Working paper / Johann-Wolfgang-Goethe-Universität, Institut for Law and Finance
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148
André Prüm has asked me to talk about “La Théorie de l´organe” supposing that this is a German invention. Well, we cannot claim the authorship or copyright for that, but it is true that this doctrine is still dominating German doctrinal thinking in company law. Let me first look at the historical development and background of this theory and then ask for its actual meaning and practical consequences.
147
„Corporate groups are a fact of life“.1 This was the starting point for a group of renowned European experts to deliver a report on a possible Directive on corporate group law in 2000.2 We all know that no such Directive has been issued.3 However, these days a fresh group of eminent experts has started, among other things, to develop an initiative „on groups of companies“.4 One reason for a European regulation to take its time might be the enormous national differences in dealing with group situations. While some countries, notably the UK,5 rely on general company law to deal with corporate groups, others provide most detailed rules specifically for groups of companies.6 German law provides an example for the latter. Do we need a law of corporate groups? Most countries regulate one or another aspect of group law.7
This is probably most common for tax and for accounting law. Insolvency law will often take group situations into account and the same is true for labour law. Regulatory oversight for financial institutions or insurance companies usually includes a group dimension. Competition law necessarily does so as well. However, in what follows when we speak about „group law“ we will focus on regulation more specifically tuned to genuine questions of company law such as the protection of minority shareholders or creditors, the standards for managerial behavior and the „enabling“ function of legal structures.
146
Capital maintenance rules are part of a legal capital regime that consists of rules on raising capital and rules on maintaining it. The function of these rules is the protection of the corporation’s creditors. This is evidenced by the fact that in public as well as private companies the provisions on legal capital are not open to disapplication or variation even with unanimous shareholder consent. Thus, providing the company with a minimum of funding and ensuring equal treatment of shareholders are mere reflexes of creditor protection or, at best, ancillary purposes of legal capital. Legal capital is part of a corporation’s equity. The key feature of equity is that it ranks behind the claims of other stakeholders in the distribution of a corporation’s assets. Consequently, equity will also be the first part of a corporation’s funds to be depleted by losses. Capital maintenance rules seek to enforce this order of priority of different groups of stakeholders by restricting distributions to shareholders. Such restrictions are not unique to legal systems that have adopted a legal capital regime. A prominent example of a statute that has eliminated mandatory legal capital is the Delaware General Corporation Law. § 154 DCGL leaves it up to the directors to decide whether any part of the consideration received by the corporation for its shares shall be attributed to capital. Thus, a Delaware corporation need not have any stated capital. This has significant impact on the funds available for distribution to shareholders. Pursuant to § 170 (a) DGCL dividends may only be paid out of surplus or, in the absence of surplus, out of net profits of the current or the preceding fiscal year. § 154 DGCL defines surplus as the excess of a corporation’s net assets over the amount of its capital, and net assets as the amount by which total assets exceed total liabilities. A corporation without stated capital may, therefore, distribute all of its net assets to its shareholders and continue business without any equity on its balance sheet. This highlights the difference between the different approaches to creditor protection in Germany and the U.S. Both legal systems acknowledge the priority of creditors over shareholders in corporate distributions. However, German law seeks to give creditors additional comfort by requiring companies to raise and maintain additional layers of assets above and beyond those corresponding to the company’s liabilities that may not be depleted by way of distributions to shareholders. While private companies must merely raise and maintain their stated capital, public companies are required to raise and maintain additional equity accounts unavailable for distributions to shareholders such as the share premium account1 and the legal reserve.2
In recent years a number of objections have been raised against this concept of creditor protection. Critics argue that contractual arrangements are a more efficient means for protecting the interests of creditors.3 Capital maintenance does not prevent creditors from negotiating for more stringent protection of their claims such as collateral or financial covenants. It does, however, provide a minimum standard of protection for the benefit of creditors who lack the commercial experience or the bargaining power or who, like tort victims, are simply unable to negotiate for contractual safeguards. Capital maintenance ensures that their protection against excessive distributions does not depend on large creditors who are free to waive covenants that, in effect, benefit all creditors in exchange for individual arrangements that work exclusively in their favour.
143
9.01 This chapter outlines the development of Contingent Convertible Securities (CoCos) for financial institutions from their theoretical origins to their current form under the European Union’s Fourth Capital Requirements Directive framework and its Bank Recovery and Resolution Directive and examines the effect the framework and the directive have had on their design and ability to fulfill the ends for which they were initially conceived. It examines this from two viewpoints: the policy goals CoCos are meant to achieve and the corporate law issues raised by the requirements of CRD IV. On the policy side we conclude that CRD IV and the RRD have significantly limited the amount of CoCos a financial institution is likely to issue, but expanded their possible forms by including write-down as well as convertible structures and narrowed the differences between them and pure regulatory bail-in structures, thus calling into question whether they are truly ‘going concern’ rather than ‘gone concern’ capital. On the company law side we conclude that a number of issues, in particular the limits on an authorization of management to issue CoCos and shares, the scope of the shareholders’ right of pre-emption, the concept of dilution and the distinction between contributions in cash and in kind merit closer attention than they appear to have received in the current discussion on CoCos.
116
This study examines the legal environment of netting agreements covering financial contracts. It concludes that an international instrument should be developed capable of improving the effectiveness of netting agreements in mitigating systemic risk. To this end, two different aspects of the enforceability of netting agreements are considered: (i) the general enforceability of netting, and (ii) the possibility of precluding the operation of netting a mechanism by way of a regulatory moratorium for considerations of systemic stability. The first part of the study presents the use of netting and the various forms it may take before going on to explain the benefits and drawbacks of enforceable netting agreements. Benefits for individual firms consist in lower counterparty risk and more favourable capital requirements. Benefits for the financial market as a whole flow from greater financial market stability since the contagion of systemically relevant institutions by the default or insolvency of another institution is limited, thus helping to avoid systemic effects. Additionally, the use of netting arrangements can improve overall market liquidity. A potential drawback of enforceability of netting, in certain situations, is that the operation of a netting mechanism could actually work against the purpose of systemic stability where the transfer of parts of the business of an insolvent financial institution to a solvent bridge entity would enhance or maintain value to a greater extent than the operation of a netting agreement would. Regulatory authorities are considering under which conditions a moratorium to halt the netting mechanism until the situation is solved could avoid this threat to systemic stability. The second part of the study examines whether there is the potential to support the purpose of enhanced systemic stability by way of international harmonisation of private and insolvency law. As regards the issue of general enforceability, the global picture of netting legislation is heterogeneous. Given the great practical relevance of the matter, an international instrument could be very useful. As to the issue of private law consequences of regulatory moratoria, the absence of a harmonised framework appears to lead to actual cross-border inconsistency and legal uncertainty as regards financial contracts that are governed by a foreign law. Taking these to aspects into account, this paper recommends that work on developing an international instrument be undertaken. The final part of the study suggests a set of preliminary guidelines for the development of suchan instrument. In the light of the findings of the previous sections, a mixed, two-step approach is recommended. First, a non-binding instrument could be developed, serving as a benchmark and reservoir of legal solutions in respect of the relevant issues. Secondly, isolated aspects relating to both the general enforceability of netting and the accommodation of a regulatory moratorium in foreign private and insolvency law could be dealt with in an international Convention, in particular where cross-border situations involving netting require uniformity of applicable legal rules.
113
The purpose of this essay is to assess the automatic exchange of information as described in EU Directive 2003/48 of 3 June 2003 on taxation of savings income in the form of interest payments with regard to the fundamental right of the individual to a private life, to banking secrecy and the freedoms on which the European internal market is based. The assessment reveals the conflicts of interests and values involved in the holding by banks (particularly those offering private banking services) of increasingly extensive, detailed and intimate information about their clients and in the automatic processing of that information by ever more powerful and sophisticated systems. Banking secrecy plays an essential role in protecting clients against the dangers which the disclosure of such information without their permission might produce. Banking secrecy exists not only in Luxembourg but also in many other European countries, and in Germany and France in particular it is not very different from the system applying in Luxembourg. While the French and German tax authorities do have some investigative powers not enjoyed by their Luxembourg counterparts, those powers are strictly circumscribed and cannot rely on the electronic exchange of information set out in EU Directive 2003/48/EC. While banking secrecy is totally incompatible with the electronic exchange of information, the core question is whether the latter can be reconciled with the respect for private life. In a Europe that sets itself up as the cradle of human rights, the general and en-masse exchange of private information cannot provide adequate and sufficient guarantees that the information exchanged will not be misused. The amount of interference in private life is clearly out of proportion to the public interest involved and is contrary to sub-section 2, article 8 of the European Convention for the Protection of Human Rights and Fundamental Freedoms and to articles 7 and 8 of the Charter of Fundamental Rights of the European Union. Since the automatic exchange of information at least potentially risks restricting the free flow of capital among Member States and discouraging the use of transborder banking services, its compliance with the fundamental principles of the internal market also needs to be closely examined. The restrictions imposed by such exchange very probably go beyond the limits within which the free movement of capital and services is possible. The European Court of Justice has found that there is no proportionality if the measures supposedly undertaken in the general interest are actually based on a general presumption of tax evasion or tax fraud. However, it would be true to say that the ECJ does not always examine the tax restrictions placed on the free movement of capital particularly thoroughly to ensure that they are necessary or proportionate. The economic effectiveness of the automatic exchange of information is far from being proved and involves significant cost to the banks providing the information and to the tax authorities using it. To date the system does not appear to have produced any significant new tax revenue nor does it prevent the continuing outflow of capital from Europe. Yet withholding at source, which respects individual and economic freedoms, does generate tax revenue that is cost-free to the State. Exchange of information on request in justified cases using the OECD Tax Convention on Income and Capital model does also fight tax fraud while at the same time providing citizens with the guarantees required to ensure their private lives are respected. A combination of these two systems - withholding at source and exchange of information on request in justified cases - would create the proper balance between the public and private interest that the automatic exchange of information cannot provide.
110
After the introduction of the euro in 1999, the debate on the financial stability architecture in the EU focused on the adequacy of a decentralised setting based on national responsibilities for preventing and managing crises. The Financial Services Action Plan in 1999 and the introduction of the Lamfalussy process for financial regulation and supervision in 2001 enhanced the decentralised arrangements by increasing significantly the level of legal harmonisation and supervisory cooperation. In addition, authorities adopted EU-wide MoUs to safeguard cross-border financial stability. In this context, the financial crisis has proved to be a major challenge to the ongoing process of European financial integration. In particular, momentous events such as the freezing of interbank markets, the loss of confidence in financial institutions, runs on banks and difficulties affecting cross-border financial groups, questioned the ability of the EU financial stability architecture to contain threats to the integrated single financial market. In particular, the crisis has demonstrated the importance of coupling to micro-prudential supervision a macro dimension aimed at a broad and effective monitoring and assessment of the potential risks covering all components of the financial system. In Europe, following the de Larosière Report, the European Commission has put forward proposals for establishing a European System of Financial Supervision and a European Systemic Risk Board, the latter body to be set up under the auspices of the ECB. While the details for the implementation of these structures still need to be spelt out, they should reinforce significantly – ten years after the introduction of the euro – the financial stability architecture at the EU level.