Article by Emilio Diaz Ruiz and Manuel Nunez Armas

Two important Royal Decrees regulating investment services on securities have been enacted in Spain this year, namely, Royal Decree 867/2001, of July 20, on the legal regime of investment firms; and Royal Decree 948/2001, of August 3, on investor compensation schemes.

These Royal Decrees represent the development of the regulations governing investment services contained in the Spanish Law 37/1998, which introduced several amendments to Law 24/1988, on Securities Markets (hereinafter "LMV"), by implementing the Directives 93/22/EEC of 10 May 1993, of the European Council, on investment services on securities, and 97/9/EC of the Parliament and of the Council, of 3 March 1997, on investor compensation schemes.

These Directives should become an essential instrument for the financial convergence in the European Community and also therefore, the internal market. They will improve the efficiency and transparency in the securities markets, and the consistency of the different systems aimed to protect investors’ interests. Likewise, Spanish Royal Decrees 867/2001 and 948/2001 intend to be a further step in this direction.

I. Royal Decree 867/2001, of July 20, on legal regime of investment firms

According to the approach adopted by Directive 93/22/EEC (hereinafter in section I "the Directive"), and followed by the Spanish LMV and Royal Decree 867/2001 (hereinafter in section I "the Royal Decree"), two fundamental principles lie at the heart of the legal framework of investment firms in the European Community. These are, the principles of home Member State supervision and mutual recognition.

Therefore, firms providing investment services covered by the Directive (and, therefore, by the Royal Decree) are subject to authorisation by their home Member States in order to protect investors and the stability of the financial system. By virtue of the latter, investment firms authorised in their home Member States may carry on any or all of the services covered by the Directive for which they have received authorisation throughout the Community, by establishing branches or as of right to provide services.

Nevertheless, in order to guarantee the internal supervision of every firm, and for these principles to be applicable, a certain coordination of the supervision systems in each of the Member States is essential.

Pursuant to this objective, the Royal Decree is aimed at achieving two objectives:

  1. to provide detailed regulations on the essential requirements and operating conditions of investment firms, and the procedure to grant the relevant authorisations by the Spanish authorities; and
  2. to regulate the provision of services throughout the EU by investment firms authorised in Spain, as well as the operations carried out in Spain by those investment firms authorised in other Member States or in non-member countries.

While the first are developed in Titles I, II and III of the Royal Decree, Title IV is devoted to the cross-border activities of investment firms.

With regard to the first of the objectives, the Royal Decree defines investment firms (using an almost literal transcription of the definition contained in Articles 62 of Law 37/1998 and 1.2. of the Directive), as "financial institutions the regular occupation of which is the provision of investment services for third parties on a professional basis."

The investment services covered by the Royal Decree are listed in Article 2, while the instruments by which those services may be provided are contained in Article 3.

The investment services include:

  1. receipt and transmission, on behalf of investors, of orders in relation to one or more of the instruments mentioned below;
  2. execution of orders other than for the firm’s own account;
  3. dealing in any of the instruments mentioned below for the firm’s own account;
  4. managing portfolios of investments in accordance with mandates given by investors on a discretionary client-by-client basis;
  5. placing of issues the instruments mentioned below;
  6. underwriting the said issues.

Moreover, the Royal Decree lists a wide range of non-score services which may be provided by investment firms, including safekeeping and administration of the instruments. These include, safe custody services, granting credits or loans to investors to allow them to carry out a transaction where the firm granting the credit or loan is involved, services related to underwriting, foreign-exchange services connected with investment services and financial advice under certain conditions.

The instruments which are covered by the Royal Decree include:

  1. transferable securities and units in collective investment undertakings,

  1. negotiable money-market instruments,
  2. contracts of any nature transferable in "secondary markets",
  3. financial-future, financial-option, and swap contracts, provided that the underlying assets consist of securities, indexes, currency, interest-rates or financial assets of any other nature, regardless of their liquidation system, and even those contracts which are not negotiable in any markets,
  4. contracts or operations not covered by the previous paragraphs, while negotiable in official or non-official markets, including contracts for non-financial assets, such as commodities.

Paragraphs "iii", "iv", and "v", combine a varied range of instruments and contracts, to which the provisions of the LMV regarding transferable securities apply. However, although the application of these rules contained in the LMV, with the necessary adaptations, is coherent in the case of transferable instruments, it seems that they are not as useful for those instruments which are not transferable in any type of market It is not surprising therefore, that some of these operations, for instance the financial-derivative contracts "over the counter", are still carried out without taking into account most of those rules.

According to the above, the Royal Decree, in the same terms as those set forth in Article 64 of LMV, distinguishes three types of investment firms: securities companies "sociedades de valores", which are authorised to provide any of the services listed above, as well as any other non-score services covered by the Royal Decree; securities agencies "agencias de valores", authorised to provide those services and non-score services which imply acting other than for their own account (i.e., they can act as brokers, but not as dealers), and portfolio management companies "sociedades gestoras de carteras", which may carry on, solely, those operations covered by paragraph "d" mentioned above, as well as non-score services concerning investment advice and advice regarding capital structure, industrial strategy, mergers and purchase, and other connected matters.

In principle, all of these activities must be provided exclusively by the three types of investment firms mentioned, as established in Article 7 of the Royal Decree. However, in accordance with Article 5, credit institutions are also allowed to carry out investment services as previously defined, unless their company by-laws provide otherwise and provided that they have obtained the necessary authorisation.

In addition to this, the Royal Decree establishes specific conditions for the setting up of such a business, according to which an investment firm must:

  1. be incorporated as a "sociedad anónima";
  2. have its head office in Spain, since this is the Member State which has issued the necessary authorisation and in which the business will be carried out;
  3. maintain sufficient capital in accordance with Article 15 (the minimum initial capital required has been reduced in comparison with previous regulations, in order to deregulate the investment services field);
  4. be directed by persons with ample experience and of good reputation ;
  5. be managed by a board of directors with at least three members in securities agencies and portfolio management companies; and a minimum of five members in the case of securities companies;
  6. have internal regulations governing the conduct of employees and persons in charge of the direction of the company, defining conflicts of interest, the activity of the agents and branches of the company, and other rules of conduct established in the LMV;
  7. have submitted in the National Securities Exchange Commission (hereinafter "the CNMV") a programme of operations, setting up the activities provided by the company and the scope thereof.

Compliance with these conditions is continuous from the granting of the authorisation onwards.

In addition, while operating in the investment services field, companies are obliged to:

  1. arrange for records to be kept of transactions executed;
  2. ii comply with certain requirements concerning internal sources, adequacy and maintenance of certain liquid assets within the company;

  3. fulfil specific proceedings in the event of amendments to the company’s by-laws, which are more burdensome than those set forth in the Spanish Laws for "sociedades anónimas" in general.

  1. provide the CNMV with sufficient information regarding these requirements, and regarding the business carried out by agents and branches of the company, the identity of the shareholders of the company, annual and quarterly balance sheets and the appointment of auditors, among others. This is all necessary in order to improve the transparency in the securities markets and therefore, the confidence of investors therein.

With a view to ensuring an efficient supervision on the investment services activities, the Royal Decree also provides :

  1. the information requirements that any person who intends to acquire, directly or indirectly, a qualifying holding in an investment company must submit ,
  2. the specific regulations governing the agency and representation contracts entered into by investment companies,
  3. the specific regime of the operations undertaken by investment companies with their clients, and the limitations and conditions regarding their sources of financing, either internal or external.

Regarding cross-border activities, the Royal Decree clarifies the concepts of the principles of home Member State and mutual recognition.

In this regard, companies authorised in a particular Member State who intend to carry out investment services in Spain, may establish a branch therein or carry out business as of right to provide services without establishing branches. In both cases, communication between the authorities of the home Member State and the Spanish CNMV is required.

In the first case, when notifying the above-mentioned information, authorities of the home Member State shall provide the CNMV, with the following information:

  1. a programme of operations setting out the types of business envisaged and the organisational structure of the branch,
  2. the address in Spain where documents can be obtained,
  3. detailed information of any compensation scheme intended to protect the investors of the branch,
  4. the names of those responsible for the management of the branch, and records concerning their previous professional activities.

In the second case, the notification required must set out the specific services which will be provided by the particular investment company, and further notifications will be necessary in the event that the company wishes to carry out services which differ from those set up in the first communication. Moreover, the CNMV will inform these companies of the conditions and rules of conduct which they must observe at all times.

Companies authorised in a Member State may also wish to provide investment services in Spain by creating a subsidiary therein or by gaining the control of a particular company already operating in Spain. In such cases, authorities of the Member State in question must be consulted by the CNMV.

This regime will differ if the investment company wishing to provide services in Spain is authorised in a non-member State. In this event, that particular investment company will also have the possibility of conducting its business in Spain by establishing a branch, by providing certain services without establishing any branch, or by creating a subsidiary or gaining control of a Spanish existing company. However, the eventual withdrawal of the authorisations needed may be based not only in the requirements applying to investment companies authorised in members States, but also in the difficulties that the Spanish investment companies may encounter in establishing themselves or providing investment services in that particular non-member country.

With regard to the cross-border activities of the Spanish investment companies, they may be carried out under the same conditions, as follows:

  1. By establishing branches in foreign countries:
  2. previous application to the CNMV will be required, and a communication made by the CNMV to the authorities in the host country if it is a Member State The authorisation may be denied for branches in non-Member States if efficient supervision by the authorities of the non member country cannot be guaranteed.

  3. By providing services without creating branches.
  4. authorisation of the CNMV will be needed if the host country is a non-member, and communication thereto will be enough for host Member States.

  5. By creating or gaining the control of a company constituted in another country.

  6. authorisation by the CNMV will be necessary if the host country is a non-member State, and the CNMV will be consulted by the authorities of the host country, if it is a Member State.

Since the aim of all these provisions is to adapt the Spanish regulations on investment services to the Directive, by developing Law 37/1998, the Royal Decree derogates certain rules which previously governed investment services and which were not in accordance with the new provisions of the Directive. They are, broadly speaking , the rules contained in Royal Decree 276/1989, and in Title IV of Royal Decree 393/1990.

Likewise, the Royal Decree may be developed by further regulations of the Ministry of Economy and the CNMV.

II. Royal Decree 948/2001, of August 3, on investor compensation schemes

As stated in Section I, Royal Decree 867/2001 lays down detailed rules which investment firms must observe at all times, including rules, the purpose of which, is to protect as far as possible the rights of investors. However, no system of supervision can ensure complete protection, especially in cases where acts of fraud are committed (for instance, in the "Gescartera scandal", filling most of the Spanish press headlines during the last few months).

As a response to these situations, Directive 97/9/EC of the Parliament and of the Council, dated 3 March, 1997, on investor compensation schemes (hereinafter in section II "the Directive") sets out the obligation to establish in each Member State an investor compensation scheme, in order to guarantee a consistent minimum level of protection, at least for the small investor, in the event of an investment company being unable to meet its obligations to its investor clients. In this regard, the Directive establishes that every Member State shall ensure that within its territory one or more investor-compensation schemes are introduced and officially recognised.

In compliance with this provision, and developing Article 77 of LMV (which implemented the Directive to Spanish Laws), Royal Decree 948/2001 of August 3, on investor compensation schemes (hereinafter in section II "the Royal Decree") provides detailed regulations on the structure of the investor compensation schemes in Spain, their management system, the obligations of investment companies in this regard, and the specific protection that these systems provide to small investors.

Among the different possible compensation schemes, the Royal Decree has adopted the Investments Guarantee Fund "Fondo de Garantía de Inversiones", which every securities company and securities agency must join. This is intended to prevent the possibility of the constitution of another Guarantee Fund by a certain group of investment firms which would not be obliged, in this event, to join the first Fund.

Each of these Funds must constitute a separate property, with no legal capacity, the representation and management of which will be entrusted to a managing company. The managing company must be a "sociedad anónima", and its capital must be subscribed by investment companies which are part of the Fund, the CNMV being the supervisory authority. The assets of the Fund/s will be constituted, exclusively, by the contributions of the member companies, though the Fund is permitted to apply for loans under certain conditions.

Regarding the specific obligations imposed on securities companies and securities agencies (not on portfolio management companies), they mainly include the obligations of creating and joining a Fund, making the specific contributions thereto in accordance with Article 8 of the Royal Decree and maintaining at their offices sufficient information on the characteristics of the Fund that can be consulted by the clients of the firm. This information however, must not be used for the purposes of advertising although a single reference to the Fund joined, can be included in the publicity material of the company).

The coverage guaranteed by the Fund/s, extends to the money and securities transferred to the investment companies by their clients to carry out the services agreed, but it does not guarantee any losses in the investment value or any credit risks. Only if a formal declaration of insolvency of the investment firm not meeting its obligations is made, either by court proceedings or by administrative proceedings before the CNMV, can the investor demand the specific coverage of the fund.

Since the objective of these Funds is principally the protection of non-professional investors, they are excluded from the coverage guaranteeing the money and the securities belonging to qualified or institutional investors, i.e., financial institutions and certain individuals connected thereto, as listed in Article 4 of the Royal Decree.

The Fund will guarantee each investor the global amount owing thereto as a result of the investment company not meeting its obligations, to the maximum sum of 20,000 Euro. Once payment takes place, the Fund holds the creditor’s position in respect of the investment company.

All of these provisions are applicable to securities companies and securities agencies. Nevertheless, since credit institutions are also allowed to provide investment services (as mentioned in section I), such credit institutions should be required, in principle, to belong to an investor compensation scheme to cover their investment business. However, it would not be appropriate to request the credit institutions to belong to two separate schemes, as they must join a Deposit Guarantee Fund anyway, in compliance with Royal Decree 2606/1996 which develops the principles established in Directive 94/19/EC of the European Parliament and of the Council, dated 30 March, 1994 on deposit guarantee-schemes. Therefore, the Royal Decree, does not oblige the credit institutions providing investment services to belong to an Investment Guarantee Funds, but introduces several amendments to the existing regulations on Deposit Guarantee Funds, in line with the rules set out in respect of the Investment Guarantee Funds.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.