, but rather only present what truly matters for their investment assessment. 23  Giorgia D’Alessandro Non-material information can be vague and challenging to verify. By focusing on materiality, regulators aim to enhance the accuracy and reliability of the information provided in a prospectus, making it easier for investors to trust and use this information. Some information may already be available in the market through other means. Requiring that information be material prevents duplicative reporting and ensures that the prospectus provides unique insights that investors cannot easily obtain elsewhere. In a world without prospectus or mandatory regulations, there could be a reduction in historical information available to investors. Issuers may not voluntarily disclose sufficient information, leading to an information gap. Companies may be reluctant to share information that gives competitors a competitive advantage. This is where the regulatory intervention comes into play – by mandating the disclosure of material information, regulators bridge the gap created by underproduction in the market. The underproduction of information can lead to market failure, as investors may make suboptimal decisions due to the lack of essential data. Mandatory disclosure through prospectuses helps address this market failure and ensures a more efficient and informed investment landscape. A counter objection to this last point. Even without the legal intervention, naturally the issuers will produce the information. TRY TO FIND THE REASONS FOR THAT! Lecture 6: 02/10/2023 Information Asymmetry and Akerlof's Theory Information asymmetry refers to situations where one party has more information than another, leading to an uneven playing field (not on the same level). Akerlof's theory, often referred to as the "Market for Lemons" illustrates how this information gap can lead to market failure. Market failure occurs when a market cannot efficiently allocate resources on its own. Causes of Market Failure and Reasons for Public Intervention: - monopoly power, where the issuer controls all the information and can fix prices without competition; - the presence of public goods or negative externalities; - the lack of information sharing for the fear of revealing advantages or threats. Example - Market for Used Cars: In the market for used cars, buyers may not trust sellers, leading to uncertainty about the quality of the product. This uncertainty can result in lower prices for all cars, regardless of their actual quality (peaches or lemons). Peaches: the car that will never let you down. Lemons: the worst bargain. For financial markets to operate efficiently, information must be shared so that investors can make informed decisions. Investors may demand lower interest rates if they have a clear understanding of what they are buying. 24  Giorgia D’Alessandro Inefficient financial markets can reduce overall wealthfare (economic well-being). To address information asymmetry and market failure, mandatory disclosure regulations can be implemented. The necessity of mandatory disclosure is debated, and there are alternative ways to address information asymmetry and market failures. Mandatory disclosure is a form of intervention by authorities to ensure transparency and mitigate market failures. One key assumption is that investors are rational and act in their best interests. 1. Inability to solve the market failure 2. Reduction in general wealthfare 3. Intervention in a mandatory way of the authorities Behavioural Economics: In traditional economics, we depart from the assumption of complete rationality among market participants. Instead, in behavioural economics we acknowledge that individuals are often influenced by biases, which necessitates adaptations to traditional economic theories. The question arises: can we anticipate either sufficient or insufficient production of information in such an environment? Are biases a deterrent to the sharing of information? 1) Herd Behavior: is a phenomenon where market players tend to mimic the actions of others, even if it goes against rational decision-making. As John Maynard Keynes once observed, "People prefer to fail like all the others rather than succeed in their own specific way". 2) Status Quo: Irrational players may exhibit a strong attachment to the status quo, making them reluctant to alter their behaviour or share information. This resistance to change is driven by a desire to maintain the existing state of affairs. 3) Social Norms: play a significant role in shaping behaviour within economic contexts. It is imperative to adapt our approach in light of these behavioural nuances. We can no longer take rationality for granted due to the presence of biases. It becomes essential to assess whether these biases lead to insufficient information sharing. Based on this assessment, we can determine whether a prospectus is necessary or whether existing information suffices. Economics can make a valuable contribution to this field. It reveals that even behind legal frameworks, there is a strong economic foundation. Structured Prospectus The structured prospectus can be presented as a single document or divided into separate parts for ease of comparison. It consists of the following sections: 1. Summary 2. Registration Document: This part pertains to the issuer and includes relevant information about the company. 3. Securities Note: In this section, you can find detailed information concerning the securities being offered. 25  Giorgia D’Alessandro It is important to note that regulations stipulate the use of clear and comprehensible English in the prospectus to ensure accessibility to all readers. The current structure of the prospectus can be quite intricate, especially for repeated issuers, such as those in the bond market (non-equity). These issuers may make multiple bond offerings without losing control of their company's equity. The absence of a cap on the number of bond issuances creates a need for simplification in the prospectus structure, because we assume that it will be able to repay the debt. It’s valid for bond issuers, but also for equity issuers that expect to issue several times. To simplify the process for issuers, two solutions have been established: 1. Base Prospectus (Article 8): for non-equity securities that tap the market several times. This historical approach involves creating a foundational prospectus containing general terms and conditions (issuer, security…), but lacks specific details (final terms and conditions) about each issue. For each tranche, a supplement is published with the essential features. The approval process primarily focuses on the prospectus and the template for final terms, eliminating the need for subsequent checking procedures. This anticipatory procedure reduces time and effort for issuers, with an obligation to update when significant changes occur. It’s a sort of privilege. 2. Universal Document (Article 9): for equity and non-equity securities. This innovation in prospectus regulation benefits issuers admitted to operate on regulated markets (RM) or multilateral trading facilities (MTF) outside the official one. Alternative trading venues can be used, according to MiFID and sometimes are cheaper, quicker and let you exchange larger quantities. If an issuer has securities admitted to trade, there might be the need for the issuer to issue repeatedly. Therefore, it’s advisable to give a simplification and to make it smoother for the company. Companies may prepare and publish a universal registration document for each financial year, which focuses on the issuer's details (first pillar of the prospectus). After two consecutive approvals, subsequent filings do not require a new registration document, offering greater efficiency. The issuer decides when to issue the Securities Note, the second part of the prospectus, which requires authority approval but features a shorter timeline. This structure streamlines future offerings, with all transaction details outlined in the base prospectus and offer-specific information in the Securities Note. Competent authorities must accept and approve the prospectus before its publication. The term "shelf registration" implies that preparations are underway, but the prospectus is already available, awaiting use. (THIS KIND OF NOTION CAN BE THE OBJECT OF THE EXAM: high level of details) First part of the Prospectus: Summary 26  Giorgia D’Alessandro The summary is intended to provide actual information that will be read by potential investors. The key concern is ensuring the accuracy and absence of misleading information in the summary. While there is significant emphasis on its content, concerns about its length and size persist. However, attaching excessive accountability would be excessive. This underscores the need to strike a balance between the amount of information required. The decision to purchase securities should be based on the entire document. Consequently, the summary should be regarded as an introduction to a more comprehensive document. If information in the summary is not entirely complete, investors are expected to read the entire document, and they cannot complain about the need to do so. Determining the issuer of the security is a critical aspect. Regulations (norm of primary level) governing prospectuses are detailed and specific, including guidelines on document formatting. The order of sections cannot be altered, although the addition of subparagraphs is permitted. In private law, false information as a source of damage has been a subject of considerable debate. If you have suffered unjust damage, you may be entitled to restore the situation. However, the issue of whether you are eligible for restoration in cases involving unfair prejudice remains uncertain. Civil liability is linked to the prospectus, and to address any potential issues, Article 11 specifies that the offeror, the entity seeking to trade in the market (receiving a sponsor), must adhere to national rules. National rules govern how to file for restoration and handle civil liability, ensuring consistency across member states. The validity of the prospectus is typically 12 months after approval, but the specific procedures and timing may vary depending on certain conditions. Sustainability in the Prospectus With the exception of one point related to sustainability, you will not find explicit mentions of sustainability in the prospectus regulations. Article 16 deals with risk factors and outlines how this provision addresses them. These risk factors may pertain to the issuer, the securities, or other relevant aspects. The aim is to present them in the prospectus, but not to an excessive degree. The objective is to address risks honestly while also exercising restraint in explaining material risks that could affect the decision to buy or not. Although the term "sustainability" may not appear explicitly in the prospectus, there are sustainability-related issues that require disclosure due to their material risk. Even without explicit chapters, there are indications in the regulations regarding disclosure of sustainability-related information. ESMA document: Public Statement - sustainability disclosure in prospectuses This document does not introduce a new legal provision but serves as a guidance document on how to interpret and apply the existing prospectus regulation concerning sustainability disclosures. It outlines how issuers and offerors should handle sustainability-related disclosures without the necessity of inserting a separate section or chapter in the prospectus (it’s implicit). In essence, the guidance emphasises that sustainability-related matters should be considered and integrated into the prospectus preparation process. While the prospectus regulation itself does not explicitly mandate a separate section on sustainability, it implicitly 27  Giorgia D’Alessandro encompasses these aspects. This approach, while comprehensive, may pose challenges in terms of ensuring consistent presentation and comparability of sustainability-related information within prospectuses. Lecture 7: 03/10/2023 (read the relevant chapter of the book for the Prospectus) MiFID Directive: the directive is not immediately mandatory for investors. It becomes binding because it requires member states to incorporate MiFID into their legal systems. MiFID has been around for some time, with the latest version dating back to 2014. Member states were given a window of opportunity to transpose MiFID into their systems. It is a directive that leaves little room for interpretation, providing extremely detailed rules, which can be seen as restrictive rather than granting freedom. One key concept in MiFID is the prohibition of "gold plating," where member states are not allowed to impose stricter rules than those set by the EU. The European Union establishes a minimum standard, and member states cannot exceed it. This standardisation is crucial to ensure a level playing field. While there can be variations in the organisation of intermediaries because it’s a national matter, how they are regulated is defined by the directive. MiFID addresses two main pillars: 1. Intermediaries and Investment Services: These are fundamental components (pillars) of any financial market. Whether you require a broker's services or need investment advice, intermediaries play a critical role in expanding the range of services available. 2. The Market: MiFID regulates market venues in terms of disclosure. Although it may seem to primarily focus on the secondary market, it also has relevance in the primary market. While it's less common for an issuer to offer securities for the first time, subsequent offerings are more likely. So, it's not entirely accurate to say that MiFID exclusively deals with the secondary market. This distinction is significant in the financial world, but holds less legal relevance. MiFID is a comprehensive regulation, composed of many additional sources that often reference the MiFID framework. Intermediaries: The primary rationale behind regulating investment services is to limit their provision to a select group of entities. Investment services are reserved; not everyone is allowed to engage in certain business activities. Only specific entities are permitted to offer these services. Investment services represent a list of business activities that are exclusively available to credit institutions and banks, and these entities must be authorised by competent authorities to provide such services. In the Italian system, this authorization depends on the goals and is granted by the Bank of Italy and CONSOB, depending on the specific type of activity. MiFID restricts the provision of investment services to the following entities: - Banks 28  Giorgia D’Alessandro - Investment firms Without proper authorization, there is no legitimate way to offer these services, and those who attempt to do so may face both criminal and administrative consequences. Specific group of entities, subject to an authorization that has to be requested to the home state. The rules governing these entities aim to address three main objectives (goals): 1. Prudential Regulation: Entities must maintain adequate capital endowment. The initial capital of a company must be readily available, and there is a continuous obligation to ensure that the financial endowment is maintained in its entirety. 2. Business Organization: To obtain authorization, entities must be incorporated in specific forms of companies. Once incorporated, there are specific rules governing how the business should be organised, including aspects such as office locations and policies. This is designed to ensure efficiency and prevent conflicts of interest, requiring policies, procedures, and department structures. 3. Business Conduct Rules (how to handle customers): MiFID outlines numerous rules governing the relationship between intermediaries and customers. It details how intermediaries should interact with customers, handle their requests, and emphasise the importance of disclosure in maintaining transparency. The concept of "Chinese walls" although not mandated by MiFID, is an example of how businesses can organise themselves to reduce potential conflicts of interest by segregating business units. MiFID, or Markets in Financial Instruments Directive, primarily governs the sale of financial instruments and securities within the European Union. It's essential to first understand the broad definition of financial instruments, similar to how the term 'security' is defined in the Prospectus. These financial instruments can also include derivatives. The architecture of MiFID relies on a specific system of defining financial instruments. Clarity is necessary in distinguishing between securities and derivatives. Authorised entities for conducting financial activities are determined by law. Banks, for example, must perform specific activities and receive authorization to be recognized as such. MiFID has evolved differently in various EU states. The market conditions, the number of financial instruments, and the need for regulation can significantly differ. Differences in market development must be considered while implementing MiFID. MiFID acknowledges that there are various trading venues available, including: - RMs (Regulated markets or stock exchanges), - MTFs (Multilateral Trading Facilities), - OTFs (Organised Trading Facilities) - Other scenarios and aims to regulate and oversee these venues to ensure investor protection and to smooth the differences between the markets. The choice between the venues depends on the costs 29  Giorgia D’Alessandro and the benefits and sometimes there are markets that have securities that the others are not allowed to sell. In general, the structure is more or less the same. Goal: try to ensure there is a similar play for the investors. In the past, in Italy there was the "concentration rule", which aimed to encourage trading on the same stock exchange. MiFID seeks to regulate such rules and aims to strike a balance between freedom and regulation. It emphasises the importance of disclosure, ensuring that investors have access to information about how the market is organised. Certain activities in financial markets may be restricted to specific entities, and MiFID likely addresses the criteria for who can engage in these activities. MiFID provides a framework for various aspects of market structure, such as the timing of negotiations, order placement rules, and transaction volume. Stock exchanges like Borsa Italiana and Euronext are public corporations, not state-owned. This implies that ownership of stock exchanges can vary, but it doesn't necessarily dictate their regulation under MiFID. Overall, MiFID is designed to provide a regulatory framework for financial markets in Europe while allowing for some flexibility to accommodate regional differences and the diverse needs of market participants. It seeks to ensure fair and transparent markets while promoting competition and investor protection. Prospectus: obligation to do something. If the MiFID is the directive on markets and financial instruments, what are the financial instruments? MiFID II (Directive 2014/65/EU) Annex 1, Section C, page 122 (...) Very long list (4-10) of derivatives. Derivatives can have a wide range of underlying assets. Originally, derivatives were primarily associated with commodities and they were non-financial at all. Traditionally it was conceived in order to separate securities from commodities and utilities. However, this distinction has become increasingly blurred. In the United States, separate regulatory authorities oversee these different categories of derivatives, and engaging in derivative trading often requires authorization. 30  Giorgia D’Alessandro When it comes to derivatives with a financial element: - Futures are standardised contracts, while forwards are not. - Options provide the holder with a right but not an obligation. - Swaps involve an exchange between parties. The financial aspect of a derivative often centres around cash settlement, which is particularly relevant in Point 10. In Point 4, derivatives can involve both physical and cash settlement. In such cases, the financial aspect is defined by the financial instrument itself. For Points 4 and 10, the relevant factors include: - The nature of the underlying asset. - The method of settlement, which qualifies the derivative as a financial instrument. - The trading venues where the derivatives will be traded (as mentioned in Point 6). MiFID covers derivatives anchored to financial assets, as well as commodities with cash settlements and even commodities delivered and traded on specific trading venues. In terms of the Prospectus, it typically applies only to Category 1 securities. MiFID has an extended scope, encompassing derivative contracts that traditionally might be considered outside the financial market, with certain exceptions. As for the rest that falls outside of these categories, it may not be subject to MiFID regulations. In a bilateral transaction involving a financial intermediary, the object of the transaction is typically a financial instrument. The financial intermediary acts as either the buyer or seller, based on their possession or future acquisition of the financial instrument. The transaction's success depends on the negotiated price. The core of this process involves the financial intermediary determining a favourable price when dealing with an account. The bank may engage a broker, and the financial intermediary earns a fee, exposing them to specific risks. The bank may further engage the market or another financial intermediary to meet the customer's requirements. The process typically adheres to specific trading venue regulations. Object of the transaction: financial instruments Investment services: 1. Dealing on the account. 2. Executing orders on behalf of the client (brokering). 3. Placing financial instruments (securities) to the public. 4. Investment Advice: give recommendation to the client. Before it was a free activity, now there is an express authorisation. 5. Portfolio management: the client comes and gives to the manager the right and the power to set a strategy for the managing of the portfolio. It’s a customised service. It’s a contract where the investor gives the authorization to manage the portfolio, maintaining the ownership of it. It’s a bilateral transaction. General advice that lacks a specific link to individual investors does not require authorization: it’s called recommendation. 31  Giorgia D’Alessandro For investment funds or collective investments, the manager assumes control of funds and individual investors lose decision-making power as their assets are pooled together. Lecture 8: 04/10/2023 - Investment firms are authorised entities that provide investment services. Typically, these firms are organised as companies, except for investment advisory services, which may be offered by a natural person who meets the MiFID requirements. Dealers, brokers, and portfolio managers are examples of roles within investment firms that usually require the establishment of a corporate entity. - Trading venues, also known as markets, are platforms where financial instruments are bought and sold. Article 4 - Definitions Investment services: 1. Dealing own account (Article 4.6): The entity conducting this activity must typically be organised as a company. 2. Execution of orders on behalf of client (Article 4.5): the bank or the investment firms finds a counterparty for a client’s order. It can be found on a trading venue. The bank or the investment firm may use a certain number of venues to facilitate the matching of orders, earning a fee for this service. 3. Portfolio management (Article 4.8): the portfolio (wallet) contains financial instruments and also cash on behalf of a client. Portfolios are tailored to individual clients' needs, with the portfolio manager making adjustments as necessary. To streamline management, portfolio managers often offer prepackaged investment strategies, creating a broad benchmark tailored to a specific client. While the client owns the portfolio, the management process tends to be highly standardised, focusing on individual client relationships rather than collective strategies. The portfolio manager finds a market and creates a specific policy to it, understanding the specific need. Standardisation is implemented by the investment firm to attract customers. Prepackaged strategies are presented in brochures with promises to adhere to specific investment guidelines. Each customer owns their portfolio, and in practice, it is highly standardised with no collective dimension; instead, it involves a 32  Giorgia D’Alessandro one-on-one relationship with each client. The entity is the financial intermediary and not the single person who is the portfolio manager. The portfolio management activity refers to the Bank that is a company. 4. Advice (Article 4.4): fundamental piece. It’s personal. According to the definition it is irrelevant who asks for the advice: it could be a client or a customer request. That is really a blurred area, when you deal with an investment firm it is really difficult to establish who is asking for the investment service. This is because they actively ask for a customer and it may create confusion or be tricky. 5. Reception and transmission: Reception and transmission is a service provided by certain banks where they are unable to carry out investment dealings directly. In such cases, the bank acts as a broker, receiving orders from clients and then transmitting these orders to another investment firm capable of executing them. This practice is more common among smaller banks with limited resources and a specific focus on these activities. Typically, these banks lack an extensive network for direct investment services and are primarily conduits for order placement. They earn a small fee for facilitating this service. 6. Placing: it’s a service offered to an issuer. The customer of the placing is the issuer or the offerer (company or a person). It’s rational to rely on a placer. The placer has to propose the financial instruments to the potential investors. This investment service is unique because it involves the issuer as the customer. The placer's oblig