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SHL ITEM BARCODE REFERENCE ONLY 19 1774643 4 UNIVERSITY OF LONDON THESIS Degree Year Name of Author COPYRIGHT This is a thesis accepted for a Higher Degree of the University of London. It is an unpublished typescript and the copyright is held by the author. All persons consulting the thesis must read and abide by the Copyright Declaration below. COPYRIGHT DECLARATION I recognise that the copyright of the above-described thesis rests with the author and that no quotation from it or information derived from it may be published without the prior written consent of the author. LOAN Theses may not be lent to individuals, but the University Library may lend a copy to approved libraries within the United Kingdom, for consultation solely on the premises of those libraries. Application should be made to: The Theses Section, University of London Library, Senate House, Malet Street, London WC1E 7HU. 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Trading Risk: the Contractual Nature of Derivative Transactions and Certain Regulatory Issues Chao-hung Chen Thesis submitted for the degree of Ph.D. University College London / TtfBi IOHDOK UMI Number: U591473 All rights reserved INFORMATION TO ALL USERS The quality of this reproduction is dependent upon the quality of the copy submitted. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if material had to be removed, a note will indicate the deletion. Dissertation Publishing UMI U591473 Published by ProQuest LLC 2013. Copyright in the Dissertation held by the Author. Microform Edition © ProQuest LLC. All rights reserved. This work is protected against unauthorized copying under Title 17, United States Code. ProQuest LLC 789 East Eisenhower Parkway P.O. Box 1346 Ann Arbor, Ml 48106-1346 I, Chao-hung Chen, hereby confirm that the work presented in this thesis is my own. Where information has been derived from other sources, I confirm that this has been indicated in the thesis. Chao-hung Chen 2 Abstract In this thesis, we explore the contractual nature of so-called “derivatives” and how they might be incorporated into existing legal concepts. This thesis takes the position that derivatives are in essence contracts to trade risk, and argues that commodity future delivery contracts fall within the legal meaning of “futures” if they are traded as notional transactions settled by cash. We also argue that derivative instruments and traditional gambling instruments are both aleatory in nature. The question then is: “How should we allocate the function between gambling and financial laws in order to control speculation?” Moreover, this thesis argues that derivative instruments in general are not traditional insurance policies. We find no convincing reason to see derivative instruments as another contract uberrimae fidei and to restrict the use of derivative instruments with an equivalent of the insurable interest test. However, whether a firm selling derivative instruments should be regulated (and furthermore, be regulated like insurance companies) may require further consideration. In addition, securities laws are constructed upon the special characteristic of “securities”, which is not shared by most derivatives. Caution is required when applying rules developed in securities regulation to derivative instruments. However, we also recognise the potential for problems with insider dealing and market abuse in the derivatives market such that regulators might have to intervene. In the end, although derivatives do not fit well in existing categories, this does not mean that we need a special set of derivative contract laws: derivative instruments are based on general contract law, and without more substance, any derivative contract law is meaningless. 3 Acknowledgement First, I would like to thank my parents, Mr. Russell Rhei-long Chen and Mrs Wan-ming Yeh, and my wife, Chunchi Hsu. This thesis would not have been completed without their tolerance and endless support. Secondly, I would like to thank Professor Michael Bridge for his valuable comments, support and supervision over the past four years. I am also grateful for Professor Philip Rawlings for his continuous encouragement. Lastly, I would like to dedicate this thesis to the late Professor Ben Pettet. It is a pity that we have lost him forever. 4 Table of Contents Abstract ..............................................................................................................................3 Acknowledgement ...........................................................................................................4 Table of Contents ............................................................................................................5 Table of Cases ...................................................................................................................8 Chapter 1 Introduction ................................................................................................13 1.1 Five Angles for Analysing Derivatives........................................................... 14 1.2 Purposes of this Research................................................................................... 16 1.3 Scope of the Thesis............................................................................................. 18 1.3.1 Relating to Exchange Trading and OTC Trading................................. 18 1.3.2 Other Issues outside this T hesis................................................................19 1.4 Map of This Thesis.............................................................................................. 21 1.5 Clarification.......................................................................................................... 22 Chapter 2 Risk: Commoditisation and Derivatives ...........................................23 2.1 The Meaning of “Risk”...................................................................................... 23 2.1.1 D efinition......................................................................................................23 2.1.2 Risk Management, Hedging and Speculation....................................... 27 2.2 Contractual Instruments for Managing Risk..................................................29 2.2.1 Traditional Instrum ents.............................................................................. 29 2.2.2 Derivatives ....................................................................................................36 2.2.2.1 General Definition............................................................................. 36 22.2.2 Exchange-traded Products...............................................................39 2.2.23 OTC Products.......................................................................................42 2.2.2.4 Hybrid and Securitised Instruments................................................ 45 2.2.2.5 Risks of Derivative Instruments .......................................................46 2.2.2.6 Commoditisation of Risk and Risk Trading...................................49 2.3 Overall View of Legal Disputes about Derivatives ..................................... 50 2.3.1 Local Authority Cases in the U K.............................................................50 2.3.2 Contractual Claims......................................................................................54 2.3.3 Suitability Claims........................................................................................ 57 2.3.4 Characterisation: An Overview................................................................ 63 2.4 Financing and Capital Market Instruments....................................................67 2.5 Insurance............................................................................................................... 70 2.5.1 Definition of Insurance............................................................................... 72 2.5.2 Weather Derivatives ....................................................................................76 2.5.3 Credit Default Swap....................................................................................77 2.5.4 Longevity Products..................................................................................... 81 2.5.5 Regulation of Insurance Business............................................................82 2.5.6 Summary ....................................................................................................... 84 2.6 Conclusion.............................................................................................................86 Chapter 3 From Physical to Notional - Commodity