Author:	Xiaoyang Zhang Lecturer of Business Law, The Open University of Hong Kong
Subjects:	Finance - Law and Legislation - United Kingdom Investments - Foreign - Law and Legislation - United Kingdom
Issue:	Volume 7, Number 1 (March 2000)
Category:	Current Developments

Contents

• Introduction
• Available Sources of External Finance
  • Traditional Credit Facilities
  • Listing on the Stock Exchange
    • Key Considerations of Suitability for Listing
    • Methods of Going Public
    • The Listing Particulars
    • Flexible Treatment is afforded to Companies Incorporated Abroad
• Establishment of Representation by Foreign Banks
  • UK Subsidiary
    • Capital Adequacy and Liquidity Control
    • Control of the Bank's Controller(s)
    • Risk Protection Control
  • Branch and Representative Office
  • Single Banking Licence Scheme
• Direct Access to Conducting Investment Business
  • Concept of Investment Business
  • Attractions of Major Investment Markets
    • The London Stock Exchange
    • LIFFE
    • The Commodity Markets
  • A Two Tier Regulatory System
    • The SIB as the Leading Regulator
    • SROs as the Second Tier Regulators
  • Routes to become authorised
    • Direct Authorisation by the SIB
    • Authorisation by an SRO
    • Automatic Authorisation to EU-based Companies
  • Measures for Investor Protection
    • The Way to Seek Business
    • Insider Dealing
    • Investors' Complaints and Compensation
• Conclusion
• Notes

Introduction

1. The financial markets in the United Kingdom (UK) may fulfil many economic functions. However, considering their relevance to foreign investors, their roles basically ought to be threefold. First, they should facilitate the raising of capital by foreign investors who resort to external finance to sustain business. Second, they should provide a place where foreign financial institutions (banks or other concerns of similar nature) can establish their corresponding presence in the market and carry out banking business in the UK. Thirdly, foreign investors (mostly foreign financial conglomerates) can gain direct access to conducting investment transactions in the market under the UK's on-going self-regulatory framework. This paper examines the structure and performance of the above primary roles played by each of the UK financial markets in foreign investment operations.

   Available Sources of External Finance

2. Foreign investors wishing to raise finance in the UK have a number of options in order to do so. While traditional credit facilities are generally available by means of bank loans or bond issues, in order to raise medium and long term capital of a large size, it is generally advantageous to have shares listed on the International Stock Exchange. This plays a central part in the UK's capital markets.

   Traditional Credit Facilities

3. Traditional credit facilities are represented by financing investment projects by means of various loans or issuance of bonds.

4. Loans may be advanced by either a single bank, or where the sum involved is a large one, by a syndicate of banks. Short term credit may be used to cover overdrafts, obtain cash advances or bankers' acceptances. These facilities are typically repayable on demand and may require a fixed or floating charge over the borrower's assets.

5. Medium and long-term loans are also available, especially for the large, strong borrowers. They normally have a draw down period, a grace period and a repayment period. In any case, lending institutions expect to be satisfied by the business plan, cash flows and earning performance of the project as a source of funds from which the loan will be repaid. In practice, lenders will invariably require certain forms of security or guarantees for the loan provided.

6. Foreign companies, especially top-quality ones, may issue bonds as medium to long term debt instruments, usually at a fixed rate of interest. The structure of a typical bond issue involves, in addition to the issuer, three significant groups: a. The managers who are responsible for managing the issue and preparing the relevant documentation; b. The selling group who place the bonds with outside investors; and c. The underwriters who are large financial institutions agreeing to purchase any part of the issue not sold by the selling group.

7. Compared with conventional loan arrangements, bond issues are likely to bring about several benefits. This includes a more favourable interest rate and a certain publicity to be achieved. This may in turn facilitate subsequent access to the market, while at the same time the issuers do not deplete the availability of resorting to the existing banking sources. However, public bond issues might be more expensive and onerous than directly applying for loans.

   Listing on the Stock Exchange

8. The objective of raising finance can be well fulfilled by having Shares listed on the Stock Exchange.

9. A full listing may afford a foreign company many advantages. First, an offer of equity shares to the public is an appropriate way of raising new funds, since the prestige attached to a full listing may well make it easier for a company to raise finance from other sources. Second, a floated company may find its shares become more marketable, therefore realising part of its investment on flotation and at subsequent times by selling further shares through the market. Third, there is a considerable degree of high reputation and publicity in connection with a full listing. This may lead to better trade terms and wider markets for the company's products and services.

10. However, there are corresponding disadvantages as well. First, having a company listed on the Stock Exchange both in terms of administrative work as well as loss of privacy is a complicated and costly process. Second, as in normal circumstances, a minimum percentage of the issued equity share capital must be in public hands. There is a certain degree of external involvement, which can incur pressure from outside shareholders for paying dividends and sometimes an exposure to risk of a take-over bid. The higher the proportion of the equity in public hands, the more obvious this drawback appears to be. As the London International Stock Exchange is a recognised exchange for the purpose of the UK Financial Services Act 1986 (FSA 1986), the official listing of securities on it is generally dealt with as a separate subject in the Act. Part IV reflects three EEC directives (namely, Council Directives 79/279/EEC, 80/390/EEC and 82/121/EEC respectively), in view of harmonising and coordinating various aspects for the admission of securities to official stock exchange listing throughout the European Union. These lay down minimum requirements for having shares listed in the Exchange. Moreover, article 9 of Council Directive 79/279/EEC also requires each member state to designate a competent authority to decide on the admission of securities to the official listing on a stock exchange operating within its own territory. By section 142(6) of the FSA 1986, the Council of the International Stock Exchange is appointed as the competent authority in the UK. This Council has the power to make listing regulations and rules which are set forth in "Admission of Securities to Listing", usually referred to as the Stock Exchange's "Yellow Book". All applications for an initial listing must be submitted to the Stock Exchange for approval. In fact, the FSA 1986 only provides a broad framework. The bulk of detailed rules are contained in the "Yellow Book" which in practice has statutory force as well.

    Key Considerations of Suitability for Listing

11. A foreign company intending to apply for a full listing must have in the first place a clear understanding of its own suitability for going public. The requirements that a company has to meet in order to satisfy the Stock Exchange's criteria for listing can be classified into three main aspects: a. Market capitalisation; b. Shares in public hands; and c. Trading record. In theoretical terms, an application for listing will not normally be considered unless the expected market value of the shares for which a listing is sought is at least £700,000.[1] In practice however, the Stock Exchange maintains a complete discretion to adjust the minimum figure. A market capitalisation exceeding £700,000 by a large margin is likely to be required for ensuring prospective outside investors that the company to be listed is a high quality one. There is a further requirement that at least 25% of its shares must be in public hands,[2] so that the nature of the public company can be guaranteed by maintaining a reasonable level of external involvement. However, outside participation is essentially not welcomed by the company to be floated, since in this case a certain degree of business control will definitely fall into other people's hands. In practice, a percentage lower than 25% may not be totally unacceptable if the market will operate properly with a lower percentage, in view of the large number of shares of the same class and the extent of their distribution to the public. Thus, this minimum 25% requirement can become quite a negotiable matter. A company should normally have a trading record of at least three years and must present audited accounts for the last three years,[3] hence ensuring that only mature companies will qualify for admission to listing.

    Methods of Going Public

12. A company flotation on the Stock Exchange is customarily represented by a sponsor, which may be a merchant bank and/or a stockbroker. The sponsor's role is crucial for linking the company with the Stock Exchange. In broad terms, the sponsor advises the company on all aspects of applying for a full listing, from assessing the company's initial suitability to the pricing and timing of the issue itself. Whilst it is reasonable for the company's directors to be responsible for the accuracy of the information provided for the listing purpose, the Stock Exchange in practice attaches particular importance to the role played by the sponsor in satisfying itself that the company is suitable for a full listing.

13. The actual methods of flotation in connection with foreign companies seeking listing for the first time may normally comprise two major kinds: a. offer for sale and b. selective placing. The choice of the more appropriate method depends on factors such as the costs as well as the company's view of prospective shareholders' profiles that are acceptable to it.

14. Offer for sale is usually conducted by the company distributing the securities that are intended to be offered to the public to an issuing house, which may or may not be the sponsor itself in the first instance. The issuing house then invites subscriptions from institutional as well as individual investors. An offer for sale can be made by way of bearing a fixed price or arranging a tender.

15. The purpose of a sale by tender is to ensure that any excess over the minimum tender price is made available to the company. This is in contrast to a fixed-price issue, where if the issue price is pitched too low, short-term speculators will easily stand to make huge profits. In theory, a tender offer provides a basis for a more accurate market valuation of the company's shares. If the issue is small and a large over-subscription is anticipated, this method will be especially worth trying as the cost incurred by the risk of failure in this instance would be minimal. In practice however, it has not always been the case and the company may find it difficult to decide whether to opt for a straightforward offer for sale or an offer for sale by tender.

16. Tender offers are mostly utilised where there is no comparable company already listed to use as a reference for deciding the company's value. The uncertainty and complexity embodied in the actual process can discourage private and small investors. In either case, before an issue of shares is made to the public, it is usual to insure the success of the issue by having it underwritten. An underwriter does not guarantee that the public will take up the shares, but agrees to subscribe for the shares themselves on the happening of the public's failure to fully purchase. The issuing house would often be the main underwriter and may find others to sub-underwrite part of the issue. In a selective placing, new shares are offered to the public selectively by the sponsor selling the shares to its own client base and finding purchasers with whom the shares are then placed. A selective placing has two main advantages. First, it is cheaper to carry out because the advertising costs are lower and the administrative work involved in handling applications is less, as the placing is merely conducted within the limited scope of the sponsor's existing clients. Second, due to the nature of the placing, it is not necessary to have the issue underwritten so that there may not be any underwriting expenditure incurred. The major disadvantage of a selective placing is that investors are deprived of an equal opportunity to acquire the securities, as the sponsor places securities with their own clients. Thus, the Stock Exchange imposes strict restrictions in this regard, and only permits the entire issue to be placed in the case of an initial public offer of £15 million or less.[4]

    The Listing Particulars

17. One of the most important and time consuming tasks in the entire process of having shares listed is the preparation of listing particulars which comprise the "prospectus" required by the Stock Exchange. The listing particulars serve two purposes. First, they include all information, which the Stock Exchange requires to be made public to investors on which they are able to base investment decisions. Second, and of great importance to the company when shares are being marketed, they describe the company, its business and prospects, which are designed to promote investment in the company's shares. Section 146 of the FSA 1986 imposes a general duty of disclosure required for listing particulars. The company must release all the information with respect to the assets and liabilities, financial position, profits and losses, prospects of the issuer of the securities, and the rights attaching to those securities. This is what an investor and their professional advisers would reasonably require in order to make an informed assessment.

18. However, the more detailed requirements in connection with listing particulars are set out in the "Yellow Book", covering the following seven aspects: a) information on the persons responsible for listing particulars, the auditors and other advisers, including a declaration by the directors accepting responsibility for the information contained in the listing particulars, and a statement that the annual accounts for the last three financial years have been audited; b) information on the shares for which application is being made, indicating the nature and amount of the issue and the fixed dates (if any) on which entitlement to dividends arises, and giving a summary of the rights attaching to the shares; c) general information about the issuer and its capital, including the legislation under which the issuer operates and the legal form which it has adopted under that legislation, the date and country of incorporation, a summary of the principal contents of each material contract entered in the last two years, the names of persons exercising control over the company and the names of any persons known to the issuer interested in 3% or more of the issuer's capital, details of the share capital of the company and any shares under option, and a summary of the provisions of the memorandum and articles of association regarding changes in the capital and rights of the various classes of shares; d) information on the company or group's activities, including a description of principal activities, information on any legal or arbitration proceedings, an analysis of sales by geographical area and category of activity, details of land, buildings and principal establishments, and information in respect of development policy, employees and material investments in other companies; e) information on the issuer's assets and liabilities, financial position and profits and losses, including consolidated information on the results and financial position for each of the last three completed financial years, a statement by the issuer as to the adequacy of working capital, and details of the issuer's indebtedness; f) information on the company's management, including directors' details, their services and remuneration, and their interests in the company's securities; and, g) information on the recent developments and prospects of the company or group.[5]

    Flexible Treatment is afforded to Companies Incorporated Abroad

19. Whilst the rules of the "Yellow Book" generally apply to companies incorporated in the UK and abroad alike, the Stock Exchange is more flexible in certain aspects with companies incorporated overseas. They may consider some derogation from the normal requirement for listing particulars proposed by such companies. These foreign companies may not need to prepare UK listing particulars if they have issued a document approved by the competent authority of another EU Member State. This qualifies for mutual recognition of listing particulars under the rules introduced by Council Directive 90/211/EEC in respect of the mutual recognition of a public-offer prospectus as stock-exchange listing particulars.

20. There are three main conditions contained in the "Yellow Book" which have to be fulfilled by a company to qualify for listing by mutual recognition. Firstly, the company must have its registered office in another Member State. If not, it must either be listed on an overseas stock exchange, or the London International Stock Exchange must be satisfied that it can properly be regarded as a company of international standing and repute.

21. Secondly, the company must have either contemporaneously with its application, or within three months prior to entry onto the Stock Exchange, had the qualifying document approved by the competent authority in another Member State. This must be done as a prospectus drawn up according to the Public Offers Directive at the time of a public offer in that Member State.

22. Thirdly, the qualifying document must contain additional information specific to the UK market. This includes a description of the tax treatment of securities holders who are UK residents, names and addresses of the registrars and UK paying agents for the securities. A statement of how notices of meetings will be given to UK residents holders of the securities is also required.[6]

    Establishment of Representation by Foreign Banks

23. Foreign banks can establish and carry on banking business in the UK. They may do this in one of three ways: as a distinct UK subsidiary, as a branch of the foreign bank, or simply as the bank's representative office. These three types of institution are entitled to different rights. Only the first two are permitted to transact in the UK, while a representative office is merely allowed to promote the interests of the parent institution overseas. Under such a context, this article is designed to examine the relating legal regulations and requirements set forth in the UK as parameters for banking supervision to which foreign banks will be subject if they intend to set up proper presence there.

    UK Subsidiary

24. A UK subsidiary of a foreign bank is incorporated in the UK as a local business entity with separate legal status. Such a subsidiary must fully comply with the usual minimum criteria of the Banking Act 1987 (BA 1987), regarding carrying on a deposit-taking business. Setting up a subsidiary is not easy, but once established it will possess complete banking functions, which are very close to those of British banks.

25. By section 3(1), no person in the UK shall accept a deposit in the course of carrying on a deposit-taking business, unless that person is an institution authorised by the Bank of England. To become an authorised institution, a foreign bank must apply to the Bank of England, which must be satisfied before granting authorisation that the certain minimum criteria specified in Schedule 3 have been properly fulfilled. The most important of these criteria are reflected from the Bank's system of prudential supervision, which comprises three major limbs: a) capital adequacy and liquidity control; b) control of the bank's controller(s); and c) risk protection control.

    Capital Adequacy and Liquidity Control

26. Capital adequacy and liquidity control has the objective of improving financial stability, which can be enhanced through the supervision of the strength of financial institutions' capital and liquidity positions. In relation to capital adequacy, the Bank adopted the proposals put forward by the Basle Committee representing the "Group of Ten" countries in 1988. The Committee's recommendations provided for banks to hold a minimum of 8% of capital against their weighted counter-party risks which were imposed on the UK banks.[7] However, this 8% of capital is a minimum sum and in reality for most banks the actual figure might be much higher. Additionally, by paragraph 6(1) and 6(2) of Schedule 3, each bank must have a minimum paid up capital and reserves of £1 million, which in practical terms may not be so difficult to satisfy. Concerning liquidity control, while paragraph 4(4) of Schedule 3 provides that a banking institution should maintain adequate liquidity, with regard to the relationship between its liquid assets and its actual and contingent liabilities, the Bank of England does not use liquidity ratios which should be adhered to by all banks as a standard. They instead indicate that liquidity management is the responsibility of each bank's management with the Bank of England seeing that individual bank liquidity needs are met.[8] In practice, the guideline ratio for the time being is 12%.[9]

    Control of the Bank's Controller(s)

27. Section 21 prohibits any person from becoming a controller of an authorised institution incorporated in the UK unless they have given notice to the Bank and the Bank does not object. Section 105(3) defines a controller in relation to an institution essentially as any person in the capacity of managing director, chief executive, or anyone who is entitled to exercise or control the exercise of 15% or more of the voting power at any general meeting of the institution, or of another institution of which the former institution in question is a subsidiary. The primary purpose of this control is to protect the UK banking sector from aggressive foreign or other undesirable take-over and from the influence and control of individuals whose interests may be harmful to those of depositors.

    Risk Protection Control

28. Risk protection control, based on providing better consumer protection, is carried out by reporting any large risk exposure and contributing to the deposit protection fund. Section 38(1) requires an authorised institution to make a report to the Bank of England whenever it enters into a transaction or transactions with a single customer with risk exposure of over 10% of its available capital resources, or proposes to enter into such transactions with risk exposure of over 25% of those resources.

29. In order to give protection to depositors against loss, the BA 1987 continues the Deposit Protection Fund under section 50(1), which was established by section 21 of the Act of 1979. According to sections 53 to 55, each institution is required to make an initial contribution to the Fund at the time of its authorisation. It must then make further or special contributions subsequently to restore the amount standing to the credit of the Fund to a minimum of £5 million and a maximum of £6 million if the Fund is reduced beyond the limit of £3 million. Payments may be made out of the Fund upon the occurrence of certain specified events which amount basically to the insolvency of an authorised institution, and are limited to a maximum of three-quarters of the depositors' protected deposits maintained at not over £20,000 (sections 58 and 60).

    Branch and Representative Office

30. It is easier for a foreign bank to set up a branch in the UK, which is equally able to carry on banking transactions. However, a branch does not have a separate juridical status, and when considering whether it meets the minimum criteria for authorisation, it will be the whole institution that is to be considered and not just the branch itself. The parent bank will also be responsible for all obligations committed to by the branch. Thus the branch assets alone do not need to meet the minimum capital adequacy and liquidity requirements. Also, it can be construed from section 38(1) that reporting large exposures may not be required for a branch whose principal place of business is outside the United Kingdom.

31. The simplest way for a foreign bank to establish business presence in the UK is to form a representative office. A representative office is not permitted to conduct a deposit-taking business. Its sole function is to assist and promote the activity of the institution based abroad. Since it does not carry on deposit-taking business, there will be no necessity for it to be authorised under the BA 1987.

32. It is likely that the Bank of England might prefer an overseas bank to establish a representative office which merely does promotion work, thus protecting the interests of domestic banking sector by controlling foreign direct participation in the business as subsidiaries or branches. To foreign banks, especially those that are not quite familiar with the UK's financial operation system, it would be better to set up a representative office in the first place. This is used as a stepping-stone for expanding its activities and becoming a branch or having a subsidiary incorporated later on.

    Single Banking Licence Scheme

33. Furthermore, as part of the developments in Europe with a view of leading to a single European market, the EC's Second Banking Co-ordination Directive enables credit institutions incorporated in a EU member state to enjoy mutual recognition throughout the whole European Union. This is by virtue of a single authorisation obtained in a member country.[10] Thus a non-EU bank may take advantage of freedoms under this single banking licence scheme by establishing itself in the UK.

34. Nonetheless, this scheme is carried out under a test of reciprocity treatment. In the context of article 7 of the Second Banking Directive, a broad view will be taken of the kind of treatment that EU credit institutions receive in the given non-EU country by judging whether EU institutions are given reciprocal treatment. If not, credit institutions from such state will be denied establishment of their presence in any EU country including the UK.

    Direct Access to Conducting Investment Business

35. Due to the existence of a number of highly developed and efficiently operated financial markets, it is likely that foreign companies would greatly benefit if they are able to carry on certain investment businesses in the UK. The entire investment sector is now administered under the FSA 1986. Central to this framework is a system of self-regulation, which relies heavily on market practitioners who can formulate rules that are acceptable to both market players as well as regulators.

36. The Securities and Investments Board (SIB) as the primary regulator has the appearance of a state agency assuming an overall regulatory responsibility, whereas the front-line delivery of regulation is made through a cluster of autonomous self-regulatory bodies which are recognised and supervised by the SIB. Foreign companies intending to carry on investment business need to apply for authorisation under this two-tier regulatory regime, which in turn is intended to ensure that investment business can only be conducted by those who are fit and proper to do so.

37. This article is designed to investigate the principal legal regulations and requirements to which foreign companies will have to be subject should they try to conduct investment transactions in the UK's financial markets.

    Concept of Investment Business

38. The FSA 1986, rather than devising an all-embracing definition, introduces a comprehensive list of investments, which might become the subject matter of carrying on investment business.

39. According to section 1(1), an investment means any asset, right or interest falling within a statutory list inserted in Part I of Schedule 1, which widely comprises: a) all types of securities and interests in securities, such as shares, bonds, notes, debentures, certificates of deposit, government and public securities, depository receipts, warrants, options, and units in collective investment schemes; b) currency and other financial options, options on metals and options on commodity futures; c) delivery-based futures (but not where the contract is made for purely commercial purposes other than a recognised investment exchange); d) contracts for differences, including index-based futures contracts; and e) most long-term insurance contracts.

40. By Part II of Schedule 1, the regulatory framework in general terms covers all types of investment business conducted in the UK, embracing: a) dealing in investments; b) arranging deals in investments; c) managing investments; d) advising on investments; and e) operating a collective investment scheme. Moreover, under section 1(3), a person carries on investment business in the UK if they carry on investment business from a permanent place of business maintained by them in the UK, or engage in investment activity which constitutes carrying on a business in the UK.

41. The statutory definition of various activities constituting carrying on of investment business is very detailed and complicated. Nevertheless, this precise definition of investment business essentially serves three important purposes. First, the FSA 1986 only applies to investment business carried on in the UK, excluding the activities wholly conducted overseas. The test is whether the relevant activities are from a permanent place of business maintained in the UK or amount to the carrying on of a business there from abroad. As a general proposition, foreign companies having UK clientele can be counted as carrying on a UK business.

42. Second, the definition is used to determine whether there is a real business involving investment activity. In practical terms, this purpose is of great significance. It may help to ascertain whether a particular transaction is an investment activity governed by the FSA 1986, so that in the event of a transaction, which is excepted from the statutory list, the company concerned will not be amenable to any disciplinary jurisdiction or statutory liability under the FSA.

43. Third, if the preponderance of a company's activities are excepted from the statutory list of investment business, certain particular transactions in which it engages that are statutory investment activities may not be subject to the provisions of the FSA. This is unless the transactions are sufficiently numerous and/or continuous to constitute a business with a recurring source of profit. The purpose of this test is to avoid having essentially non-investment business entities from being unnecessarily regulated.

    Attractions of Major Investment Markets

44. As the objectives of different investors may vary, the kinds of investment which they choose to meet their varying objectives will differ correspondingly. The most attractive benefit of carrying on investment business in the UK lies in the fact that within the financial markets, there is a wide range of trading arrangements, which are made to locate investors with whom to carry on transactions. The principal characteristics of investment markets in the UK can be highlighted by performance of three major investment exchanges - the London Stock Exchange, LIFFE (the London International Financial Futures and Options Exchange), and the commodity markets.

    The London Stock Exchange

45. The London International Stock Exchange is one of the world's best-known markets for the trading of equities. It brings together those wanting to raise finance with those who wish to invest. In general, the Exchange offers markets for buying and selling of four major types of securities: a) British domestic equities; b) foreign equities; c) UK gilts; and d) bonds or fixed interest stocks. It has set up a highly developed trading system for market participants to transact efficiently.

46. So far as foreign companies conducting investment transactions are concerned, the secondary market existing on the Stock Exchange as the place where securities are traded is of the closest significance to them. The active secondary market maintained by the Stock Exchange provides foreign companies numerous opportunities for realising their investment aims. Since the substantial change to the Exchange's rules in 1986 (i.e. the "Big Bang"), the separation of members into brokers and jobbers has ceased.[11] All business entities can now become brokers, able to represent clients in the markets or principals buying and selling securities on their own account, and are also permitted to register as market makers.[12]

    LIFFE

47. Created by the merger of the London International Financial Futures Exchange and the London Traded Options Market in 1992, LIFFE is now one of the world's leading exchanges devoted to financial futures and options.[13]

48. With unprecedented volatility in the financial markets at the present time, new opportunities and their associated risks exist simultaneously. Not only must financial assets be prudently and vigilantly protected against potential market adversities, but opportunities must also be afforded for enhanced performances, which are expected to be recognised quickly and selectively pursued. The result is an environment in which financial futures and options markets have become a necessity for investors and traders. The principal benefit of financial futures and options markets lies in the effective risk protection against adverse movement of financial instruments' values in question. At the same time, LIFFE transactions can be employed to implement a range of aggressive and speculative strategies. It provides risk management and trading chances in fixed income, treasury and equity products with instruments which encompass both the short and long end of the yield spectrum, and are denominated by a total of seven major world currencies.[14]

    The Commodity Markets

49. The commodity markets in the UK are composed of the London Metal Exchange and the London Commodity Exchange. The function of the London Metal Exchange is to provide an efficient and orderly market on which transactions take place in non-ferrous metals. The Exchange's members may act on behalf of their customers to purchase or sell standard quantities of metals. Bargains are made either for immediate settlement or for delivery in three months time. Additionally, member businesses may issue or deal in options to buy or sell standard quantities of metal for delivery in three months time.[15] The Exchange is a useful place for hedging and speculating, and primarily concerned with variations in the price of the metals but not their physical supply. The London Commodity Exchange is Europe's primary centre for the trading of soft commodity futures and options contracts.[16] Like the Metal Exchange, the Commodity Exchange is a financial market concerned with price movement and fulfils the same functions as the Metal Exchange in respect of hedging and speculating. Contracted commitments by its members are usually closed out by entering into counteracting forward contracts or by paying differences between the contract price and the ruling market price at the time of settlement, with very few physical deliveries.

    A Two Tier Regulatory System

    The SIB as the Leading Regulator

50. In 1981 the UK government commissioned Professor L.C.B. Gower to inquire into the operation and effectiveness of the existing law governing investor protection. Based on Gower's report, the government published its own proposals for new legislation.[17] The common feature of the Gower proposals and the government's proposals was the conclusion that the most effective, practical and economical way to regulate investment markets and activities would be to combine regulation by the representative organisations whose members are engaged in various branches of investment business. This would include a supervisory function and a residual degree of regulation by a government appointed body acting as an agent of the state.[18] This notion thus formed the basis of the FSA 1986 and also the SIB's role as the leading regulator.

51. A self-regulatory system is now applied under the auspices of the SIB in the capacity of a government-designated agency responsible for authorising a series of self-regulatory bodies and overseeing their business operations.

52. The role of the SIB can virtually be classified as standard setter and as supervisor of regulators. Whilst the FSA 1986 provides the legal basis for the SIB to be empowered to make rules concerning the conduct of business under section 114, the primary role of the SIB in practice is to formulate and develop policies which set standards of investor protection and market integrity. This does not mean that the SIB needs to write more rules in sophisticated technical terms, but means that it spells out where the goal posts are. So on the one hand, it provides a benchmark of equivalence to judge the rules of the second-tier regulators. On the other hand, it ensures that investors can know what is expected of business entities engaged in investment activities with which they deal and equally such business entities can know what is expected of them.

53. The role of SIB as supervisor of regulators is crucial to the achievement of the objective of cost-effective investor protection. Under the two-tier system, the self-regulatory bodies are the front line regulators with the job of carrying out day-to-day regulation. They are thereby responsible for the quality of the relationship between the members and the public and between their members dealing with each other. However, these self-regulating bodies have to obtain recognition of the SIB in the first instance. Thus, the SIB's duty as supervisor of regulators is fulfilled by carrying out recognition or withdrawal of such recognition so as to guarantee that standards set for regulating recognised bodies are properly delivered.

    SROs as the Second Tier Regulators

54. The second-tier regulators, which are of closest relevance to foreign companies, are self-regulatory organisations (SROs). Under the SIB's supervision, they are responsible for the regulation and authorisation of their members, and also have to devise rules that are at least as stringent as those of the SIB itself. Although the SIB undertakes regular supervision of them to ensure that they do their jobs properly, the system of the second-tier regulation runs parallel with that of the direct regulation by the SIB. By section 8(1) of the FSA 1986, SROs play the role of regulating the carrying on of investment business of any kind by enforcing rules binding on their members, who carry on business of that kind. Although the SIB retains ultimate control, members of SROs are regulated by the rules and constitutions of SROs themselves, and not directly by the SIB. In practice, most foreign investment companies need to obtain their authority to carry on investment business through SRO membership. And a conglomerate conducting a wide range of investment business is likely to face the prospect of joining more than one SRO.

55. There are currently four SROs recognised by the SIB: Securities and Futures Authority (SFA), Investment Management Regulatory Organisation (IMRO), Financial Intermediaries, Managers and Brokers Regulatory Organisation (FIMBRA), and Life Assurance and Unit Trust Regulatory Organisation (LAUTRO). SFA is a SRO responsible for regulating business entities that are securities, and derivative dealers and advisers. Their members are active on the London International Stock Exchange, LIFFE, and the London Metal Exchange.[19] IMRO principally regulates fund managers and advisers undertaking management of investments, and trusteeship of collective investment schemes. Its members are mainly from merchant banks, investment trusts, pension fund managers, unit trust managers and insurance companies.[20]

56. FIMBRA regulates overseas investment advice and services offered by independent investment intermediaries in life assurance, unit trusts, pensions and personal equity plans. FIMBRA normally divides its members into one of the following three categories, depending on whether they handle clients' money and the type of investment business they do: a) members who do any investment business regulated by FIMBRA, and are entitled to handle clients' money and assets; b) members who are involved in any business regulated by FIMBRA except dealing as principal with clients, and are entitled to handle clients' money and assets; c) members who are engaged in the same areas of business as those in category b), but who may not handle clients' money and assets.[21] LAUTRO has its business scope confined to the marketing of life assurance, unit trust products and other collective investment schemes. They mainly consist of insurance companies, friendly societies, unit trusts, and other operators of collective investment schemes.[22]

57. Duplication of regulation over a company or a group of companies which has to join more than one SRO is obviously a potential problem. Many foreign companies are concerned about the overlapping requirements of different SROs that they have to join simultaneously due to the wide range of activities which they want to carry out. To solve this problem, close co-operation between SROs is essential and any single SRO ought to be willing to share information with all other counterparts.

58. Also, the SROs' responsibilities pertinent to financial surveillance of the member concerned should be clearly allocated by virtue of expertise to a specifically designated SRO, which becomes responsible for the member's business as leading regulator in its own field. Moreover, mergers between certain SROs equipped with similar and overlapping functions are necessary to be conducted as well.

    Routes to become authorised

59. Foreign companies proposing to carry on investment business in the UK need to apply for authorisation. The FSA 1986 by section 3 prohibits the carrying on of an investment business without authorisation. There are three main routes to become authorised: a) application directly to the SIB; b) becoming authorised by getting approval from a SRO in most circumstances; and c) becoming automatically authorised as EU-based companies.

60. In the first two events, foreign companies must be aware that incorporation of a subsidiary in the UK through which operation is carried out is an important pre-condition to be fulfilled. Difficulties in monitoring the capital adequacy of a foreign company operating on a worldwide basis as a single entity may lead the SIB or SROs to reject its application for conducting investment activities in the UK via a branch. This is unless the home country exceptionally agrees with the UK authority ensuring the imposition of the necessary supervision with which the UK authority can be satisfied.

    Direct Authorisation by the SIB

61. A foreign company may apply for direct authorisation by the SIB. The application should include the information as to the investment business proposed to be carried out, the services provided, and any other information required by the SIB (section 26(2)). The SIB upon receipt of an application for authorisation will first of all consider from the information furnished whether the applicant is a fit and proper person to carry on the investment business (section 27(2)).

62. The fitness and propriety are essentially determined by the applicant's financial capability, which has to be proved to the satisfaction of the SIB by fulfilling the financial resources rules set forth by it. However, the provisions in the FSA 1986 do not reveal any exact amount as to the adequate level of financial resources required. The SIB makes rules imposing different financial resources requirements under different circumstances (section 49(2)).

63. In addition, the SIB will also consider other factors in making its decision to grant or refuse an application. For example, information about the controllers of a company (i.e. directors or shareholders who control 15% or more of the voting powers at the general meeting, or another body corporate of which the company in question is a subsidiary), the proposed employees, and the appointed representatives in question, might additionally be asked for (sections 27(3)(a) and 207(5)(a)).

64. Direct application to the SIB is often based on two reasons. First, in the case of the company having no permanent place of business in the UK, the SROs might be very reluctant to grant authorisation to it. Thus there could be no other alternative but directly applying to the SIB. Second, the intended investment business might fall within the scope of several SROs and it will be more convenient if authorisation could be acquired once and for all from a single source. However, direct authorisation is not easy, nor does the SIB encourage it.

    Authorisation by an SRO

65. The role that SROs are playing is of the utmost importance to the self-regulating legal structure. Most foreign companies obtain their authority to carry on a business through membership of and participation in SROs so as to meet the diverse investment demands to their own advantages.

66. Members of a SRO shall be fit and proper persons to carry on investment business of the kind with which the SRO is concerned. In order to prove their fitness and properness, they should satisfy the financial resources requirement and other factors, same as those discussed above in connection with authorisation by the SIB (paragraph 1(1) and 1(3), Schedule 2).

67. Each SRO has rules regarding its own business scope prohibiting its members from carrying on a kind of investment business which it does not itself regulate (section 10(3)). The applicant shall ensure that correspondence does exist between its planned investment business and categories of the investment scope of the SRO. To avoid conflicts arising from inconsistencies between the desired activities and the rules of the SRO, the company intending to participate in a number of separate investment activities shall join more than one SRO.

    Automatic Authorisation to EU-based Companies

68. A foreign company becomes automatically authorised to carry on investment business in the UK if it has established a business entity in an EU member state other than the UK. Once under the law of that state, it is recognised as a national, authorised to carry on investment business in that country (section 31(1)). A foreign company may firstly set up a permanent business place in an EU member state, where it is likely that they may be subject to looser administrative control than in the UK, and then carry on the UK investment business indirectly from their EU base. This method could be used to avoid or at least minimise the cumbersome procedures for obtaining authorisation in Britain.

69. To become automatically authorised, an EU-based company must ensure that the law of the member state where their investment business entities are established affords protection to investors in Britain, at least equivalent to that provided by the provisions contained in the FSA 1986 (section 31(3)(a)). Additionally, the provisions of the law under which they are authorised to carry on investment business shall satisfy the conditions laid down by the regulations of the Council of Ministers for the European Communities for the co-ordination or approximation of the laws, regulations or administrative provisions of member states relating to the carrying on of investment activities (section 31(3)(b)).

    Measures for Investor Protection

70. The FSA 1986 is intended to provide substantial investor protection with the aim of ensuring healthy, internationally competitive investment markets in which all investors can have confidence. The rules and regulations with which each regulator under the two-tier system has to comply are maintained and enforced by the SIB and the relevant SROs. They principally cover the areas relative to the conduct of investment business by authorised entities, which must guarantee that adequate protection can be secured by investors.

71. The current two-tier regulatory system provides regulators a substantial armoury of supervision sanctions concerning the way that foreign investment companies seek business, regulate insider dealing, and treat investors' complaints and compensation.

    The Way to Seek Business

72. The marketing of investments is tightly controlled by the FSA 1986. Misleading advertisements, statements, claims and unsolicited calls to sell investments are generally prohibited.

73. Pursuant to section 57(1), investment advertisements must only be placed by authorised businesses. In the context of section 48(2)(e), these businesses, while issuing advertisements must observe the rules made by the SIB regulating the form and content of investment advertisements. Since investment advertisements are where investors are very probably at greatest risk, certain warnings about matters such as the volatility or marketability of the investments advertised shall be given to prospective investors in advance. Unsolicited calls to sell investments are normally banned, even by authorised businesses (section 56(1)). The main exceptions to this are calls relating to life assurance and unit trusts, where such a cold-call results in a sale, where the customer normally has a 14-day "cooling-off period". This is a period in which the rescinding or the withdrawing of offers to enter into investment agreements are available according to section 51(1)), during which they can reconsider the transaction and withdraw if they wish.[23]

74. To seek business, authorised entities must release appropriate information to prospective investors. Information about charges, fees and commissions claimed after doing business with clients is to be provided (section 48(2)(g)). If an authorised business itself has a material interest in a transaction, conflicts of interest may arise in the course of marketing of investments. In such a position, the authorised business must timely disclose the nature of the conflicted interest to investors (section 48(2)(h)). Some changes have been made to disclosure rules recently. The most important change is the separation of information into a) key features (vital information to be given at the time when the product is recommended); b) important information (to be provided no later than the start of any cooling-off period); and c) usual information (available on request).[24] These new amendments will mainly affect how intermediaries who advise on and sell packaged products are to disclose to potential investors their status and the details of the products offered.

    Insider Dealing

75. Insider dealing, the practice of using confidential or price-sensitive information for personal gain, was rendered a criminal offence firstly under Part V of the Companies Act 1980. The Companies Securities (Insider Dealing) Act 1985 re-enacted the earlier legislation with relatively minor amendments.[25]

76. Under sections 1 and 2 of the Insider Dealing Act 1985, insider dealing is specifically defined as dealing when an individual knowingly transacts in a security whilst in possession of unpublished price sensitive information relating to that security. The Act summarises the following 12 categories as offences of insider dealing:
    1. primary insider dealing in the securities of the insider's own company;
    2. primary insider dealing in the securities of a company with which the insider's company has or is about to enter into a transaction;
    3. secondary insider dealing in the securities of the informant's company;
    4. secondary insider dealing in the securities of a company with which their informant's company has or is about to enter into a transaction;
    5. dealing in a capacity other than an offeror;
    6. secondary insider dealing by other than the offeror;
    7. counselling or procuring a person to engage in insider dealing;
    8. communicating inside information for the purpose of insider dealing;
    9. primary insider dealing by a public servant;
    10. secondary insider dealing on the basis of inside information obtained through a public servant;
    11. counselling or procuring a person to deal on the basis of inside information obtained as or through a public servant;
    12. communicating inside information obtained as or through a public servant for the purpose of insider dealing.

77. The regulation of insider dealing is in the hands of the Department of Trade and Industry (DTI), and self-regulatory authorities such as the Stock Exchange and the Panel on Takeovers and Mergers. Inspectors of the DTI have wide investigative powers if insider dealing is suspected. The self-regulatory authorities assist the DTI by duly ensuring release of information and regulating the conduct of their members. Insider dealers may face severe punishment. By section 8 of the Companies Securities (Insider Dealing) Act 1985, an individual convicted on indictment of any of the above-mentioned twelve offences is liable to a term of imprisonment not exceeding two years and/or an unspecified fine.

    Investors' Complaints and Compensation

78. Authorised investment businesses are required to fully investigate and handle all customer complaints. The proper fulfilment of such obligations is under the supervision of SROs and the SIB, which have intervention powers that can be used in the interests of investor protection. The SIB is required to make proper arrangements for the investigation of complaints in respect of authorised businesses to be carried out in appropriate cases independently of the SIB and those authorised businesses (paragraph 4(2), Schedule 7, the FSA 1986).

79. The SIB may take further actions including prohibiting the employment of unfit persons, and applying for an injunction or restitution order to restrict the business of the authorised entities. SROs may also discipline their members. However, if the authorised businesses in question express disagreement with the investors' complaints as well as the disciplinary measures taken by the SIB or SROs, they may appeal to the Financial Services Tribunal for judgement.

80. The Tribunal is an independent body, which functions to prevent the possible abuse of power by the SIB against the authorised businesses. The Tribunal has the authority to investigate a case referred to it, and will compel attendance of communities or persons in question as well as production of any documentary evidence (section 98(1), paragraph 5(1) of Schedule 6). It shall be the duty of the Secretary of State for Trade and Industry to decide on the matter forthwith in accordance with the Tribunal's opinions (section 98(1)). According to section 54(1), the SIB may make rules establishing a scheme for compensation of investors who are owed money or other assets by an authorised business which has become insolvent, either deliberately through fraud or from poor trading. This provision permits creation of a centralised compensation scheme, known as "the Investors' Compensation Scheme", applying to all members of participating SROs and all directly authorised businesses, under which affected investors have chance to be paid up to £48,000 at present.[26]

    Conclusion

81. Generally speaking, as regards foreign investors, the above discussed three facets in the UK financial markets have assumed fundamental importance. The highly developed financing facilities provides foreign companies with opportunities of seeking sources for external fund raising, either through the traditional credit vehicles or via seeking public listing. In this sense, the UK's capital markets have an efficient mechanism and are mature enough to enable foreign companies as borrowers to issue claims which could be properly arranged to be taken up by those willing to accept.

82. Foreign banks may take advantage of the UK's active money markets, foreign exchange market, financial futures and options market to carry out both international and domestic banking business, particularly Eurocurrency finance and foreign exchange transactions. However, setting up representation needs to be supervised by the Bank of England for safeguarding the interests of depositors as well as protecting bank counterparts. Due to the existence of the UK's mature and well-developed investment industries, it is worthwhile for foreign companies to tap into the various financial markets by carrying on investment business from the angle that they act as brokers, agents, advisers or market-makers. The FSA 1986 is intended as a system of regulation relating to the entire investment sector, from large financial institutions to small investment advisers.