Darwinian Natural Selection and Polity: The Exchange Legal Framework

The world is currently experiencing events for which history provides no guidance:

most countries have concentrated trades in one single domestic city and a

few countries have gone even further by allowing their national exchanges to integrate

newly created cross-border groups of Stock and Exchanges. The study of world

Stock Exchanges shows that they have adopted a wide range of practices, structures, rules,

and regulations, changing over time and sometimes exhibiting great differences, but tend-

ing toward some convergence over time.1 Of course, all markets always respond to the

needs of the people living in its neighbourhood, and the current vision of a Stock Exchange

is again the response of issuers, intermediaries, and investors, to the particular demands of

trading.

However, seems to be a singular case of response due to two special charac-

teristics of its own history: on the one hand, the pressures stemming from the Discoveries

in the endeavor of the fifteenth century dictated the centralization of a market in Lisbon,

where commodities, financing, and insurance, could be traded in order to cope with the

needs of those Discoveries; on the other hand, domestic and geopolitical aspects of the fol-

lowing centuries disturbed the smooth development of such centralized markets in Portu-

gal. Since then, the role of the Portuguese trade and financial services in the global network

of financial operations has been reflected in the special legal rules and settings that framed

the Lisbon Bourse. In any event, at the end of the twentieth century, and against all odds,

Portugal was able to recuperate the domestic capital market, and the success was so intense

that a number of foreign countries have come to study this unexpected “miracle”. The fol-

lowing sections reveal how shareholder protection, market transparency, and economic ef-

ficiency were pursued in a Darwinian natural selection process for best practices, and illu- 1

strate how important prevailing politics are in stimulating or cancelling legal and organiza-

tional improvements. The paper summarizes that historical evolution, and, in particular,

highlights the events that most contributed to the demise of the domestic Exchange and the

recovery of the Lisbon Stock Market.

Earliest Juridical Aspects and Regulations in the Lisbon Stock Exchange

Examining Exchanges’ juridical features throughout Portugal’s history is of interest.

There is much evidence that during the 15th century, at the peak of the Portuguese Discov-

eries, a rudimentary form of centralized market existed in Lisbon, precisely as a response

to two main problems: mobilizing the large amounts of money necessary to finance the

fleets and the successive voyages; and dealing with the premium of the insurance contracts

to cover the associated risks.2

It must be admitted that this was not a very organized market, and all transactions

were conducted on the open air in a corner of a major downtown street, Rua Nova, which is

described in most archival documents as the longest and the noblest in the city. It served

many professional establishments, which made it vibrant, and also connected the many nar-

row and twisting medieval streets to the royal palace. The presence of foreign merchants

living in Lisbon or attending its seaport explains why this rather informal market offered

trading in commodities, as well as in exchange letters, and foreign currencies. Milanese,

Genoans, and Florentines performed an important role in this kind of financial business in

Lisbon. 3 Additionally, the traffic of commodities, in particular those brought from re-

cently discovered overseas regions, required funds for investment. At this stage one cannot

yet speak of a specialized market, but of a business center, a centralized market for freight,

trade, insurance, and negotiation, where credit and risk had to be rewarded.

2

From the docks near the royal palace, fleets left for the Mediterranean, France, Flan-

ders, and Britain, and more and more regularly for the Atlantic islands and Africa. In the

1500s they were also sailed to India, following da Gama’s voyage, which opened the Cape

sea route to that destination in 1498, and to the New World, crossing the Atlantic, thanks to

Columbus’ and Cabral’s voyages.4 Trading in all these segments was then under the sur-

veillance of the local municipal authorities, with the operations on exchange letters follow-

ing Crown regulations.5 The Lisbon Bourse also developed the professional expertise for

managing contracts, and the presence of brokers is documented in archival sources on mu-

nicipal regulations from the fourteenth century for urban provisioning businesses, and for

maritime businesses thereafter.6 In fact, the law of 23 August 1342 compiled the rules for

the exercise of the brokerage profession, and defined tabular data for the value of the list-

ing fees and intermediation commissions. This legal framework represents the earliest

known attempt to control transaction costs, and provisions for market transparency.

By the end of the fifteenth century, a royal law of 15 February 1492 reduced the num-

ber of brokers from 25 to 12, in order to promote the implementation of a policy of profes-

sional privileges, which should be a monopoly of the royal decision, in order to reward the

king’s 12 most trusted aristocrats, for relevant services provided to the Crown.7 This re-

veals that the profession was up-scale and profitable. The regulation also means that the

profession was honorable in a society based on clear social cleavages resulting from the

differentiation between common laborers and the highest strata, which comprised respect-

able merchants and traders. Financial business was not considered an unsavory way of life

for the Portuguese nobility.8 The warrior/merchant was a very elegant gentleman, coupling

military activities in Portugal or overseas with benefits and profits, a noble condition of

life.

3

All the revenues from listing fees and commissions on financial businesses in that

market were pooled together (in a purse) and shared equally among all brokers, according

to a 1458 resolution of the municipal Senate.9 As some brokers were more agile than others

in dealing and negotiating the operations, two years later, some of them complained to the

king, but the equal division of the revenues prevailed, and a new law of 15 July 1473 con-

secrated that principle and even forbade competition among them.10 These facts illustrate

that the government saw the existence of the Bourse, and the services it provided to trade

and long-distance markets, as a public good whose dominant role was to fuel the imple-

mentation of a geopolitical project for the nation. The original 1485 Regulations (Regi-

mento de 1485) also required that all operations be recorded in a single ledger as a corpora-

tion, by a clerk so that the equal division among the brokers of the profits collected by the

receiver, could be honest, in spite of recognizing that some of them had a larger portfolio

of clients and operations.11 This means that a division of labor within the corporation cre-

ated specialized tasks among the brokers. Penalties collected for disrespectful behavior

were also registered in the book, as well as some common costs of the corporation (such as

the funeral expenditures upon the death of a broker). The elevated esteem of the profession

was clearly expressed in the law of 11 November 1491, in which it was stipulated that bro-

kers should take a leading position in the rank-structured file of Lisbon’s annual Corpus

Christi procession, which wandered from the cathedral throughout the main streets of the

capital city.12

The importance of market trust and confidence was a decisive feature, but it did not

prevent the authorization for sub-establishment of the brokerage privilege, which was con-

secrated in the royal law of 20 August 1500. This meant that the brokerage function be-

longed to a restricted number of nobles, who could delegate the practice of his function to a

specialized clerk under his responsibility, as clearly registered in the regulation book for

4

the profession (Livro do Regimento dos Corretores): there are four cases of individual bro-

kers, whose names are followed by another name.13 This regulation reveals that the profes-

sion required technical abilities that only trained people could provide, was very honorable

from a social perspective, in high demand for the high revenues it could provide to the enti-

tled person, and very conspicuous with the political authorities in order to provide financial

help to them, both at the central and local (municipal) governmental level. To implement

market transparency and maximize rewards for the regulatory authority, in 1500 it became

routine for the municipal Senate to award those broker positions to the highest bidder,

thereby discontinuing the monopoly aristocratic condition for applicants, because the con-

dition of trader and merchant could also lead to a personal nobility entitlement to attain the

merchant/warrior status.14 It also happened that political authorities inspected the business

of exchange letters to apply penalties for usury behavior, but overlooked those penalties

against the opportunity of obtaining loans for the king and the government. For example, in

January 1443 the government bought armaments in Bruges with the credit granted by local

merchants and paid by letters of exchange issued by Lisbon traders and merchants, who

lent to the central state.15 Then, brokers could deal in maritime transportation, insurance,

freight, credit, exchange letters and currency exchanges, international trade, and lending to

government.

Domestic public debt (short-run floating debt and long-run redeemable public debt)

also became a financial business in the Lisbon stock market, because the Crown developed

entrepreneurial merchant (retail) activity in the Cape route shipping. As public revenue was

not enough to manage the huge colonial empire that the government dared to build, the par-

ticipation of the central state in the maritime shipping provided funding for new undertak-

ings.16 The non-specialization of brokerage in each of these businesses may result less from

the small development of each one of these financial branches, and much more from the

5

strong ties and inter-connections among all of them, which produced positive externalities

and synergies to tackle all of them simultaneously.

In the seventeenth century, complaints against the “impure blood” of some individu-

als approved for the position of broker were coupled with the compulsory character of their

intervention in all transactions, as they should encourage businesses rather than hinder

them. The royal law of 28 October 1718 defended their business assistance as an important

social mission to assure safety and confidence, and also refers to their meetings in a house

close to the main downtown Lisbon location. The complaints may reveal a decrease of the

relative importance of the Lisbon Exchange-market in the European context, as other coun-

tries developed powerful trade companies as assertive and successful business organiza-

tions.

However, the very destructive earthquake that struck Portugal in 1755 allowed a

thoughtful prime-minister – Pombal – to tackle the huge problems created by that catastro-

phe, especially the rebuilding of a significant part of downtown Lisbon. Destruction, dis-

ruption of trade, social turmoil, and de-regulation of economic life, led a group of impor-

tant traders and merchants of Lisbon to ask for the use of a collective donation to rebuild

the customs house and the Bourse (a physical place for negotiation, dealing, and financial

operations). The decree of 2 January 1756 granted the collective donation, the decree of 28

May created its rules as a disguised tax, and the decree of 16 January 1758 ordered the re-

construction of the Stock Exchange house. The fact that Pombal also founded in Portugal

the first three limited-liability corporations, funded by shares, led him to construct a proper

place within the Ministry of Finance, on the eastern side of the rebuilt central square, to

headquarter the Lisbon Stock Exchange and to decree rules for that market to function

properly on a daily schedule.

6

These corporations17 brought a new business to the stock market, leading some au-

thors to define this moment as the birth of the Lisbon Stock Exchange. In fact, economic

functions propel stock markets, and stock markets develop when large capital is required

for larger enterprises.18 This is the reason to consider the first day for operations on 1 Janu-

ary 1769, as the inaugural date for the Lisbon Stock Exchange.19 The issue of bonds with

the character of exchange letters may be considered as the first loan of the modern public

debt, according to the decree of 29 October 1796. These two features point to corporate fi-

nance and bonds issuing as the criteria for defining the existence of a real Stock-

Exchange.20 Increased by the law of 13 March 1797, public debt was also a new financial

business, and a very successful one in the conversion of earlier public loans. Military ex-

penditures, aggravated by the Napoleonic invasions, obliged the Exchequer to seek finan-

cial innovation, particularly the issuing of paper-money in the stock market, according to

the law of 13 July 1797.

The plural stock markets phase in Portugal

More recently, and in the northern part of Portugal, another centralized market was

put in place in the city of , probably following the spirit that Napoleon brought to the

country as a result of the three invasions of his army, from 1808 to 1811. This second mar-

ket was necessary because of the needs of the local community of merchants: exports of

Port wine to Britain and elsewhere created specialized farming and a large, wealthy mer-

chant class. Recall that Spain established its first Exchange in Madrid, which opened on 28

January 1811, following the royal decree of 14 October 1809, when Napoleon’s brother,

Joseph I, ruled over the country. The regulation of the decree of 20 July 1810 was clearly

inspired by the Parisian model.21 The Spanish war for Independence interrupted this mar-

7

ket’s operations for two decades, and the law of 10 September 1831 is now considered as

the juridical foundation of the Madrid Stock Exchange.22

The Portuguese 28 February 1825 regulations for the profession (Livro do Regimento

dos Corretores) mentions 12 brokers in Lisbon, as usual, and 8 in Porto. It was a very lib-

eral system of regulation. The municipality of Lisbon lost the right of decision in the provi-

sion of these positions in the capital city, as only technical abilities were required, inde-

pendently of conditions of birth. The Bourse was no longer conceived of as a corporation.

Each broker should receive compensation according to his own operation, and the revenue

from listing fees and commissions was no longer pooled together. Moreover, traders were

not obliged to use the brokers’ intervention, something that had been in practice for two

decades: businesses were free to devise anti-competitive strategies. Nineteenth-century

Portugal was really bi-polar country.

Two more things helped to modernize the financial sector in Portugal. One was the

emergence of the first bank in Portugal (the Bank of Lisbon), authorized by the law of 31

December 1821. The other was the first Commercial Code of 18 September 1833, authored

by José Ferreira Borges, who acknowledges his inspiration in the Prussian, Flemish, and

French codes, which, once again, gives a corporate character to the Stock Exchange.23 The

important legal framework for all commercial activities deserved detailed regulations and

Stock Exchange businesses found them in the Code Title II, seeking to avoid volatility

provoked by de-regulation.24

A different perspective prevailed in Spain, where Pedro Sainz de Andino, the 1829

Code’s author, avoided including any regulations on stock markets, choosing to devote to

this new market a separate law, of 10 September 1831, that could be adjusted independ-

ently of the commercial code. According to some interpretations, this reflects a strong need

of a Stock Exchange in Madrid to issue public debt in order to support the construction of a

8

state bureaucracy, but at the same time great hesitation about the success of an official

market strongly regulated by government.25

In Portugal this was not the case, and the consequent regulation book for brokers re-

sulting from the first Commercial Code of 18 September 1833 was approved much later by

the decree of 16 January 1837, which fixed the commissions for each kind of operation,

and allowed for different rewards for the brokers. Public debt had become an important

segment of the operations in the stock market, because in spite of the abolition and with-

drawal of the paper money by the decree of 23 July 1834, new debt was issued throughout

the 1832-34 civil war. Specialization among the brokers was recommended for Lisbon

(into bill brokers, exchange brokers, shipping brokers, stock brokers, insurance brokers,

and custom-house brokers) but not for Porto, meaning that the dimensions of the two mar-

kets were very different. A room for their meetings was also provided in Lisbon, contigu-

ous to the trading floor, while in Porto, only later on, did the law of 19 June 1841 give a

building (the old convent of São Francisco) to the city stock market.

The books registering the operations, exchange rates, and quotations for bonds,

shares, and securities in Lisbon dating back to 1837 are preserved in the municipal ar-

chives. They list companies and new banks, as well as more and more public debt, which

was issued for public works, and the military costs of the 1846-47 civil war. A general

conversion of all public debt (into a single 3 percent consolidated loan), authorized by the

decree of 18 December 1852, simplified the operations on bonds and created confidence in

a central state. Accelerated construction of railways from the mid-1850s onwards, also con-

tributed to new stock operations, and the law of 22 June 1867 liberalized the creation of

domestic limited liability companies, and regulated the entrance of foreign companies to

operate in Portugal.26 Foreign enterprises needed to apply for government authorization

(from the Ministry of Public Works, Commerce, and Industry), after submitting their stat-

9

utes and pledging to abide by Portuguese law and court rulings. Foreign companies were

coming more and more into sectors such as mining, insurance, engineering, railway con-

struction, urban gas illumination, and water provision to urban centers. Listings in the two

Stock Exchanges of Lisbon and Porto increased, and companies were to be audited accord-

ing to the same law of 22 June 1867. This was an important step into foreign direct invest-

ment (FDI) capital flows and global business for Portugal.27

Global business cycles afflicted the market in periods such as 1875-76, when the 1875

euphoria developed options, futures, and warrants, and gave place to crisis and panic in 1876,

particularly for the owners of some bank securities. Transactions outside the official stock mar-

ket worried government in the aftermath of the crisis, as may be detected in the law of 7 May

1878, where the reasons for the creation of an additional percentage to the stamp tax mention

the existence of private Bourses (bolsins) whose transactions escaped transaction costs (bro-

kers’ fees, bank commissions, and taxes). Such a worrying attitude reveals the desire to tax the

provision of such service and also government’s vision for the Stock Exchanges as a public

good, calling for a legally-defined environment to ensure a seal of trust and confidence to the

users to avoid bad practice.

Private Stock Exchanges were a common situation in some European countries,

whenever the initiative of merchants and traders created self-regulated bourses under com-

petitive intermediation, some of which became large markets (even in a same city). In

Spain, for example, the Barcelona Exchange, whose operations date back to the 1840s, and

the Bolsin Catatalan El Casino Mercantil, a local bourgeois club, are good examples.28

The main difference is their organization as free associations under private initiative (and

not as corporations), enjoying autonomy from government, under the management of a

commission of brokers. In spite of long-rooted experience in trade and insurance affairs

(particularly in the Netherlands, Belgium, and France), most Stock Exchanges are recog-

10

nized as nineteenth-century developments (New York, London, Berlin, Milan, and Vi-

enna),29 and today prominant differences in corporate finance literacy may be due more to

political events (such as the differing participation in the world wars) than to differences

between the civil law and the common law systems for their legal environment.30

The first Portuguese commercial code (1833) could not cover every kind of transac-

tion and operation, and in the government’s perspective became obsolete after serving for

55 years. The recovery from the 1870s crisis, which raised the Portuguese GDP to a peak

in 1875, brought the opportunity for more businesses, as well as fears of herd behavior in a

new speculative bubble, which could lead to subsequent firm and bank failures in the

downturn following the burst. The enactment of a new code, published in the law of 28

June 1888, authored by Francisco António Veiga Beirão, was an attempt to regulate and

avoid bad practice.31 This code did away with the freedom to create new Stock Exchanges,

either official or not, and forbade the existence of more than one stock market in the same

city (article 85).32 Regarding foreign companies, the new code confirmed all the features

established in the law of 22 June 1867: decisions on listing belonged to the Chamber of

Brokers, domestic bonds were automatically listed, and bonds from foreign countries

needed authorization from the Portuguese government to be listed.

Very soon, however, a new global crisis affected both Exchanges in Portugal: the Bar-

ing crisis afflicted the kingdom, not only because of the traditional heavy dependence on

public borrowing from these bankers, but also because of their influences on the Portu-

guese economy via Brazil. The crisis triggered the abandonment of the gold-standard

(1891) and the national Treasury bankruptcy (1892).33 In this historical context, the Ex-

change regulation from the decree of 8 October 1889 was revised: in spite of giving the

surveillance of the stock markets in the kingdom to the government (to the Ministry of

Public Works, Commerce, and Industry, in particular), the issuing of debentures did not re-

11

quire any authorization.34 In the aftermath of the crisis, even in banking, through the decree

of 12 July 1894, which was converted into a law on 3 April 1896 the issuing of debentures

became subject to government authorization. In spite of the publication of the stock market

regulations, the regulation on brokers was missing, and the need for more flexible rules on

limited liability corporations was also felt for the recovery.35 The regulation on brokers was

published only in this same year, by the decree of 10 October 1901, and it would last until

1974. This means that the period from the Veiga Beirão code (1888) to the 1901 regula-

tions was a real first package of state regulation, a genuine founding structure, as Figure 1

shows. Using the call-auction system, assets were traded in the Lisbon stock market five

days per week, and once per day they established the binding price of all matched orders.

Transparency was assured in this law-based system, and a daily bulletin was issued with

the equilibrium prices. The bid and ask prices per asset were also available in the bulletin,

which was released to the press to be included in the most leading daily newspapers.

The twentieth century was a “step-mother” to the Portuguese capital market due a

number of events that negatively affected its development, if not its very survival. The new

century came on the heels of the bankruptcy in 1892. In 1908, the King and the crown

Prince were both assassinated in an assault on the royal carriage by two gunmen, and in

1910 a military coup established a republic, ending a monarchic regime that had lasted

since the birth of the country in the twelfth century. The stock market was very small at the

beginning of the century: the 3 to 5 p.m. schedule was enough for all transactions in 1901,

and in 1910 was even reduced to the period from 2 to 3:30 p.m. In 1901 telegraph facilities

connected the Lisbon market to Paris, London, and Berlin, thanks to a contract established

with the Havas agency intended to allow following European markets’ behavior, at a

monthly cost of 46$130. The most important companies listed were the banks, water, urban

gas and electricity provision, and companies having colonial businesses.36 The fact that the

12

10 October 1901 regulation on brokers prevailed until 1974 shows that the volume and di-

versity of businesses did not require legal adjustments.

For a short time, a decree of 13 April 1911 required the disclosure of more accounting

information from listed companies and their surveillance by government.37 The First

World War interrupted normal operations in businesses and financial markets, and intro-

duced restraints, while “British capital controls helped New York displace London as the

world’s largest market”.38 As in any crisis of war, financial distress reduced asset prices in

foreign markets, and increased transaction costs.39 In Portugal, the decree 1645 of 15 June

1915 authorized the creation of privileged shares in limited liability companies, but was

suspended by law 340 of 30 July 1915, to be reintroduced by decree 4118 of 18 April

1918. The post-war recovery was very short and abruptly interrupted. The confusion that

followed the first republic led to the 1926 revolution, which established an authoritarian

regime (lasting until 1974). The Great Depression (1929-1933) was severe in a global

perspective, but drew attention to the need for a separate housing for the Commodity Ex-

change, close to the Stock Exchange, as many tropical goods were produced in the over-

seas territories and samples of these commodities were displayed in glass cases, for the

people to trade in. “From the two large lateral entries for the people one can see a large

floor and a frontal semi-elliptic balcony for the brokers. Back, on a stage, will be located

the blackboards for writing the quotations”.40

Following the Depression, Stock-Market trading volumes could only increase until

1939, to drop again until the end of the Second World War, when historical sources indi-

cate that transactions of real estate and securities from non-listed companies were helping

to support the stock market.41 In many nations, even in wealthy nations such as France,

Germany, and Italy, “the polity did not support capital markets in the immediate post-war

decades”.42 Perhaps the same can be said of Salazar’s government. Although nationaliza-

13

tions did not occur (as in those countries), public capital penetrated many companies in

sectors such as electricity, water provision, transports, and communications. Moreover, as

Portugal remained a neutral country throughout the War, export opportunities, war refu-

gees, and capital inflows brought some prosperity, paving the way to a golden age of eco-

nomic growth in Portugal in the 1950s and 1960s.

Joining the Marshall Plan and the OEEC in 1948 paved the way to considerable co-

operation with European partners and brought Portugal into close contact with global stock

markets. The post-war period was the most successful growth period in Portugal’s history,

with a sustained economic growth at 2-5 percent annual rates in the 1940s and 1950s, and

at 5-7 percent annual rates in the 1960s, following Portugal’s participation in the European

economic integration process. A genuine economic modernization and urbanization oc-

curred.43 The period witnessed the formation of conglomerates through firms’ affiliation

under the government development policy. This policy may have been a critical survival

mechanism for small firms, by allowing them to gain benefit from homeland and colonial

markets in a wild and inhospitable international business environment. The most important

were family groups and venture capital firms.44

Within the context of the European Free Trade Association (EFTA), Portugal con-

verged with her partners in regulations on corporations, and the issuing of shares and de-

bentures, in decree 44652 of 27 October 1962 and in the new Civil Code of 1966. Thanks

to the development of agricultural co-operatives in the context of the EFTA, decree-law

49184 of 11 August 1969 created the legal background for group agricultural associations.

Concerning the financial sector, a decree-law of 6 January 1969, quoting the 1967 British

Company’s Act, regulated association’s ownership in establishing the rules for the securi-

ties market because of the domain of companies in case of divergent views or conflict of

interests between boards of directors and auditing committees.45 Mergers and crossed-

14

capital participations were able to bring strength to several economic groups, listing flour-

ished, and corporations greatly increased their equity. In many companies ownership sepa-

rated from control and corporate governance became powerful.46 Although the use of

firms’ reserves and provisions in funding corporations’ increases of capital was very im-

portant, and the role of bank loans for venture capital firms was very frequent, this period

witnessed considerable issuing of share capital in the stock market. Enthusiasm increased

and decree-law 1/72 of 3 January regulated the profession of official auditors, their profes-

sional chamber, and the auditing firms, in order to guarantee transparent accounting and

clear appraisal of corporations’ financial situations.

As legal uniformizations were underway in the European Economic Community, the

Portuguese regulation on mergers dating from the old 1888 Commercial Code was consid-

ered to be insufficient, in spite of Portugal’s participation in the EFTA trade zone and not

in the European customs union. Regarding mergers and demergers the decree-law 598/73

of 8 November 1973 adopted the European laws in advance.47 Just before the first oil shock

(last quarter of 1973), which greatly affected the western world, decree 8/74 of 14 January

was a real novelty in promoting a more stimulating background for the Stock Exchange. In

the preamble of the decree the legislator states that the impact of the stock market on eco-

nomic growth critically depended upon the old, legal, regulatory and political environment

prevailing in the country since “the archaic decree of 10 October 1901”. If it was already a

constraint to the number of operations in the exchange when its pace was slow, it was “a

real blockade against the spectacular growth” it was experiencing then. The decree pre-

pared the juridical environment of stock markets in the country for a sizeable multiplica-

tion of operations and negotiation, in the context of the highest GDP growth rates ever ex-

perienced in Portugal. Strongly influenced by the Finance Secretary of State Luís Sa-

pateiro, it opened the possibility of the creation of autonomous exchanges in any Portu-

15

guese city where the volume, frequency, and expectations of transactions should require

the presence of a market. They should be under the surveillance of one of the two ex-

changes (Lisbon or Porto), and the whole market was to be co-ordinated and overseen by

the Ministry of Finance for conflict arbitrage, with the help of a consulting Board compris-

ing the governor of the central bank, the president of the public debt general office (Junta

do Crédito Público), representatives of the banking and insurance sectors, and of firms and

exchanges. It imposed many duties on the corporations listed in the stock market, particu-

larly regarding their admission. Shareholder protection, fixed fees, and strong enforcement

were key features.48 All of this should result in greater stock market capitalization, initial

public offerings (IPOs), and a greater number of publicly traded companies.49 The decree

also regulated term operations and brokerage firms headed by the duly authorized stock-

brokers. The daily schedule was divided into specialized operations,50 administrative prac-

tices were detailed according to brokers’ specialization, and the appointment to the special-

ized positions (on bonds, commodities, insurance, etc.) resulted from an election among the

brokers.

The decree promised a large and multiplied system for transactions that would be

long-lasting, but it was suddenly interrupted by the 1974 military revolution, and is re-

called as an interim package of regulation, as Figure 1 shows. Portugal experienced a mili-

tary coup (the ) on 25 April 1974 with strategic consequences for the

domestic economy (and therefore upon the domestic Stock Exchange as well).

The phase of suspended stock-markets (1974-1977) and operations

On the day after the Carnation Revolution, the Portuguese financial authorities de-

cided that the two Stock Exchanges should halt their operations. The military board Junta

de Salvação Nacional “suspended” the operations in both markets on 29 April 1974. The

16

reason was to avoid large volatility price swings, brought on by the prevailing uncer-

tainty.51 As the political scene became increasingly confused and became influenced by the

communist and other leftist parties, a program of nationalizations took place, affecting

much of the domestic economy – banks in particular. Meanwhile, the government granted

full independence to all overseas colonial territories in 1975. The stock market remained

closed for around three years. For our analysis, it matters that equity investors were de-

prived of their wealth in many different ways. Share prices dropped sharply in most coun-

tries as a consequence of the oil shock, but much more so in Portugal precisely due to the

local political events: banks, insurers, transport companies, utility corporations and many

other sectors saw all their enterprises nationalized in March 1975, and (worse) with indem-

nities paid to their shareholders late in time, and with very deflated coupon rates, an undis-

guised mechanism to pay much less than market values; all listed companies headquartered

in any of the overseas territories were nationalized when the newly independent govern-

ments assumed the political power there. The damage and denigration to the Portuguese

stock market can hardly be overstated. It is little surprise that when the stock market re-

opened in 1977, only a few companies remained listed in the Exchange and even fewer

traded any security in the months that followed.

This political background was a heavy handicap for those investors who needed to

liquidate their share holdings, a situation that lasted for almost three years. The decree of

12 January 1976 authorized transactions on bonds on the Lisbon Stock Exchange. Only on

the 7th of March 1977 was trading resumed in the Lisbon market, although the order from

the government was dated three days earlier. Porto remained closed until 1981.52 Mean-

while, a second world oil shock added to the adjustments brought about by the above

events and forced the country to negotiate two standby agreements with the International

Monetary Fund (IMF). For some time, no laws were issued on stock markets, and when

17

trading in shares resumed, the number of listed companies was extremely reduced, none

were large entities, and investors were very risk averse due to the traumas brought recently

to them by the political and economic events following the revolution. The quotations were

below the average, a fact that one would expect after the turmoil associated with the politi-

cal, social, and economic upheaval. The subsequent early recovery from the end of 1979

did not last long, due to the country’s domestic economic crisis, which could only be tack-

led after a second standby agreement was signed in 1983 between Portugal and the IMF.

To understand the legal environment of the last two decades of the century it is absolutely

necessary to stress that this period witnessed the tremendous technological revolution

based on computers from the 1980s on, and the internet and mobile communications in the

1990s, which brought transformations of various sorts, including the move from oral to

screen trading. As a result, the Lisbon database in electronic format covers data from listed

companies and the market as a whole only since 1988.

On another front, “fighting communism was central to the domestic political agenda

in much of Western Europe and East Asia. This anti-communist agenda alone strongly af-

fected Western European and East Asian nations’ policies toward capital markets through

the 1980s. (…) Important policymakers at international development agencies such as the

World Bank (…) criticized codification as overregulation”. 53 Deregulation in global stock

markets led to unfixed commission rates in 1983 (Canada), in 1984 (Australia), and in

1986 the London Big Bang separated brokers and jobbers, although Japan did not deregu-

late exchange commission rates until after their 1997 Big Bang.54 From February 1983

on55, the Lisbon Exchange market was divided into two segments: the so called “Official

Market” – the main market – where the larger and “senior” companies could list their

shares; and the “Market without Quotations”, created to trade (but not list) some junior

companies or the provisional certificates of shares (and bonds) issued by corporations al-

18

ready listed, while their final paper certificates were being printed and distributed among

the investors.

Following the unanimous will of joining the European Community, the 1980s offered

conditions to turn around the domestic capital market. New private companies, in particu-

lar, decided to list their shares and bonds on the Exchange, along with a string of national-

ized corporations that the government decided to sell back to the market from 1989 on. Af-

ter 1985, the Finance Minister, Miguel Cadilhe, started a new policy to re-instate a profes-

sionalized capital market in Portugal and the country’s investor community reacted very

positively to the initiative along with a number of new companies that entered the market

for the first time. In the expectation of joining the EEC on 1 January 1986, the level of the

market rose by a factor of 50 between January 1985 and October 1987. The temporal co-

incidence of the termination of the 1983 crisis with the long-term recovery from the 1974-

75 turmoil fuelled the bubble that ended with the October 1987 crash. A number of listed

companies saw their shares “implode” from 1984 to 1987, until the Black Monday of that

last year. In the beginning of 1988, the market was still above the average and it is aston-

ishing that Portugal’s domestic market offered such inflated rates of return in the 1980s.56

This was the environment for a second package of historically milestone regulations,

which was issued from 1988 to 1999, as Figure 1 shows. The decree-law 210-A of 27 May

1987 was replaced by decree-law 59/88 of 27 February 1988. It created a compensation

system for the operations in requiring the deposit of the involved assets in financial institu-

tions, to treat them as fungible assets. A package of decree-laws, all dated from 4 July 1988

(220-A, 229-B, 229-C, 229-D, 229-E, 229-F, 229-G, 229-I, 422-A, 422-B, 422-C, 422-D)

and from 22 July 1988 (480 and 481), improved the operability of the market, forcing bro-

kers to change from simple individuals to broker or dealer companies, and started to lead

the country to the rules and mechanisms in use in the capital markets of other member

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states of the European Community. A main step was the de-materialization of the securities

adopted in decree-law 229-D88 based on “the Brazilian legislative model”, to expedite

clearing of operations, in spite of the fears of people’s reactions to this innovation. It was

supposed that people might prefer other applications for their savings and move their

money to bank deposits, because of the traditional attitude of seeing paper assets as a mate-

rial expression of personal wealth.57

The first Public Offer for Sale (OPV) occurred in the Porto Exchange on 7 November

1986; the first Take Over Bids (OPA) in Lisbon on 27 February 1989; and the first privati-

zation operation occurred on 26 April 1989 (15 years after the Carnation Revolution). An

important regulation was issued in the law of 10 April 1991, this time conceived entirely

by Luís Sapateiro. This law transferred ownership and management of the Lisbon and

Porto Stock Exchanges to two not-for-profit private Civil Associations. The new philoso-

phy for the capital market included “the full disclosure consecrated in the American rule

since 1933, (…) autonomy, de-statization, de-governmentalization, liberalization (…) pro-

fessionalization, de-bureaucratization, and dynamization”.58 From now on, supervision and

regulatory powers were transferred to a local Securities and Exchange Commission (Co-

missão do Mercado de Valores Mobiliários, CMVM), which is autonomous from govern-

ment, to perform the functions and inspections that previously belonged to the Minister of

Finance. The idea was “to defend the legitimate interests of investors (…) and avoid un-

justified submission to other [European] member states (…) that were more expedite in in-

troducing the appropriate reforms”.59 These parameters greatly constrained the feasible

range of organizational choices. Maximizing the globalization of demand and supply was a

top aim. Criminal penalties were defined for insider trading and market manipulation. De-

materialization abandoned the Brazilian model, following the French principles of freedom

to preserve the investors’ accounting of underwritten securities in any financial intermedia-

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tion institution. Financial futures and options were regulated, and all negotiation systems

were allowed, from the call system to the continuous negotiation system.

OTC markets and special markets were identified as de-regulated possibilities in de-

cree-law 142-A of 10 April 1991 and received the attention of decree-law 186/94 of 5 July

1994 to identify the Minister of Finance as the regulatory entity for them.60 The Lisbon

market then returned to higher quantitative levels for transactions, but was again negatively

influenced by the 1993 crisis. A specialization agreement between the two Portuguese Ex-

changes, signed on 1 June 1994, led to the concentration of cash operations in Lisbon, and

derivatives in the Porto Exchange. The liberalization of emissions of securities by foreign

entities was established in the same year.61 Procedure adjustments were introduced in de-

cree-law 261/95 of 3 October 1995, namely the bookbuilding practice (a registration with-

out a definitive price or interest rate).62 In this new historical context, a formal market for

contracts on derivatives and futures was inaugurated in the Porto Stock Exchange on 20

June 1996, while the Repo operations began on 14 April 1997.63 Formal operations on op-

tions were resumed on 19 March 1999 and a system for automatic borrowing, SEA (Sis-

tema de Empréstimo Automático de Valores Mobiliários), was adopted.

A single stock market in Portugal (2000-2002). The innovation

On 4 January 1999 all transactions were expressed in the new currency unit, the .

On 20 December 1999 the two general assemblies of the two domestic Exchanges decided

to merge into a single entity.

The new institution was called BVLP (Bolsa de Valores de Lisboa e Porto) and was

legally chartered as a completely private corporation organized as a for-profit entity, in the

law of 10 February 2000. This is a significant break from the former status of not-for-profit

civil associations of financial intermediaries. Due to the specific demand of trading in large

21

blocks of public debt, the Treasury decided to create its own centralized market in 2000,

the so called MEDIP, which is also considered a regulated market on Exchange under the

MIFID Directive.64

At the same time, the EURONEXT project was launched in Paris, Brussels and Am-

sterdam in March 2000. The Lisbon Exchange joined this innovative project only two years

later, on 1 February 2002, after a memorandum signed on 13 June 2001 that led to the

agreement on the financial conditions for the merger, which were accepted by the BVLP

shareholders and its governors. The BVLP thus changed into a new institution EURON-

EXT LISBON.

The emergence of new instruments such as the certificates, authorized by the decree

of 18 June 2002, and the capacity of EURONEXT LISBON members to deal in all cash

products listed on the Paris, Amsterdam, and Brussels Exchanges, that was agreed on 2

September 2002, were major steps toward global dealing from Lisbon.65 In April 2007 this

purely European group merged with the American NYSE Group to form the current trans-

atlantic NYSE Euronext Group. The Code published in decree-law 357-A/2007 of 31 Oc-

tober defined all the operational features. Today, the Lisbon headquartered organized mar-

ket – Euronext Lisbon, part of the NYSE Euronext multinational group – is the Portuguese

branch of a global group of Exchanges, and trades are mostly concentrated in equity issues.

Although listed in this Exchange, Treasury Bonds and Treasury Notes are mostly traded on

the MEDIP market because this is mainly a wholesale market.

Summary and Conclusions

Although centralized markets, as any other economic activity, were born and always re-

sponded to economic needs of their “clients”, recent years have exhibited profoundly important

legal and/or organizational changes in most stock markets around the world.

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Figure1 Portugal joins EEC in Jan 1986

EFTA created in Stockholm in Jan/60. Portugal founding member

War in Africa with 3 fronts

End of Monarchy in Oct/10 “” regime in Portugal: May/26 to Apr/74

WWI WWII

1900 1910 1926 1961 1974 1986 2000

1st Package Interim Package 2nd Package

1.Código Veiga 1. Creation of 1. Package of Beirão (1889) Inpecção-Geral July 1988 2. Regimento de Crédito e 2. Código Sapa- Corretor (1901) Seguros (1949) teiro (1991) 3. Regimento 2. Decree-Law 3. Código dos Operações de 8/74 Valores Mobi- Bolsa (1901) liários (1999)

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It is of interest to look at the Lisbon Exchange Market case study, because it is a special example other countries have looked upon to gain insight. Market stability, harmony according to convenience, and guidance according to behavioral aims, have been main concerns in the le- gal framework in the hundred years of the Lisbon Stock Exchange. The promotion of more per- fect market interactions was implemented over the centuries in preserving rational ways and collective intelligence in stock markets. Laws were issued to promote the society’s interests.

Established as a reference system, the set of regulations on the Lisbon Exchange survived ac- cording to a Darwinian natural selection process.

Legal origins and frameworks affect finance, but politics and globalization dictate the tools to build markets and advance economically. Depending on political conditions, Ex- changes may disappear under unfavorable polity, or flourish very suddenly in a stimulating political environment. In Portugal the aftermath of the Carnation revolution put an end to centuries of business and Darwinian-selective legal and organizational improvement. Po- litical reasons must be included to explain the close convergence of juridical features to other countries. Joining the European Union in January 1986 (EC at the time), brought a new credibility to the future of the country, which led to a progressive opening of borders to financial investment from abroad (adding upward pressure to the price of any Portu- guese asset). This upward pressure also resulted from the fact that the market was so lim- ited in size that even small influxes of cash fueled discussions on the juridical background.

Coupled with the privatization program during the 1990s, the country executed an un- expected miracle that was so impressive it drew the attention of several other European

Exchanges, a fact that led in February 2002 to the merger of Portugal’s markets with others in what was then called the Euronext Group. Institutional convergence assured that in a few years it was possible to overcome most of the fears regarding small size, and establish

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a “normalized” capital market that is open to foreign investors and mature enough to ac- commodate the overreaching aims of capital-free circulation in a global perspective.

1 On convergence see Ranald Michie, Stock Exchanges since 1960, Focus, March 2010:11-14, p. 14. 2 Santarém, Pedro de, Tractatus de Assecurationibus et Sponsionibus 1552 (Lisbon: Edição Grémio dos Segurado- res, 1961), is a treatise on insurance regulation. See also Amzalak, Moses Bensabat, O tratado de seguros de Pedro de Santarém (Lisbon: [S.n], 1958). 3 Marques, A. H. de Oliveira, Portugal na Crise dos Séculos XIV e XV, Vol. 4 of Nova História de Portugal, vol, IV (Lisbon, Presença, 1st edition, 1987),: 176. 4 Justino, 1994: 5-10. Ullrich, Ruy Ennes, Da Bolsa e Suas Operações (Coimbra: Imprensa da Universidade, 1906): 103. 5 Justino, 1994: 31. 6 Justino, 1994: 11, quoting Oliveira Eduardo Freire de, Elementos para a Históra do Município de Lisboa, (Lis- bon, Typographia Universal, 1891): 92-94. 7 Justino, 1994: 13. 8 Godinho, Vitorino Magalhães, Estrutura da Antiga Sociedade Portuguesa, (Lisbon, Arcádia, 1980). 9 Justino, 1994: 22. 10 Justino, 1994: 22. 11 Justino, 1994: 25-26. 12 Ullrich, Ruy Ennes Da Bolsa e suas Operações, Coimbra, Imprensa da Universidade de Coimbra, 1906: 102. 13 Justino, 1994: 13, quoting the Livro do Regimento dos Corretores, Lisbon Municipal Archive, follium 31 Vº. 14 Justino, 1994: 15. 15 Justino, 1994: 33, 34. 16 Godinho, Vitorino Magalhães, “Finanças Públicas e Estrutura do Estado” in Dicionário de História de Portugal, vol. II, (Lisbon, Iniciativas Editoriais, 1971): 244-264. 17 The Companhia de Grão Pará e Maranhão was created by the law of 6 June 1755, Companhia Geral da Agri- cultura e das Vinhas do Alto Douro by the law of 10 September 1756, and the Companhia de Pernambuco e Pa- raíba by the law of 13 August 1759. 18 Roe, Mark, “Legal origins and modern stock markets”, Harvard Law Review, 120 (2006): 460-527: 1. 19 Justino, 1994. 20 Brealey, R.; Stuart M., Richard and Stuart Myers, Principles of Corporate Finance (Lisbon: McGraw-Hill, 2009). 21 Rojo, José Angel, “José Bonaparte (1808-1811) y la legislacion mercantil e industrial española, Revista de dere- cho mercantil, 1977, nº 143-144: 121-184. 22 Cagigal, Juan Carlos Rojo, “Las origenes de los Mercados Bursátiles en España, 1800-1939”, Bolsa, 4º trimestre de 2009: 40-46: 41. 23 Ullrich, 1906:111. 24 The entire legal concept of economic life is described at Borges, José Ferreira, Diccionario juridico-commercial (2nd ed. - Porto: Typ. de Sebastião José Pereira, 1856), (1st edition 1833). http://purl.pt/298/3/sc-1369-v_PDF/sc- 1369-v_PDF_24-C-R0075/sc-1369-v_0000_capa-426_t24-C-R0075.pdf. For stock market aspects see (1856): 7, 57, 106. 25 Cagigal, 2009: 41. 26 Mata, Maria Eugénia (1998) "Sociedades anónimas: regulação e economia", Boletim de Ciências Económicas, vol. XLI: 3-26. 27 Mata, Maria Eugénia “A forgotten country in Globalisation? The role of foreign capital in nineteenth-century Portugal” Margrit Müller; Timo Myllyntaus (eds.), Small European countries responding to Globalisation and De- globalisation, (Bern, Berlin, Bruxelles, Frankfurt am Main, New York, Oxford, Vienna, 2008): 177-209. 28 Cagigal, 2009: 42, 43. 29 Ullrich, 1906: 64-69, 153-170, 414-416. 30 Roe, 2006: 1. 31 Published in the official journal Diário do Governo of 6 September 1888. 32 In Spain the 1885 Commercial Code already included regulation for all Spanish stock markets, but recognized the existence of private stock markets. Valencia, Santander, and Seville had their own stock markets and in 1915 a fourth stock market was created in Barcelona. Cagigal, 2009: 45.

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33 Mata, Maria Eugénia As finanças públicas portuguesas da Regeneração à Primeira Guerra Mundial (Lis- bon:, 1993), Economic History Series, no. 4. 34 For a general view on the available concepts for economic life, see Duarte, Inocêncio de Sousa, Dicionário de direito comercial, 2 volumes, (Coimbra, Imprensa da Universidade, 1880). 35 Regimento dos corretores. A synthesis on commercial law is available in Saldanha, Eduardo de Almeida, Estudos sobre o direito comercial português, (Coimbra : Imprensa da Universidade, 1896). 36 Bulletins, Euronext historical Archive. 37 By the Repartição Técnica de Fiscalização das Sociedades Anónimas, created by the decree of 14 January 1911, as a mixed direction for Statistics, also. 38 Hennart, Jean-François, “Transaction-Cost Theory and the Free-Standing Firm” in Mira Wilkins and Harm Schröter The Free Standing Company in the World Economy 1830-1996, (Oxford: Oxford University Press, 1998), chapter 2, pp. 65-98: 84. 39 Amihud Y; Mendelson, H., “Asset pricing and the bid-ask spread”, Journal of Financial Economics, 17, 1986: 223-249. 40 Associação Industrial Portuguesa, Revista da Associação Industrial Portuguesa, 3º ano, nº 33, Novembro1930, p. 64. 41 Daily Bulletins, Lisbon Stock Exchange Historical Archive. 42 Roe, 2006: 2. 43 Amaral, Luciano How a Country Catches Up: Explaining Economic Growth in Portugal in the Post-War World (1950s to 1973), Doctoral Dissertation (Florence, European University Institute, 2003). Maddison, Angus, The World Economy, a Millennial Perspective, (Paris, OECD, 2001). 44 The CUF (Mello family), the Sommer group (Champalimaud family), the Fonsecas & Burnay, and the Espírito Santo Martins, Maria Belmira, Sociedades e Grupos em Portugal (Lisbon: Estampa, 2nd edition, 1975): 21-65. 45 Duarte, 2008: 42, 43. The motivation for decree-law 1/71 was to prevent the merger of Bank Pinto & Sotto Mayor related to an economic group (Champalimaud) with another successful bank, Banco Português do Atlânti- co, revealing government fears about large concentration and economic power. 46 On the criteria for historians to discover this separation, see Hilt, Eric “When did ownership separate from con- tro? Corporate Governance in the Early Nineteenth Century”, Journal of Economic History, 68- 3 (2008): 645-685: 652. Ullrich, Ventura, Raul, “Fusão e Cisão de Sociedades”, Revista da Faculdade de Direito da Universidade de Lisboa,vol. XXIV, 1972. 47 Duarte, 2008: 55, quoting Ventura, Raul, “Cisão de Sociedades” Revista da Faculdade de Direito da Universi- dade de Lisboa,vol. XXIV, 1972. 48 Penalties for disrespectful behavior were also established (articles 53, 133 and 134, of the decree 8/74, official newspaper Diário do Governo, I Série, nº 11, 14 January 1974, p. 42-(12) and (22). 49 La Porta, R.; Lopez-de-Silanes, F.; Shleifer, A.; and. Vishny, R.W, Legal Determinants of External Finance, 52 Journal of Finance 3 (1997), 1131-1150. La Porta, Rafael; Lopez-de-Silanes, Florencio; Schleifer, Andrei; Vishny, Robert “Law and Finance” Journal of Political Economy, 1113, 1998. 50 Options and primes in the first hour, for example. 51 On assessing volatility see Stephen; Westerfield, Randolph; Jaffe, Jeffrey, Corporate Finance,(London: McGraw Hill, 2005). 52 2 January 1981. 53 Roe, 2006: 3. 54 Karmel, Roberta S. “A retrospective on the unfixing of rates and related deregulation“, Focus, May 2010:3-4: 3. 55 See Daily Bulletin for 13 January 1983. 56 From value-index of Jan 1988 =100 - of 60 in Jan 1985- to around 3000 in October 1987. 57 As later on is confessed in the Preamble of 10 April 1991. 58 Preamble of the of 10 April 1991. 59 Preamble of the of 10 April 1991. 60 OTC markets are Open, Transparent and Connected marketplaces. 61 Decree-law 204/94 of 2 August 1994. 62 The Porto exchange published a noted code including all aspects: Azevedo Maria Luísa, Azevedo, Maria do Rosário; Bandeira, Luís; Cunha, Miguel, Código do mercado de valores mobiliários e legislação complementar: anotado e comentado, Porto: Instituto do Mercado de Capitais, (Porto: Bolsa de Valores do Porto, 1996). 63 After an adjustment to decree-law 142-A/91 of 10 April by decree-law 196/95 of 29 July 1995. 64 Markets in Financial Instruments Directive 2004/39/EC. 65 On the premises of EURONEXT LISBON there is a Documentation Center that keeps, among other documents, all Daily Bulletins of the Lisbon and Porto Exchanges (on paper) since the 19th century.

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