Author: | Published: 8 Apr 2002
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For many years, there was uncertainty about the precise scope of the securities brokerage licence requirement of the Securities Market Supervision Act (SMSA or Wet toezicht effectenverkeer 1995). It was always beyond doubt that both intermediaries which effect securities transactions in or from The Netherlands for their clients' accounts and entities that, in a professional or commercial capacity, effect such transactions for their own account need a licence. But it was uncertain whether bilaterally negotiated, non-transferable OTC derivatives could qualify as 'securities'. The Spot Forex judgment of the Dutch Supreme Court (Hoge Raad der Nederlanden, or the Hoge Raad) has clarified this.

The Hoge Raad made it quite clear that non-transferable financial instruments may qualify as 'securities'. Accordingly, those who enter into such non-transferable instruments, including legal entities, may require a licence. It was also in doubt whether securities institutions set up outside the European Economic Area (EEA), which obtained their Dutch clients through the intermediation (including marketing activities in The Netherlands) of an SMSA licenced entity, required a Dutch licence. A large number of US booking entities or derivatives product vehicles (DPVs) are serviced in this way by EEA intermediaries. The Dutch Financial Markets Authority (AFM or Autoriteit Financiële Markten), which was known before March 1 2002 as the Securities Board of The Netherlands (STE or Stichting Toezicht Effectenverkeer), has now confirmed that such non-EEA booking entities or DPVs do need a Dutch licence. Both of these issues result in a substantial extension of the SMSA's licence requirement, particularly in the OTC derivatives area. A failure to obtain a licence could result in contracts entered into becoming void, as a result of a consistent flow of lower court case law.

Below we will also discuss the Ofasec judgment of the Hoge Raad. This judgment concerned the rights of holders of bearer debt securities and was long awaited in the Dutch financial community. Next, we will discuss the new rules for Dutch finance companies and special purpose vehicles used for securitization, repackaging and structured finance transactions (SPVs), which are a significant source of primary market activity emanating from The Netherlands. The new rules could have significant consequences for issuance of commercial paper and unlisted bearer notes under MTN programmes by such finance companies and SPVs.

Licence requirement for OTC derivatives: The Spot Forex judgment

Non-transferability as safe harbour?

In June 2001, the Hoge Raad ruled in the Spot Forex case that there is no basis in the SMSA's definition of securities to require that an instrument can only be a security if it is transferable or marketable. It seems that with this decision, any arguments that there is a safe harbour for the SMSA's securities brokerage licence requirement for entering into bilaterally negotiated, non-transferable or illiquid OTC derivatives transactions are no longer viable. In an earlier judgment in 1999 concerning a so-called pyramid-game, the Hoge Raad ruled that the contracts that participants in the pyramid game entered into with the organiser did not qualify as 'securities', which it based (among other things) on the nature of the contracts and their non-transferability. Some legal writers read the pyramid game judgment as suggesting that the (non-) transferability of contracts was a decisive factor in qualifying a financial contract as a security or otherwise, a view which the Hoge Raad has now denied.

The Hoge Raad's decision was taken in relation to spot forex contracts, but has a wider scope and may be interpreted generally and extended to other OTC financial products. The decision implies that persons or legal entities involved in a professional or commercial capacity (either as an intermediary or otherwise) in the conclusion of bilaterally negotiated non-transferable OTC contracts (eg options or forwards), in principle qualify as securities brokers and are subject to the SMSA's licence requirement. The licence requirement also applies to the provision of securities (intermediary) services between professional parties, as the SMSA does not provide for an exemption from the licence requirement in this case.

Swaps and the SMSA's securities brokerage licence requirement

Although swaps are not regarded under the SMSA as 'securities', persons or legal entities that engage in the swap business are in principle deemed to perform securities (intermediary) services and need to obtain a securities brokerage licence. The Hoge Raad's pyramid game judgment seemed to provide a haven for non-transferable or illiquid OTC contracts and there were persuasive arguments that, if the non-transferability haven was available for securities then it should also apply to swaps. With the Spot Forex judgment it must now be assumed that those entering into non-transferable or illiquid swaps are treated on the same footing as those that effect transactions in other non-transferable OTC financial products and therefore require a securities brokerage licence.

Securities (intermediary) services or hedging

Whether or not a person or legal entity is in fact offering or performing securities (intermediary) services and subject to the SMSA's licence requirement, has been commented on in individual letters by the AFM. The AFM takes the view that those which enter solely into securities or swap transactions (eg principal-to-principal-negotiated OTC contracts) as end-users of the transaction (ie they at most hedge certain risks arising from their ordinary business, such as currency risks) do not qualify as securities brokers and do not require a licence. The end-user status typically implies that positions are not transferred, whether legally (by way of assignment) or economically (eg through hedge transactions on or off-exchange). It may be questionable whether or not a particular person is such an end-user in respect of all its securities and swap transactions. Therefore, before relying on this guidance, a detailed overview of activities with Dutch counterparties is usually submitted to the AFM. The guidance does not help financial institutions, since they invariably transfer or hedge their position.

Hoge Raad qualifies certain spot currency contracts as securities

In the Spot Forex case, the Hoge Raad also ruled that not only forward currency transactions, but also certain spot currency transactions might qualify as 'securities'. This could similarly affect the position of spot commodity transactions that share certain or all of the characteristics of the spot forex transactions ruled upon by the Hoge Raad. The defendant in the spot forex case was indicted for having acted as a securities broker in The Netherlands without the appropriate licence. The SMSA defines a securities broker (among others) as "any person acting in a professional or commercial capacity as an intermediary in the trade in securities...". The Amsterdam Court of Appeal held in this case that the defendant was actually an intermediary, which was confirmed by the Hoge Raad. The case therefore boiled down to the question of whether or not the currency transactions were to be considered as securities, and so whether the defendant was to be considered a securities broker.

The spot currency transactions at issue

The defendant had approached several clients for one or more purchase and sale agreements relating to certain foreign currencies. At the time of the purchase, no specific date was set for the settlement of the transaction. The client, however, indicated the extent to which he accepted price risks by giving stop profit or stop loss instructions, resulting in settlement of the contract if the relevant threshold was crossed. Although the contracts were formally spot contracts, they were rolled over every day, ie they were settled pro-forma every day but continued immediately after the pro-forma settlement. Actual settlement would normally occur only at the client's specific request, and then did not involve the transfer of any purchased currencies or purchase price, but was merely conditional on the balance against either the defendant or the client resulting from the various purchase and sale transactions and was effected in a certain base currency.

The Hoge Raad qualified these particular spot forex contracts as 'securities', particularly because:

  • simultaneous buy and sell orders were given (ie via the stop profit or stop loss instructions);
  • the intention actually to deliver currencies was absent; and
  • the settlement of the transactions was such that price differences were netted after a certain period in a certain base currency.

Given the characteristics that the Hoge Raad found relevant in qualifying the spot forex contracts as 'securities', it can reasonably be argued that spot commodity contracts would not qualify as securities if the commodities are actually delivered the same or the following day and the transactions are not rolled over for one or more days. With regard to spot electricity contracts traded on the Day-Ahead-Market of the Amsterdam Power Exchange (APX), the Dutch Minister of Finance ruled that they do not qualify as securities and no licence requirement is triggered with respect to brokerage activities relating to such APX-traded contracts. In subsequent guidance given before the Spot Forex judgment, the STE stated that the period of one day within which spot electricity transactions on the APX's Day-Ahead-Market are settled is not intended to benefit from price differences, whereas the spot forex contracts were.

Intermediation for non-licenced entities prohibited

Recently, the STE has given further guidance on the SMSA's licence requirement for non-Dutch securities brokers or portfolio managers (together called: securities institutions or principals) that provide securities (intermediary) services on a cross-border basis to Dutch customers, through the intermediation of another securities institution (the intermediary).

The STE's guidance on intermediation centred on the question of whether or not the principal requires a Dutch licence in the event it:

  1. provides securities (intermediary) services to Dutch customers, through the intermediation of an affiliated (non-Dutch) intermediary which has the necessary licence or exemption to offer or perform securities (intermediary) services in The Netherlands on a cross-border basis; or
  2. enters into a contract with the intermediary which mirrors a particular contract (relating to securities (intermediary) services) that the intermediary has entered into with its own Dutch customers, without entering into a contract with such customers themselves (a back-to-back structure).

The STE has confirmed that the principal requires a licence in situation (a), but not – unsurprisingly – in situation (b). This has brought about much-needed certainty in a debate on whether non-EEA booking entities or DPVs are relieved from Dutch licence requirements if trades with Dutch customers are intermediated through the agency of an affiliated EEA company, with the requisite licence to be active in The Netherlands.

How do intermediation structures work?

In the context of securities markets and the provision of securities (intermediary) services, the term intermediation (or fronting) is generally used to describe structures in which an intermediary intermediates in finding customers for the principal, with a view to bringing together these customers and the principal, after which the principal provides securities (intermediary) services directly to customers and/or enters into an OTC derivatives contract on a 'principal-to-principal' basis with such customers. Practically speaking, intermediation means that the intermediary introduces the customers or the customer's orders to the principal. A large number of US booking entities or DPVs are serviced in this way by EEA intermediaries. In these intermediation structures, the principal will end up having a direct relationship with the customer. The relationship could either be:

  • a principal-to-principal relationship, eg within the context of a trade between the customer and the principal, whereby both parties act for their own account (eg an OTC derivative contract); or
  • an agency relationship (in which the principal will perform securities intermediary services for the customer, eg executes a transaction in securities for the customer's account or provides portfolio management services for the customer).

After arranging the first contact between a customer and the principal, the intermediary may provide further services, perhaps by functioning as a contact address for the customer, providing information to customers on behalf of the principal, by providing investment advice to customers or otherwise.

Typically, the intermediary is (i) a non-Dutch securities institution, (ii) established in the EEA and licenced in its home state in accordance with the EU Investment Services Directive (ISD), (iii) operates in The Netherlands on a cross-border basis (ie without a branch office in The Netherlands) in accordance with its ISD passport and the notifications made to the supervisor in its home state and (iv) intermediates in securities (intermediary) services which it is allowed to offer and perform in The Netherlands. Usually, the principal is the parent or a group company of the intermediary, located outside the EEA, and has no licence to offer or perform securities (intermediary) services in The Netherlands.

What is a back-to-back structure and why is it used?

A structure in which the intermediary enters into contracts with the principal which mirror particular agreements (relating to securities (intermediary) services) that the intermediary has concluded with its own customers, is typically called a back-to-back structure. A reason to use it may lie in the intermediary's wish to transfer certain (financial) risks associated with the contract with its customer to a third party. A back-to-back structure entails that the principal will enter into an agreement only with the intermediary and not with the customer. In an economic sense, the securities (intermediary) services will be performed for the customer by the principal, but only indirectly and without the customer's knowledge and consent. The customer's knowledge and consent is not necessary, as the intermediary enters into the (mirror) agreement with the principal in its own name and for its own account. The customer's rights vis-à-vis the intermediary are in no way conditional upon the principal fulfilling its obligations vis-à-vis the intermediary.

The statutory framework: what triggers the SMSA's licence requirement?

The critical test to determine whether the principal requires a licence under the SMSA is whether or not it offers or performs securities (intermediary) services in or from The Netherlands. For non-Dutch entities, this criterion is fulfilled if the services are aimed at the Dutch market.

It is a general rule under the SMSA that both an introducing broker (the intermediary in an intermediation structure) and its 'principal' (also if set up abroad) are subject to the licence requirement. The argument is that both the intermediary and the principal are offering and/or performing securities (intermediary) services in The Netherlands. This also applies if the foreign principal has not marketed itself to the Dutch market, but engages another party (ie the intermediary) for this purpose. This was confirmed in a 1999 Amsterdam Appeals Court judgment concerning a German broker which had engaged a call centre, which in turn had approached Dutch residents. The licence requirement is, however, not triggered if the initiative for the introducing brokerage activities rests with the customer. This presupposes that the principal has not actively marketed itself in The Netherlands (directly or indirectly through the intermediary) and does not actively seek to expand any mandate received from the customer, ie once the initial contract has been entered into without a licence being required, each further and additional service must also be rendered solely at the customer's initiative in order to avoid a licence becoming required. This is called the initiative test.

It is not only Dutch introducing brokers that must ensure the principal is licenced; there is a general conduct of business rule that prohibits SMSA licenced securities institutions and ISD passport-holders (eg the intermediary) from doing business with non-authorised securities institutions. Such business includes introducing clients or clients' orders to a securities institution that (i) is not licenced in The Netherlands or (ii) can not have the benefit of a particular exemption from the licence requirement. It must be assumed that this prohibition relates to non-licenced or non-ISD passported entities which engage in marketing and solicitation activities (whether directly or indirectly through intermediaries) in The Netherlands.

Intermediation and back-to-back structures: the STE's view

In view of the statutory framework, it should come as no surprise that the STE has now confirmed that if the intermediary approaches its customers in order to introduce them (or their orders) to the principal, both the intermediary and the principal require an SMSA licence (or ISD passport). Without a licence having been obtained by the principal, the intermediary would be in breach of applicable conduct of business rules when introducing customers to the principal. The STE has not elaborated on the initiative test in connection with intermediation. Therefore, it may still be possible that the principal would not require a licence if (i) the customer sought out the principal, (ii) the customer instructs the intermediary to arrange a transaction with the principal and provided (iii) the principal has not actively marketed itself in The Netherlands and does not actively seek to expand any mandate received from the customer (whether directly or indirectly). This solution is rather tenuous in the event that the principal and intermediary are affiliated. If so, it will be difficult to argue that the principal has not actively marketed itself in the Dutch market. It is, however, conceivable that the AFM or a Dutch Court could be persuaded by this line of argument.

As for back-to-back structures, the STE has indicated that the principal does not require a licence, as it does not market its services to and does not enter into an agreement with Dutch customers.

Bondholder rights: The Ofasec judgment

In March 2001, the Hoge Raad ruled on the high-profile Ofasec case, which concerned the rights of bondholders (represented by their trustee) who had invested in certain bearer bonds issued in 1988 by DAF, the terms and conditions of which were set out in a trust deed. DAF was the holding company of several truck manufacturing companies and went bust in 1992. According to the 1988 trust deed, bondholders had the benefit of a pari passu clause and a negative pledge clause preventing DAF from granting any (additional) security to other lenders, whether for existing loans or in connection with new credit facilities. It was contested to what extent the pari passu/negative pledge clauses extended to the granting of (additional) security by DAF's subsidiaries to their respective lenders. Contrary to the literal text of the trust deed, the prospectus had given the impression that these clauses extended to DAF's subsidiaries, so that bondholders would share equally in (additional) security provided by DAF's subsidiaries. At the beginning of 1992, a group of banks which had extended credit to DAF and DAF's subsidiaries requested additional security from both. This security was granted, not to the banks themselves, but to a newly established off-balance sheet entity. This entity, a foundation named Ofasec, guaranteed all the debts of DAF and the DAF subsidiaries vis-à-vis their respective lenders, subject to sufficient security being granted to Ofasec and to the interpretation of pari passu/negative pledge clauses in the various agreements. Under Ofasec's administration conditions, it appeared that DAF's creditors (including the holders of the 1988 DAF bonds) were left empty-handed, because the security granted to Ofasec by DAF itself was worthless. Ofasec refused to let the DAF bondholders share in the security granted by DAF's subsidiaries. The trustee sued Ofasec, alleging that Ofasec had incorrectly interpreted the pari passu/negative pledge clauses. The proceedings were primarily based on breach of contract and did not at first involve the bank which had been involved in preparing the prospectus. However, the trustee also filed a claim based on prospectus liability against the lead manager for the DAF bonds, a claim which was conditional on the contractual claim being denied.

The Hoge Raad's judgment

In its judgment, the Hoge Raad ruled that the precise wording of the trust deed was decisive for the bondholders' contractual rights. Since the trust deed was clear in stating that the pari passu/negative pledge clauses related only to DAF itself, the trustee's claim against Ofasec was denied. In particular, the Hoge Raad stressed that the character of bearer debt securities implies that bondholders which acquire the bonds in the secondary market should have rights that are identical to those who subscribe in the primary market. Accordingly, the Hoge Raad ruled that all of the bondholders' contractual rights should be apparent from the bearer paper embodying the claim. This meant that the bonds' terms and conditions, as stated in the trust deed, were decisive for the bondholders' contractual rights and that a prospectus which gave another impression did not matter. Now that the Hoge Raad has denied the trustee's claim against Ofasec, the Court of Appeal of The Hague, to which the case has been referred, still has to decide on the claim for prospectus liability.

New rules for Dutch finance companies

In the wake of the September 11 attacks in the US, the Dutch Minister of Finance published a paper on the integrity of the financial sector and the war on terrorism in November 2001. One of the paper's main recommendations was that some form of supervision should be imposed on Dutch finance companies that are exempt from banking supervision exercised by the Dutch Central Bank (DNB or De Nederlandsche Bank), in order to prevent them from abusing their exempt status to engage in money-laundering activities or to fund criminal or terrorist activities. Dutch finance companies (DFCs) and SPVs used for securitization, repackaging and structured finance transactions were, subject to certain economic conditions, exempt by virtue of the Ministerial Regulation of February 4 1993 from the DNB's supervision under the Credit System Supervision Act 1992 (CSSA or Wet toezicht kredietwezen 1992), the principal Dutch banking regulation. The system of available exemptions (conditional on the maturity of borrowings and the source and application of funds) is set out below.

Maturity of borrowing:

short term
(<2 years)
long term
(=2 years)

Source of funds Restriction on use of funds

1. short-term and/or long-term funds guaranteed by ultimate parent

non-professional market parties (PMPs)

at least 95% of balance sheet total in loans and/or investments within the group

2. short-term and/or long-term funds guaranteed by ultimate parent

combination of non-PMPs and PMPs (and/or group companies)

at least 95% of balance sheet total in loans and/or investments within the group

3. short-term funds (whether or not in combination with long term funds) guaranteed by ultimate parent

exclusively from PMPs (and group companies)

loans and/or investments within the group and/or loans to, and/or investments in, PMPs and eligible securities

4. short-term and/or long-term funds

exclusively from group companies

no restrictions on loans or investments made

5. long-term funds

exclusively from PMPs (and group companies)

no restrictions on loans or investments made

6. short-term funds rated by recognized credit rater

exclusively from PMPs (and group companies)

exclusively to purchase a homogenous pool of receivables from a single originator

As a consequence of the global anti-terrorism efforts, an amendment to the Ministerial Regulation was published on December 21 2001, making all exemptions subject to certain additional conditions. This amendment imposes new and far-reaching conditions to all available exemptions for DFCs and took effect on January 1 2002, subject to certain grandfathering periods. If the new rules are not complied with in time, DFCs are likely to lose their exempt status and become subject to (i) administrative orders and penalties, (ii) punishment with fines and/or imprisonment and (iii) the appointment by the court of a special administrator at the request of DNB, if the DFC does not meet Bank of International Settlement capital adequacy requirements.

The rules apply to any and all companies that qualify as a credit institution (kredietinstelling). The CSSA defines a credit institution as an enterprise or institution that conducts the business of (i) receiving repayable funds (whether or not for a certain period) and (ii) granting loans or making investments for its own account. Any entity that falls within this definition, regardless of whether it belongs to a group of companies or is stand-alone, qualifies as a credit institution and, unless it benefits from an exemption, requires a full banking licence under the CSSA.

The new rules

The new rules apply not only to DFCs which enjoyed exempt status under the previous version of the Ministerial Regulation, but also to those that have the benefit of an individual dispensation under the CSSA. It is important to bear in mind that certain companies which have raised finance to acquire other entities, companies that borrow money to acquire and then lease an asset as lessor, and certain passive holding companies that raise finance to on-lend or invest in or outside their group may qualify as credit institutions and therefore become subject to the new rules. The only entities to which the new rules do not apply are (1) licenced banks, (2) corporates that cannot be considered as credit institution, ie companies whose commercial activities outweigh their borrowing and lending/investment activities, (3) foreign finance companies offering notes into The Netherlands, and (4) Antilles finance companies.

Restrictions on the issuance of bearer debt securities

Before the amendments of December 21 2001, there was no restriction to the type of instruments that DFCs were allowed to issue. They could issue both bearer and registered bonds and notes. In order to allow DNB to monitor money flows into The Netherlands more closely, the Minister of Finance has amended all exemptions available to DFCs so that they are no longer permitted to issue bearer debt securities, unless the bearer debt securities are listed on certain Western stock exchanges or are registered with the SEC (permitted bearer notes). Consequently, after January 29 2002, exempt DFCs may only fund themselves (apart from equity), and then only in accordance with the Ministerial Regulation's economic restrictions:

  • by way of intra-group borrowings (not evidenced by unlisted bearer debt securities, eg promissory notes);
  • through bilateral or syndicated credit facilities (not evidenced by unlisted bearer debt securities);
  • by issuing registered debt securities or permitted bearer notes;
  • by issuing unlisted bearer debt securities with prior DNB dispensation (see below).

These restrictions could have significant consequences for issuance of commercial paper and unlisted bearer notes under MTN programmes by DFCs. Fortunately, DNB has proved to be willing to grant individual dispensations from the prohibition to issue unlisted bearer debt securities, provided the DFC confirms that it complies with the Ministerial Regulation's economic restrictions as to the maturity and sources of funding.

New filing requirements for DFCs

Previously, if a DFC intended to rely on an exemption under the Ministerial Regulation it did not have to apply with DNB or register with any other public authority. Under the new rules, companies that start operations as DFCs on or after February 26 2002 must notify DNB at least four weeks before they begin their operations and must submit full details on their company, their directors and anyone who has a qualifying shareholding (5% or more) in the company. At the same time, a compliance statement confirming that the company fulfils management reliability requirements and administrative requirements needs to be filed.

New management reliability requirements for DFCs

In order to continue to be exempt from DNB's banking supervision, the directors and holders of a qualifying shareholding of a DFC must meet DNB's requirements for reliability, which include criteria such as prior convictions and insolvencies. The DFC itself determines who is reliable and confirms this in the compliance statement, although DNB is willing to provide a ruling on the reliability of directors and holders of a qualifying shareholding on request.

New requirements for the administrative systems of DFCs

In order to continue to be exempt from DNB's banking supervision, all DFCs must have or have amended their administrative systems so it is ensured that:

  • the identity of all persons which provide funding (either equity or debt) to the DFC or are funded by the DFC is known;
  • the source of all received monies (whether equity or debt) and the destination of all on-lent and invested monies is known.

The DFC may not enter into any transaction or perform any act to obtain, lend or invest funds if it does not know these identities and sources and destinations of monies.

This does not apply in respect of funds obtained, loans or investments made or in respect of transactions to obtain, lend or invest funds, through the issuance or acquisition of securities (bearer or registered, equity or debt) that are listed on certain Western stock exchanges or are registered with the SEC. Equally, the above requirements do also not apply in respect of bearer debt securities issued by DFCs before January 29 2002 or if unlisted bearer notes are issued after this date with DNB dispensation.

If a DFC issues unlisted registered notes in principle it has to comply with all these requirements. DNB has indicated that it is not sufficient to identify the common depositary for one or more clearing systems as the holder of the relevant global-registered note. However, a dispensation can be obtained from DNB with relative ease, thereby discharging the issuer of unlisted registered notes from the requirements.

Furthermore, the DFC must at all times monitor and investigate transactions which are proposed to the company and that are unusual, and may not enter into transactions if it doubts the legitimacy or purpose of such transactions.

Selling restrictions for professionals-only DFCs

Under the previous version of the Ministerial Regulation, DFCs that must fund themselves exclusively from professional market parties could either (i) impose a worldwide selling restriction in the issue documentation (prohibiting offers and sales other than to professional investors) or (ii) issue notes with a minimum denomination of €500,000 (or equivalent).

Under the new rules such DFCs must print the worldwide selling restriction on the face of the permitted bearer notes unless these have a denomination of at least €500,000 (or equivalent). For registered debt securities the position is unclear. Unless such securities are listed or registered with the SEC, the DFC must be able to identify the holders.

* The author gratefully acknowledges the invaluable assistance of Mr Erwin Schreuder, senior research associate.

Clifford Chance
Droogbak 1A
1013 GE Amsterdam
Tel: +31 20 711 9000
Fax: +31 20 711 9999