Role of Lawyers in Capital Market Transactions

This article has been written by Piyush Bajaj. Piyush is currently a BCom LLB student at Amity Law School, Noida.

Capital market is a market where buyers and sellers engage in trade of financial securities like bonds, stocks, etc. The buying/selling is undertaken by participants such as individuals and institutions.Capital markets help channelize surplus funds from savers to institutions which then invest them into productive use. Generally, this market trades mostly in long-term securities.Capital market consists of primary markets and secondary markets. Primary markets deal with trade of new issues of stocks and other securities, whereas secondary market deals with the exchange of existing or previously-issued securities. Another important division in the capital market is based on the nature of security traded, i.e. stock market and bond market.

CAPITAL MARKET TRANSACTIONS

The capital market transactions are made while trading in the capital market securities. Stocks and bonds are the two types of securities where the capital market investments are done. Capital market transactions are monitored by the financial regulatory bodies. A typical capital market includes the trading of securities.
This is also the ideal market place for the companies and governments to raise funds. There are financial regulatory bodies in every country that monitor and regulate the capital market transactions to protect the investors from being cheated. U.S. Securities and Exchange Commission, Australian Securities and Investments Commission, Canadian Securities Administrators, Financial Services Authority (UK) and Securities and Exchange Board of India are some of the major financial regulators that regulate the capital market transactions in their respective countries.

The investment in the capital market can be done either in the new issues or in the existing securities. The primary capital market controls the new issue transactions while the secondary capital market takes care of the trading of the existing securities.
The corporations, banks or governments release stocks and bonds in the capital market to raise the long-term funds. The individual investors, companies, agencies and corporations can invest in these stocks and bonds either by purchasing or selling them. The trading of stocks and bonds in the capital is not easy for the novice and not even for the seasoned investors. It’s difficult to predict the trends of a capital market.

Every investor wants to play safe with their investments. There are financial advisers available to guide the investors telling them where to invest and where not to. There are stock brokers also who are experienced and eligible to guide people with stock and bond investments.

The capital market transactions are done by the brokers who are registered with the exchange to carry out the trading on behalf of their clients. Any individual cannot just walk in the stock exchange and invest on the stocks or bonds. He must have to go through the brokers to make any kind of transaction in the capital market.

EXAMPLES OF CAPITAL MARKET TRANSACTIONS

A government raising money on the primary markets

When a government wants to raise long term finance it will often sell bonds to the capital markets. In the 20th and early 21st century, many governments would use investment banks to organize the sale of their bonds. The leading bank would underwrite the bonds, and would often head up a syndicate of brokers, some of whom might be based in other investment banks. The syndicate would then sell to various investors. For developing countries, a multilateral development bank would sometimes provide an additional layer of underwriting, resulting in risk being shared between the investment bank, the multilateral organization, and the end investors. However, since 1997 it has been increasingly common for governments of the larger nations to bypass investment banks by making their bonds directly available for purchase over the Internet. Many governments now sell most of their bonds by computerized auction. Typically large volumes are put up for sale in one go; a government may only hold a small number of auctions each year. Some governments will also sell a continuous stream of bonds through other channels. The biggest single seller of debt is the US Government; there are usually several transactions for such sales every second,which corresponds to the continuous updating of the US real time debt clock.

Trading on the secondary markets

Most capital market transactions take place on the secondary market. On the primary market, each security can be sold only once, and the process to create batches of new shares or bonds is often lengthy due to regulatory requirements. On the secondary markets, there is no limit on the number of times a security can be traded, and the process is usually very quick. With the rise of strategies such as high-frequency trading, a single security could in theory be traded thousands of times within a single hour. Transactions on the secondary market don’t directly help raise finance, but they do make it easier for companies and governments to raise finance on the primary market, as investors know if they want to get their money back in a hurry, they will usually be easily able to re-sell their securities. Sometimes however secondary capital market transactions can have a negative effect on the primary borrowers – for example, if a large proportion of investors try to sell their bonds, this can push up the yields for future issues from the same entity. An extreme example occurred shortly after Bill Clinton began his first term as President of the United States; Clinton was forced to abandon some of the spending increases he’d promised in his election campaign due to pressure from the bond markets. In the 21st century, several governments have tried to lock in as much as possible of their borrowing into long dated bonds, so they are less vulnerable to pressure from the markets. Following the financial crisis of 2007–08, the introduction of Quantitative easing further reduced the ability of private actors to push up the yields of government bonds, at least for countries with a Central bank able to engage in substantial Open market operations.

ROLE OF LAWYERS

“There are lots of laws which regulate the trading of loans and debts,like whether they are public or privately traded. Lawyers also get involved in creating the product: the packaging of loans and selling of the interests in them.”

Lawyers are key players in the transactional processes which permeate the world of capital markets. They advise debt and equity issuers and the investment banks which structures and sells the financial instruments. The role of lawyers includes advising on legal and regulatory matters, drafting documents, negotiating contracts, and working with bankers to obtain approval from various external parties such as regulators, listing agencies and rating agencies. Some transactions are straightforward (‘cookie cutter’) deals because some parties are frequently active in the market and use standard documents. Some transactions are bespoke and more complex. Junior lawyers cut their teeth on cookie-cutter deals, but as lawyers gain more experience they (hopefully) work on more specialized deals.

Legal and regulatory advice: In equity capital markets an IPO is transformatory for a company. It requires hours of lawyers’ time to ensure the company is ready to list on an exchange and take the company’s board through every step in the process. A first-time borrower in the debt capital markets also requires a lot of lawyer time to prepare it for the new transaction. Much of this type of activity is cross-border, which means considerable time need to be spent working out how various regulations fit together and liaising with local lawyers. For example, it is not unusual for a UK firm to lead on the IPO of a Kazakh company, listed in the EU, with offerings in other jurisdictions, including in the USA. And there’s nothing cookie-cutter about all that.

When it comes to drafting documents, there are key clauses to get right, and in many cases huge volumes of documents to prepare and amend. While swap confirmations and other derivatives contracts are often short (although complex), most capital markets transactions are just the opposite. The selling document for securities (a prospectus) can range from 15 pages to more than 500, and the contractual documents are not far behind. Securitization probably tops the charts for most documentation and therefore worst hours! At university, the longer the essay the more likely you were to stay up all night, nothing much changes in a law firm.

Negotiating contracts is a big part of the job. There are a lot of contracts which need to be signed off by a lot of parties and every contract is of great importance to every party. As such, negotiations can be protracted. Issuers want the best terms; investment banks need the clauses to be acceptable to their internal credit committees, and in the case of securities, they want terms that make the product optimal for selling. Investors are usually not involved in the negotiations; however, if they don’t like the way the instruments are structured, they won’t buy them!

Regulatory and other approvals are a necessary step. They range from simple listing approvals for frequent bond issuers, to more time-consuming activities like a first listing approval of a securitization of Russian credit card loans on the London Stock Exchange. Ratings agencies also require legal advice when determining a product’s rating.

Long hours, complex contracts, demanding clients – What is the attraction? The opportunity to work with a client on a huge transaction; the sense of teamwork involved when grafting alongside people from banks, client companies and other law firms; the fun of negotiation and the buzz of finally creating a transaction that complies with all the different laws and regulations and which an investor will still want to buy.


The December book bucket

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