France has embarked on a major competition to benefit from Brexit and the weakening of London's financial center. President Emmanuel Macron, as well as Prime Minister Edouard Philippe and Economy Minister Bruno Le Maire, have boasted, in turn, of the advantages of France and its infrastructure (its education system, health, and transportation).
However, the importance of building a legal infrastructure has been largely ignored. The strengthening of the Rule of Law, which the French call ‘l’Etat de Droit’, is nevertheless the cornerstone of the development of financial markets and, more generally, of the prosperity of a country. This issue is at the heart of the work of economists James Robinson (Harvard) and Daron Acemoglu (MIT) who have published a best seller on the subject ’Why Nations Fail: The Origins of Power, Prosperity, and Poverty’.
The French tend to underestimate the importance of the role of law and institutions in the development of financial markets, as I have written, with my co-authors Mathieu Luinaud and Mathieu Kohmann, in ‘French institutions, innovation and growth’. France still has to prove that it speaks the same language as investors.
A fundamental change of culture is necessary regarding the French elite who are at the helm. At present, in contrast to the British and American elite, who are, at least in part, drawn from a background in Law, the French elite is in fact the result of the very special system of “grandes écoles” (ENS, Sciences Po, ENA and Polytechnique) in which business law is not really taught.
Thus, a number of measures are in our opinion essential:
1. Substantive rules for the protection of investors' rights
Rules for the protection of the rights of shareholders in financially sound companies: the alarm signal must be the degree of concentration of the capital of French listed companies (much more significant than in the United Kingdom or in the United States). It is necessary to be aware of what this means, specifically the difficulty for shareholders to control the management other than by retaining control of the general meeting and the board of directors, and the consequences of this situation for shareholders in general, who face the risk of tunnelling by majority shareholders to the detriment of the minority shareholders.
We must realize that we cannot both set a goal of maximizing shareholder value in order to allow for the development of the financial markets (indispensable for the development of tech today, given the ‘winner takes all’ phenomenon) and, at the same time, encourage managers to be accountable not only to shareholders, but to stakeholders at large (including employees and suppliers). Recently, French business leaders have let the public at large know that change is desirable, in a piece they have published in the Journal le Monde: ‘Advocating for a responsible market economy’ [’Plaidoyer en faveur d'une économie de marché responsable'].
The role of regulation is to force companies to think about their environment. Infringing the contract that binds the management and the shareholders is dangerous. This idea is likely to have unintended consequences, since managers might become free from oversight if they are subject to conflicts between their objectives. This idea is fiercely defended by the Nobel Prize winner for Economics, Jean Tirole, in his latest work aimed at the general public: ‘The Economy of the common good’ [‘L'Economie du bien commun’]. Strangely, the UK is moving away from this idea, and has embarked on a process of reforming their corporate law in favour of stakeholders, as a way of combating inequality in the UK.
Among the measures necessary to improve the protection of minority shareholders, for example, is a review of the regime of related-party transactions, in order to apply a ‘substance over form’ principle that can capture any type of transaction that poses a risk to minority shareholders. To date, the agreements concluded between parent companies and their sub-subsidiaries can, surprisingly be excluded from the regime of related-party transactions with the consent of the statutory auditors.
It is necessary to impose a duty of loyalty on the part of the majority shareholders towards minority shareholders and to reinforce the loyalty duties of directors towards shareholders as a whole, so that the latter can legally defend their rights in court.
In the area of securities law, it is necessary to step out of the European Commission's ‘ box-ticking’ approach and to require companies to disclose all information that is ‘material’ to investors.
Rules for the protection of creditors rights where the enterprise is insolvent: it is the role of insolvency law to protect investors. In this respect, French law needs to be considerably revised, especially in a context of financial market development, as I mentioned recently, in my paper ‘Bond workouts, distressed equity offerings and State interventionism - Analysis of the Consequences of the Inefficiency of French Law Concerning the Restructuring of Large Size Companies’ and in this blog.
2. Procedural law rules
It is not enough to give rights to investors; these rights have to be really effective before the courts. The rules of evidence must be changed along the lines of the United States discovery rule; and class actions must be favoured in financial litigation and framed in order to avoid the known problems experienced in the United States.
The low number of disputes in this context showcases the poor health of the French judicial system. It is necessary to recognize the inability of the Autorité des Marchés Financiers (the ‘AMF’) to play its full role. We have noted the very low level of litigation against issuers, a lack of litigation against the underwriters of issues, and very few actions against auditors.
3. Judicial institutions
There is enormous need for the specialization of judges. Today, the level is insufficient to guarantee the protection of financial contracts because of their monolithic formation. It is impossible for a judge with no previous experience in the private sector to understand 400-page agreements drafted in English.
In order to limit the cost of such reform in a context of budgetary difficulties and to encourage mediation, our judicial system should stop being a two-tier jurisdiction where there is a right to appeal in all circumstances, and appeals should stop having suspensive effect. This is the model that exists in the UK, but also, to some extent, in EU law.
These changes would allow for the reallocation of resources in areas where the inadequacy of the justice system has systemic effects on the French economy (if the judge has a low expertise in finance, market efficiency might become at risk).
The question of the attractiveness of the law is a painful subject for France because the French once were, thanks to Napoleon, the world leaders. So far, the French State has come to the rescue of the Colbertist capitalism that the French have inherited, which does not operate in favour of investors. The level of the French sovereign debt does not allow such reminiscence any more, and a radical approach is necessary to ensure long-term change.
Sophie Vermeille is the President of the Droit & Croissance (Rules for Growth) Institute (‘Droit & Croissance’).