In the paper, The Legal System and the Development of Alternative Methods of Financing to Bank Credit… Or How French Law Has Failed to Adapt to the Evolution of the Economy and Finance, which was recently made publicly available on SSRN, I evaluate the French legal system following the strengthening of the “Basel III” prudential regulations and advocate urgent reform. A large number of commentators have predicted that Basel III is likely to result in a reduction in the contribution made by banks to financing the economy. This evolving role for banks invites us to re-examine French law (to the extent that the legal system has an impact on the development of alternative methods to traditional bank financing, recourse to financial markets and the private equity market). It is indeed a major issue for France. Unlike the US and the UK, financial markets in France (as in the rest of Continental Europe), are bank-centered. Against the backdrop of a declining economy and the development of prudential regulations, France must therefore adjust quickly its legal system. This is the tenet of my paper, which is the long version of a report that I wrote initially at the request of the French National Economic Council for the office of the French Prime Minister.
In France, investors currently perceive a climate of relative legal uncertainty. I consider in detail several methods of financing: (1) high yield bonds, covered bonds and mezzanine bonds (all of which are held by institutional investors); (2) loan to own transactions (the purchase of debt instruments on the secondary market by distressed funds with a view to taking control of distressed borrowers); (3) loans made available by hedge funds to companies which are filing for bankruptcy; and finally (4) the purchase of equity by venture capital funds. All these financing methods require that the parties involved can rely on contracts which are tailored to their specific needs and that the courts will duly enforce those contracts if needed. However, French company law, French bankruptcy law and the law governing security interests in France all impose mandatory obligations on parties which affect their ability to design optimal contracts.
Why does the law impose so many regulations in areas where freedom of contract should predominate? The reason is that the law & economics movement has not yet really taken off in France. For years, French legal scholars have not taken any real interest in the economy. Furthermore, French economists no longer have a clear understanding of all the complex subtleties of French law that derive from its habit of enacting regulations first and (perhaps) examining the side effects later. As a result, there is no longer a dialogue between legal scholars and economists and the gap between the two is widening as the French system becomes getting more and more complicated.
Deputy Warsmman’s first recommendation in 2008, after he was commissioned by the French Prime Minister to prepare a report on the quality and simplification of the law, was to entreat public officers to carry out more impact studies to improve the preparation phase of statute enactment. In our view, carrying out impact studies is equivalent to conducting research in law and economics. While it is important for the administration to be more concerned about the impact which the laws it promulgates will have, it is increasingly important that individuals who are independent from the French executive — such as academic researchers — are able to conduct prospective studies on subjects which are important for society. However, of Warsmann’s 397-page report, the word “University” appears only three times, and no academics were among the sixty-two people interviewed for the report.
The task is therefore immense if French academic researchers in social sciences wish to influence the drafting of statute law. This article concludes in favor of a revision of certain provisions of French law and / or of European law and also in favor of a fundamental reform of the judiciary, in order to facilitate financing on the financial markets and capital investment in risky companies and projects.
The full paper is available for download here.