Exchanges are marketplaces where negotiable items are traded with a high degree of standardization. In organizing the trading, exchanges bring together supply and demand at low transaction costs. Most prominent is the trading in shares and bonds that have been issued by stock corporations, but there are many other items being traded on exchanges (the most recent example are emission permits).
Closely connected to the marketplace’s establishment is its regulation. Standardization requires rules governing the process of trading, the items that are admitted to trading, and the persons that are authorized to trade. In addition, exchanges have two other functions: disseminating information about the traded items and, through establishing minimum standards, improving their quality (especially of shares and bonds: corporate governance). Last but not least, over the course of the last two decades more and more exchange operators have sought to pursue a further goal: making profit. For this purpose, exchanges or their operators have given up their traditional structure and have become stock corporations whose shares are listed on exchanges and are publicly traded (see 6. below).
For providers of capital and those seeking it securities exchanges have a transformative function: they permit short-term investments in long-term projects. This makes capital commitments more attractive for both sides. Investors remain flexible, since they can recover their investment at any time, indirectly, by selling their shares or bonds at the current market value on the exchange. Listed companies can plan for the long term because they can refer investors who do not want to commit themselves for a longer period to the exchange market and, to increase planning dependability, lock-in the capital and exclude the redemption of the deposit temporarily (bonds) or indefinitely (shares).
The legal definition of ‘exchange’ is one of the core problems of exchange law. Within the markets that organize trading in negotiable items, there is a wide spectrum of venues with no clear criteria that could form the basis of a legal distinction. Which organizations should be subject to exchange regulation is therefore a policy decision rather than a matter of legal analysis.
To date, no legal system has managed to identify a wholly satisfactory definition of ‘exchange’. The problem was identified early and has since been the subject of prolonged debate in some jurisdictions (in Germany since the famous Feenpalast decision by the Prussian Superior Administrative Court of 26 November 1898, PrOVGE 34, 315). During the same period, however, technological progress has evened out many of the physical differences that have been developed to distinguish exchanges from other markets. While, in the past, the local (namely the exchange building), temporal (for instance two hours in the afternoon), and material (such as 30 specified bonds) concentration of trading helped identify exchanges, these physical criteria have become increasingly irrelevant over the last decades (markets for financial instruments). Therefore, it seems advisable to introduce a formal and a material exchange definition: exchanges in the formal sense are marketplaces that are admitted by the competent authorities as a ‘recognised investment exchange’ (United Kingdom), a Börse (Germany) or a marché réglementé d’instruments financiers (France). Exchanges in the material sense are organizations that meet the requirements for being admitted, registered or recognized as an exchange.
The new German Exchange Act (2007) contains, for the first time, a legal definition: ‘Exchanges are institutions of public law with partial legal capacity that regulate and monitor, in accordance with this Act, multilateral systems that bring together or facilitate the bringing together of interests of a large number of people, in buying and selling goods and rights permitted to trade at the exchange, within the system according to established rules in a way that results in a contract for the purchase of these traded goods.’ (§ 2(1)) The definition, which in large parts follows European law (see 5. b) below), properly describes the core function of exchanges, ie the establishment and regulation of a market for negotiable items (see 1. above). However, the definition offers little help in applying the law or identifying exchanges because it does not distinguish between formal and material aspects, but instead mixes the consequences of official recognition (eg partial legal capacity) with its prerequisites (eg contract within the system).
The beginning of exchanges is inextricably linked to the question of what the characteristics are that distinguish exchanges from markets and fairs.
Common trading places are as old as mankind because the market is an obvious device of the ζῷον πολιτικόν (zóon politikón). But even at the height of the ancient economy, there were no exchanges, ie no marketplaces with standardized trading in negotiable items. Opinions to the contrary, which are still widespread today, are based on an unreflective adoption of formulations of the 19th and early 20th centuries, when the term ‘exchange’ was not the technical term that it is today.
Exchanges, understood as marketplaces with standardized trading, are therefore an invention of modern times. The dealers themselves initiated the first ‘founding wave’ at the end of the Middle Ages and the beginning of the early modern era, eg in Bruges (1409), Antwerp (1460), Amsterdam (1530), Cologne (1553), Hamburg (1558) and Frankfurt am Main (1585). The second group of exchanges was established as an instrument of mercantilist economic policy, especially in Paris (1724), Berlin (1739) and Vienna (1771). Finally, industrialization brought the establishment of new exchanges, such as the London Stock Exchange (1773) and the New York Stock Exchange (1792).
Most of the provisions that govern exchanges belong to public law. Rules that are genuinely private law, which is the subject of this Encyclopaedia, may, for instance, be found in the trading rules that are issued by the exchanges themselves or by committees associated with them.
a) Function of exchange law
The economic implications of exchanges explain the public interest that exchanges attract. This interest will not necessarily lead to the adoption of exchange laws since policy makers with realistic self-assessment would prefer to trust the exchanges to find a sensible organizational structure and establish proper trading rules.
The scandals, however, that frequently occur at exchanges and in their environment ultimately led to public calls for more exchange regulation. As a result, all developed jurisdictions have a comprehensive regulatory regime today. Regulation tends to address two main subjects: first, the organization of the exchange itself (exchange organization law, Börsenorganisationsrecht), such as the permission to operate an exchange, the organizational structure of the exchange and the regulatory powers of the exchange; secondly, the trading at the exchange (exchange trading law, Börsenhandelsrecht) which includes the process of trading as well as the admission of items and dealers to trading.
b) Development of exchange law
Exchange law is a relatively young branch of law. The French Code de commerce (1807) contained a few provisions with little regulatory relevance (Arts 71–73: des Bourses de commerce). The draft of a general German commercial code, the Allgemeines Deutsches Handelsgesetzbuch (ADHGB) (1861), did not address exchanges at all. Because of scattered references to the Börsenpreis or ‘exchange price’ (eg in Arts 343, 353, 376), some German states enacted local rules for the establishment, approval and supervision of exchanges (especially Prussia in its Introductory Act of 1861, Art 3). It was not before the federal Exchange Act, the Börsengesetz (1896), that the German Reich established a detailed regulatory regime for exchanges. Much later, only two-and-a-half decades ago, the United Kingdom enacted the Financial Services Act (1986) with rules for exchanges.
c) Current state of exchange law
The statutory basis of exchange law is currently in the United Kingdom part eighteen of the Financial Services and Markets Act (2000), in Germany the Börsengesetz (2007), and in France the second title of book four of the Code monétaire et financier (2000).
Exchange law has passed the zenith of its importance and is today usually understood as a part of securities law (or capital markets law). This shift is particularly visible in Germany. Shortly after its enactment, the Börsengesetz (1896) had already lost the section on broker-dealer conduct to the Commercial Code, the Handelsgesetzbuch (1897); with the introduction of the Securities Trading Act, the Wertpapierhandelsgesetz (1994), the exchange rules on ad hoc publicity were abandoned; a few years later, in one of several reforms, the Viertes Finanzmarktförderungsgesetz (2002) transferred the law of future trading, since its very beginning the most controversial subject of the Börsengesetz, to the Wertpapierhandelsgesetz; the last major loss related to the provisions on alternative trading systems, which were moved (2007) from the Börsengesetz to the Wertpapierhandelsgesetz. Today, the Börsengesetz is a limbless torso whose existence can be explained only historically. The United Kingdom (Financial Services and Markets Act, ss 285–313) and France (Code monétaire et financier, Arts L 421–426), where the operation of exchanges is regulated as one financial service among many (financial supervision), might allow a glimpse into Germany’s future.
5. Legal harmonization
European legal harmonization is well advanced in the area of securities law (capital markets law). Exchange law is one of the few exceptions.
a) Harmonization of securities law
Exchange law in the broadest sense, which is today understood as securities law (or capital markets law), was the subject of four central directives: a) Dir 79/279 of 5 March 1979 coordinating the conditions for the admission of securities to official stock exchange listing; b) Dir 80/390 of 17 March 1980 coordinating the requirements for the drawing up, scrutiny and distribution of the listing particulars to be published for the admission of securities to official stock exchange listing; c) Dir 82/121 of 15 February 1982 on information to be published on a regular basis by companies the shares of which have been admitted to official stock-exchange listing; and d) Dir 88/627 of 12 December 1988 on the information to be published when a major holding in a listed company is acquired or disposed of. A decade ago, these four directives were consolidated in Dir 2001/34/EC of 28 May 2001 on the admission of securities to official stock exchange listing and on information to be published on those securities. This directive, in turn, has been significantly amended by Dir 2004/109/EC of 15 December 2004 on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market (known as the Transparency Directive).
The aim of these directives is to increase the transparency on the securities markets and, thereby, to foster the development of a single European financial market (capital markets law). However, for political reasons the markets have been opened before a sound level of harmonized law and enforcement had been achieved, ie the second step has been made before the first, by forcing the Member States to admit financial instruments which have been recognized elsewhere (European passport). The purpose of Dir 2003/6 of 28 January 2003 on insider dealing and market manipulation (market abuse), which replaced Dir 89/592 of 13 November 1989 coordinating regulations on insider dealing (insider dealing; market manipulation), is to ensure fair market prices on securities exchanges.
b) Harmonization of exchange law
The directives mentioned in the previous subsection govern the environment of exchange trading, in particular the issuers of financial instruments, but not the organizational structure of the exchanges themselves. This issue is addressed by Dir 2004/39 of 21 April 2004 on markets for financial instruments (commonly referred to as ‘MiFID’). The MiFID is the successor to Dir 93/22/EEC of 10 May 1993 on investment services in the securities field (details: markets for financial instruments), and is accompanied by Commission Reg 1287/2006 of 10 August 2006 and Commission Dir 2006/73 of 10 August 2006. The last amendments to the MiFID date from 2007 (Dir 2007/44 of 5 September 2007).
The central term of the MiFID is ‘regulated market’ (Art 4(1) No 14). It is not only central to the application of the MiFID’s own rules but also to the application of European securities law as a whole, namely to the Market Abuse Directive (Art 9(1)), the Prospectus Directive (Dir 2003/71 of 4 November 2003, Art 1(1)), the Takeover Directive (Dir 2004/25 of 21 April 2004, Art 1(1)), the Transparency Directive (Art 1(1)) and the Shareholder Rights Directive (Dir 2007/36 of 11 July 2007, Art 1(1)). In its third title, the MiFID contains detailed rules on ‘regulated markets’ (Arts 36–47), which are supplemented by provisions that govern the authorities that have oversight over regulated markets (particularly Arts 48–55). Member States may grant ‘regulated market’ status only to trading systems that meet the requirements of the MIFID (Art 36(1)). The provisions of the MiFID have had a great impact on national exchange legislation. In Germany, for instance, the MiFID led to the enactment of a substantially revised Börsengesetz (2007). The explanatory memorandum to the draft (Bundestag printed matter 16/4028 of 12 January 2007) mentions the MiFID no less than 91 times over just 11 pages (79–89).
6. Current challenges
Exchanges and their regulators are faced with three main challenges today: profit orientation, internationalization and fragmentation.
a) Profit orientation
The last two decades have witnessed a revolution in the organization of exchanges: the conversion of exchanges from not-for-profit public institutions that were, in many respects, comparable to medieval trading gilds, to profit-seeking international stock corporations whose own shares are listed at the exchange and scattered among financial investors (‘demutualization’). In Europe, all major exchanges or their operators are listed and publicly traded today.
This fundamental change poses regulatory challenges because the profit orientation of the exchanges raises concerns that, in exercising their supervisory powers, exchanges might be guided by the financial implications of their decisions, not by regulatory motives and needs. For instance, market operators could be tempted to over-regulate areas in which they can impose significant penalties or, conversely, neglect areas in which such ‘supervisory returns’ are not possible. In addition, there is the risk that exchanges regulate competitors more strictly than affiliated companies.
None of the leading jurisdictions has so far managed to satisfactorily resolve these conflicts of interest. The MiFID only demands the avoidance of the ‘conflict of interest between the interest of the regulated market, its owners or its operator and the sound functioning of the regulated market’ (Art 39(a)), without offering any solution as how to avoid it. In Germany, the Börsengesetz, like the MiFID, only states the requirement that exchange operators ‘make arrangements’ to identify and avoid conflicts of interest (§ 5(4)(1)). The Code monétaire et financier (Art L 421-11(1)(1)) is as brief as the German Börsengesetz; the rules of the French supervisor (Règlement Général de l’Autorité des Marchés Financiers, Arts 512-3–512-6) are a little more detailed. The best, but far from exhaustive guidance is offered by the regulatory authority in the United Kingdom (FSA Handbook, REC 2.5.10–16).
The international dimension of exchange law is a rather young phenomenon for many jurisdictions. For instance, the German legislature enacted rules to restrict the access of foreign trading systems to Germany only after the United States prevented foreign operators from entering the American market, ie less for regulatory than rather for political reasons (accomplished through one of the reform acts, the Viertes Finanzmarktförderungsgesetz of 2002).
Additional problems are presented by cross-border exchange mergers such as the combination of the New York Stock Exchange and Euronext (2006), which itself is the holding company of exchanges in Belgium, France, the Netherlands, Portugal and the United Kingdom. National regulators feel increasingly uncomfortable with the oversight over such international entities and are looking for new regulatory approaches, either through intensifying the cooperation with foreign regulators or through extending the extraterritorial reach of their own laws. The planned merger of NYSE Euronext with Deutsche Börse (announced in 2011) highlights the problem.
The rivalry between exchanges and other marketplaces is, as the long-lasting difficulties to distinguish between the two (see 2. above) suggests, not new. But until recently, the network effect of exchanges prevented other marketplaces from gaining larger market shares (‘network effect’ describes the phenomenon that the more liquid a market is, the lower the transaction costs are, and the lower the transaction costs are, the more attractive and thus more liquid the market is). However, over the course of the last decade, technological advances have reduced and, in some areas, eliminated the network effect because alternative trading systems are now accessible from anywhere in the world (which increases their liquidity) at low transaction costs (which attracts more liquidity). As a result, exchanges have lost market share in many fields, sometimes even their market leadership, and markets have become more fragmented.
Originally, most parties involved welcomed this increased competition because it has considerably reduced trading costs. Even the exchanges acknowledged the benefits because the overall market often grew to such an extent as to outweigh their loss of market share. Only recently observers have begun to realize the negative consequences of market fragmentation, such as decentralized and therefore heterogeneous pricing or inequalities in the trading options that might lead to advantages for professional traders over other investors. Regulators might soon feel the need to intervene.
In the area of exchange law, European legal harmonization is less advanced than in relation to securities law as a whole. Much time was spent on improving the disclosure regimes for traded financial instruments, but it was not until the MiFID that significant organizational requirements were imposed on exchanges. With these provisions the development came to a temporarily halt. According to the White Paper (2005) of the European Commission on Financial Services Policy 2005–2010, there were no plans for new rules on regulated markets; the focus instead should be on ‘dynamic consolidation’. While the European Commission stuck to its original plan and refrained from revising the MiFID before the end of the decade, the Commission has now decided to put forward proposals to amend the directive soon. Whatever the results of this initiative will be, experience suggests that the new regime will not constitute the ‘end of history’ in the regulation of exchanges. As over the course of the last five centuries, there will be scandals on the securities markets, and policymakers will, to reassure themselves and the public, respond to these scandals with new rules. Exchanges and exchange law will keep evolving.
Gunnar Schuster, Die internationale Anwendung des Börsenrechts (1996); Klaus J Hopt, Bernd Rudolph and Harald Baum (eds), Börsenreform (1997); Ruben Lee, What is an Exchange? (1998); Andreas M Fleckner, ‘Stock Exchanges at the Crossroads’ (2006) 74 Fordham Law Review 2541; Christoph Kumpan, Die Regulierung außerbörslicher Wertpapierhandelssysteme im deutschen, europäischen und US-amerikanischen Recht (2006); Michael Blair and George Walker (eds), Financial Markets and Exchanges Law (2007); Stavros Gadinis and Howell E Jackson, ‘Markets as Regulators: A Survey’ (2007) 80 Southern California Law Review 1239; Alain Couret and Hervé Le Nabasque, Droit financier (2008); Andreas M Fleckner and Klaus J Hopt, ‘Entwicklung des Börsenrechts’ in Handelskammer Hamburg (ed), Die Hamburger Börse 1558–2008 (2008) 249, also: ‘Evolución del Derecho Bursátil’ in Klaus J Hopt, Estudios de Derecho de Sociedades y del Mercado de Valores (2010) 325 and ‘Razvoj borznega prava’ (2010) 36 Podjetje in delo 26; Horst Hammen (ed), Interessenkonflikte beim Börsengang von Börsen (2009); Ruben Lee, Running the World’s Markets—The Governance of Financial Infrastructure (2011).
Code de commerce (10–15 September 1807), Bulletin des lois No 164, 161 ff; Entwurf eines allgemeinen deutschen Handelsgesetz-Buchs (12 March 1861): Allgemeines Deutsches Handelsgesetzbuch (ADHGB); Einführungsgesetz zum Allgemeinen Deutschen Handelsgesetzbuch (24 June 1861), Gesetz-Sammlung für die Königlichen Preußischen Staaten 449 ff; Börsengesetz (22 June 1896), Reichsgesetzblatt 157 ff; Financial Services Act 1986 (7 November 1986), 1986 ch 60; Gesetz zur weiteren Fortentwicklung des Finanzplatzes Deutschland (Viertes Finanzmarktförderungsgesetz) (21 June 2002), Bundesgesetzblatt part I 2010 ff European Commission, White Paper: Financial Services Policy 2005–2010 (5 December 2005), <http://ec.europa.eu/internal_market/finances/docs/white_paper/white_paper _en.pdf>; Entwurf eines Gesetzes zur Umsetzung der Richtlinie über Märkte für Finanzinstrumente und der Durchführungsrichtlinie der Kommission (Finanzmarkt-Richtlinie-Umsetzungsgesetz), Bundesrat printed matter 833/06 (8 December 2006) = Bundestag printed matter 16/ 4028 (12 January 2007).