Global Capital Markets Center
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Steven L. Schwarcz 50 Duke Law Journal 1541 |
ABSTRACT:
Worldwide financial markets increasingly depend on structures that reduce risk by interposing intermediaries between investors and the companies obligated to pay them. This reduction of risk may be offset, however, by the risk that an intermediary will fail and its creditors then will claim against assets held by the intermediary for the benefit of investors. If the intermediary holds assets solely in a custodial capacity, this risk traditionally is addressed by agency and trust law. What is novel, however, is that intermediaries in a wide range of domestic and international dealings — including the trading of investment securities, the sale of loan participations, and securitization transactions — now hold assets in which they, as well as investors, share beneficial rights. (For example, brokers are intermediaries with respect to their investment securities, in which they sell fractional undivided interests ("undivided interests") to investors; banks are intermediaries with respect to their loans, in which they sell undivided interests (called participations) to third parties, usually other banks; and companies are intermediaries with respect to their receivables, in which they use securitization to sell undivided interests to investment vehicles. In each case, these sales are made in order to diversify and thereby reduce risk.) The sharing of these rights creates significant uncertainty as to whether the intermediary's creditors can look to all those assets, or merely to the intermediary's interest therein, for repayment. This "intermediary risk" not only affects individual investors and increases transaction costs but also can be systemic: the failure of an intermediary may trigger a chain reaction of failures of investing institutions that contract with the intermediary. Moreover, the problem of intermediary risk raises innovative legal issues that blur the boundaries between commercial law and property. This article analyzes how legal systems should respond to this risk. It concludes that a uniform rule is needed to regulate intermediary risk in cross-border commercial and financial transactions, and examines how such a rule should be implemented in a international law context.
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