Financial law
Financial law is the law and regulation of the commercial banking, capital markets, insurance, derivatives and investment management sectors. Understanding financial law is crucial to appreciating the creation and formation of banking and financial regulation, as well as the legal framework for finance generally. Financial law forms a substantial portion of commercial law, and notably a substantial proportion of the global economy, and legal billables are dependent on sound and clear legal policy pertaining to financial transactions. Therefore financial law as the law for financial industries involves public and private law matters. Understanding the legal implications of transactions and structures such as an indemnity, or overdraft is crucial to appreciating their effect in financial transactions. This is the core of financial law. Thus, financial law draws a narrower distinction than commercial or corporate law by focusing primarily on financial transactions, the financial market, and its participants; for example, the sale of goods may be part of commercial law but is not financial law. Financial law may be understood as being formed of three overarching methods, or pillars of law formation and categorised into five transaction silos which form the various financial positions prevalent in finance.
Financial regulation can be distinguished from financial law in that regulation sets out the guidelines, framework and participatory rules of the financial markets, their stability and protection of consumers, whereas financial law describes the law pertaining to all aspects of finance, including the law which controls party behaviour in which financial regulation forms an aspect of that law.
Financial law is understood as consisting of three pillars of law formation, these serve as the operating mechanisms on which the law interacts with the financial system and financial transactions generally. These three components, being market practices, case law, and regulation; work collectively to set a framework upon which financial markets operate. Whilst regulation experienced a resurgence following the 2008 financial crisis, the role of case law and market practices cannot be understated. Further, whilst regulation is often formulated through legislative practices; market norms and case law serve as primary architects to the current financial system and provide the pillars upon which the markets depend. It is crucial for strong markets to be capable of utilising both self-regulation and conventions as well as commercially mined case law. This must be in addition to regulation. An improper balance of the three pillars is likely to result in instability and rigidity within the market contributing to illiquidity. For example, the soft law of the Potts QC Opinion in 1997 reshaped the derivatives market and helped expand the prevalence of derivatives.
These three pillars are underpinned by several legal concepts upon which financial law depends, notably, legal personality, set-off, and payment which allows legal scholars to categorise financial instruments and financial market structures into five legal silos; those being simple positions, funded positions, asset-backed positions, net positions, and combined positions. These are used by academic Joanna Benjamin to highlight the distinctions between various groupings of transaction structures based on common underpinnings of treatment under the law. The five position types are used as a framework to understand the legal treatment and corresponding constraints of instruments used in finance.
Three pillars of financial law formation
Three different regulatory projects exist which form the law within financial law. These are based on three different views of the proper nature of financial market relationships.Market practices
The market practices in the financial field constitute a core aspect of the source of law of the financial markets, primarily within England & Wales. The actions and norms of parties in creating standard practices creates a fundamental aspect of how those parties self-regulate. These market practices create internal norms which parties abide by, correspondingly influencing legal rules which result when the market norms are either broken or are disputed through formal, court, judgments.The principle role is to form soft-law; as a source of rules of conduct which in principle have no legally binding force but have practical effects. This has created standard form of contracts for various financial trade associations such as Loan Market Association, which seeks to set guidance, codes of practice, and legal opinions. It is these norms, particularly those provided by Financial Market Law Committees, and City of London Law Societies which the financial market operates and therefore the courts are often quick to uphold their validity. Oftentimes "soft law" defines the nature and incidents of the relationships that participants of particular types of transactions expect.
The implementation and value of soft law within the system, is particularly notable in its relationship with globalisation, consumer rights, and regulation. The FCA plays a central role in regulating the financial markets but soft law, voluntary or practice created legal schemes play a vital role. Soft law can fill market uncertainties what are produced by common law schemes. Obvious risk that that participants become lulled into believing statements of soft law is the law. However, the perception that an opinion constitutes ipso facto a clear and widely held opinion is wrong. For example, the consumer relationship in the case of Office of Fair Trading v Abbey National UKSC 6 where the bank was fined by the FSA for failing to handle complaints set out in soft law principle practices on broadly worded business principles which state that the bank must pay due regard to the interests of its customers and treat them fairly. Oftentimes the self-regulation of soft law can be problematic for consumer protection policies.
Another example of the expansiveness of soft law in the financial market is the explosion of Credit Derivatives in London, which has flourished on the back of the characteristically robust opinion of Potts for Allen & Overy regarding the ISDA Master Agreement in 1990 which helped the industry separate itself from current market restrictions. A the time, it was unclear whether Credit Derivatives were to be categorised as insurance contracts under English legislation of the Insurance Companies Act 1982. ISDA was firm in rejecting a statutory definition of insurance, stating that
This was crucial as Insurance companies were restricted from participating in other financial market activities and a licence needed to be granted to participate in the financial market. As a result of the Potts Opinion, credit derivatives were categorised as outside of insurance contracts, which allowed them to expand without the limitations set in place by insurance legislation.
Soft law has practical effects in that it is liable in many cases to be turned into "hard law", but with verified and experienced practice evidence. In the case Vanheath Turner the court remarked that custom of merchants is part of the common law of the United Kingdom. This highlights a long history of incorporating and accounting for the lex mercatoria into the English law in order to facilitate financial markets. Law merchant had been so absorbed by the 18th century that the Bills of Exchange Act 1882 could provide common law rules and merchant law in tandem. We might consider Tidal Energy Ltd v Bank of Scotland, where Lord Dyson held that "a man who employs a banker is bound by the usages of bankers", meaning that if a sort code and account number was correct, it did not matter if the name did not match.
There are risks on over-reliance on soft law sources, however. English law makes it difficult to create a type of security and reliance on rules may result in established views which reinforce errors. This could result in unacceptable security even if legally valid.
Case law
The second category which financial law draws most of its pragmatism with regard to the standards of the markets originates in litigation. Often, courts seek to reverse engineer matters to make commercially beneficial outcomes and so case law operates in a similar manner to market practice in producing efficient results.There are two exceptions, attempting to limit the expectations to reasonable commercial men and uphold the freedom of contract. Autonomy is at the heart of commercial law and there is the strong case for autonomy in complex financial instruments. Re Bank of Credit and Commerce International SA highlights the striking effect a commercially beneficial practice can have on financial law. Lord Hoffman upheld the validity of a security charge over a chose in action the bank held which it owed to a client. Despite the formidable conceptual problems in allowing a bank to place a charge over a debt the bank itself owed to another party, the courts have been driven to facilitate market practices as best as possible. Thus, they are careful to declare practices as conceptually impossible. In BCCI, the court held that a charge was no more than labels to self-consistent rules of law, an opinion shared Lord Goff in Clough Mill v Martin where he wrote
Unfortunately, case coverage is unsystematic. Wholesale and international finance is patchy as a result of a preference to settle disputes through arbitration rather than through the courts. This has the potential to be detrimental to advancing the law regulating finance. Market participants generally prefer to settle disputes than litigate, this places a greater level of importance onto the "soft law" of market practices. However, in face of disaster, litigation is essential, especially surrounding major insolvencies, market collapse, wars, and frauds. The collapse of Lehman Brothers provides a good example, with 50 judgments from the English Court of Appeal and 5 from the Supreme Court of the United Kingdom. Despite these problems, there is a new breed of litigious lenders, primarily hedge funds, which has helped propel the pragmatic nature of financial case law past the 2008 crisis.