Legal aspects of financial instruments

Aug 28, 2014News & Analysis

With the rapid development of high technology and modern means of communication and exchange of information, trade in stocks and other types of securities and financial instruments has become extremely popular, first in the economies of developed Western democracies and the high-tech East, and later in Bulgaria. There was a lot of talk about stocks, bonds, options and other types of financial instruments, and gradually these concepts of reserved territory for economists, professional investors and other people with narrowly specialized knowledge in the field became available to the average middle class. The legislative regulation of securities and financial instruments is contained within the Commercial Act (CA), the Public Offering of Securities Act (POSA), the Markets in Financial Instruments Act (MFIA) and a number of other laws and regulations. In this sense, securities, financial instruments and their trading, in addition to their predominantly economic aspects, also have their legal ones, which is why an attempt to summarize the legal aspects of financial instruments has never been delayed or useless.

First of all, there should be a division of financial instruments, which aims to bring some clarity to the mazes of matter.

The financial instruments are:

  • Valuable books;
  •  Instruments other than securities, such as:
    – Money market instruments;
    – Shares of collective investment enterprises;
    – Derivative financial instruments with different underlying assets;

It is worth noting here that this division of financial instruments is conditional and is made only with a view to trading them, because from a legal point of view all financial instruments are securities. Our national law recognizes different types of divisions of securities such as: investment and commercial securities; available and dematerialized securities, etc.

Cashless and available securities

This division of securities is made depending on whether the security as a source of the rights enshrined in it is objectified on some material, paper medium. This division of securities finds its practical legal reflection mainly in the regime of transactions with the subject of a given available / dematerialized security.

The registration and transactions with dematerialized securities take effect from the moment of their registration by the Central Depository.

The bill of exchange, the promissory note, the check and the commercial paper as types of commercial securities cannot be dematerialized. As a rule, they always have their own material carrier.
Trading and investment securities

Commercial securities can incorporate receivables, property rights, but never membership rights. Membership rights for reserved territory for investment securities. As regards the period by which the rights under a commercial or investment security are limited, it should be noted that investment securities could be holders of both term and perpetual rights. Commercial securities, in contrast, can be holders of term rights only. By their nature, investment securities are a means of publicly attracting investment.

Investment securities in some part, as will become clear later, are financial instruments, while private commercial securities (bills of exchange) are not financial instruments.

The answer to the question which securities are financial instruments and which are not should be sought in MFIA. Depending on where they are legally regulated, the investment securities are those under the CA and those under the POSA. The dividing line between the two is whether they can be offered to the public on regulated capital markets. Securities under the POSA have the characteristics of financial instruments, while securities under the CA do not.

Only dematerialized securities may be subject to public offering under the POSA. The available securities could reach the regulated capital markets, but only after going through a procedure before the Central Depository for their conversion into dematerialized securities.

Depending on whether an investment security is free to be the subject of subsequent transfer transactions after its initial subscription or whether there are corresponding restrictions, the securities are ordinary and bound. It is characteristic of bound securities that either there is a total ban on their subsequent transfer by their original acquirer, or certain restrictions are imposed on their subsequent transfer. Due to the discrepancy between the idea of the public offering under the POSA and the nature of the bound securities, the latter cannot be the subject of a public offering under the POSA.

Issuers of publicly available securities are initially burdened with the legal obligation and periodically disclose certain information. Only in full compliance with the requirements of the Public Offering of Securities Act could the registration of a given issue of securities for trading on the respective regulated market – the so-called “listing”.

The listing of an issue of securities for public trading on the stock exchange in the respective market segment – “A”, “B” or “C” could pursue both the attraction of the capital of an unlimited number of third parties and their use for the purposes of a certain business, and conducting an “advertising campaign” and thus taking an important step to increase the rating of a company.

As made clear above, the generic concept of a financial instrument should include both different types of securities and a number of financial instruments that are not securities in terms of the specifics of their trading. Among this second group of financial instruments that are not securities we should include:

  • Money market instruments;
  • Shares of collective investment enterprises;
  • Options, Futures, Swaps, Forward Contracts and other derivative contracts with different underlying assets;
  • Derivative financial instruments for credit risk transfer;
  • Contracts for difference;

Types of markets in financial instruments

Depending on whether they are subject to constant control and specific legal requirements for their structure and operation, the markets for financial instruments are regulated and unregulated.

In turn, regulated markets are divided into formal and informal. Conventionally speaking, the informal market, also known as the stock market, is a kind of “waiting room” for small and medium-sized companies before they enter the primary market.

Within the scope of their activity, investment intermediaries, which are an important participant in the activity of stock exchange trading in financial instruments, can develop and maintain multilateral trading systems, but these systems do not overlap and do not displace the regulated financial market as a “place”. there is a trade in financial instruments.

Another division of the capital markets is that of primary and secondary. Newly issued issues of securities that have not been offered so far are offered on the primary capital market, while securities that have already been the subject of transfer transactions are traded on the secondary market.

Securities that have the characteristics of financial instruments can be issued (issued) by: public companies within the meaning of the POSA, the state as an issuer of medium and long-term government securities, municipalities as issuers of municipal bonds, commercial banks as issuers of mortgages bonds, etc.

Issuers of financial instruments that are not securities may be: open-end investment companies; mutual funds, issuing units of collective investment undertakings; commercial banks and financial institutions – through the money market instruments issued by them; the state as an issuer of short-term treasury bills.

Types of securities as financial instruments

The first division of securities, which have the quality of financial instruments, is into basic (underlying) securities and derivative securities. The first group – that of the main (underlying) securities, as can be seen from its very name, includes securities that are not “upgraded” over any asset, different and independent of the security. Derivative securities are based on some underlying asset, which could be stocks, bonds, exchange rates, interest rates or yields, commodities or other indices or indicators.

It is important to keep in mind that derivative securities that are “upgraded” over other underlying securities have the legal characteristics of securities with all the ensuing legal consequences. Derivative financial instruments, on the other hand, that are “upgraded” over other financial instruments (not having the quality of securities) are not securities.

Examples of derivative securities could be:

  • Rights to subscribe for shares from the capital increase of a joint stock company;
  • The warrant;
  • The Bulgarian depository receipt;
  • • Depository receipt:

Another possible division of securities, which are financial instruments, could be that of equity securities and debt securities. Debt securities are generally transferable receivables against their issuer, and a bond could be cited as the most typical example of this group. Equity securities could be shares in companies, other securities equivalent to them, derivative securities giving the right to acquire shares, etc.

The shares as a representative of the group of securities,which are financial instruments

In general, the shares of the capital of a joint stock company guarantee their holders three basic rights:

  • the right to vote in the general meeting of the company;
  • the right to dividend (in case a decision has been taken for the allocation of such);
  • the right to a liquidation share in the liquidation of the company;

The legal way for the transfer of registered securities (including registered shares) is the assignment agreement. Bearer shares, in turn, are transferred through their simple tradition (transfer) without the need to perform any additional legal action. The specificity of the transfer exists in the registered available share, which due to its legal characteristics of a promissory note is transferred by means of a giro. Demand-bearing securities as a type of financial instruments are transferred through an assignment agreement.

Bearer securities cannot be investment securities and financial instruments. The available registered shares, on the other hand, can be a financial instrument only exceptionally and after going through a procedure for their “immobilization” in the Central Depository.

Only those shares that are dematerialized and issued by public companies within the meaning of the POSA could be a financial instrument. Only those persons who have either already acquired the share giving the right to dividend as of the date of the General Meeting at which the annual accounting report was adopted and a decision for distribution of the profit has been made, or have acquired this share, are entitled to dividend on these shares. up to 14 days from this date. The right to dividend in public companies has the characteristic of an independent right, which can be traded separately from the share.

Given the special nature of public companies and the securities issued by them, there are certain specifics for them. In the first place, unlike an ordinary joint-stock company, a public joint-stock company cannot issue preferred shares which give the right to an additional liquidation share to its holders. Only those shareholders who have acquired their shares no later than 14 days before the day of the respective general meeting of shareholders have the right to vote at the general meeting of the public company. Another specificity of the public company is that it cannot issue shares giving the right to more than 1 vote to its holders. A specific type of contract that the shareholders in a public company could conclude is the contract for entrusted management of shares, according to which the right to vote on certain shares is exercised by a third party at the expense of the shareholder. Another case in which the right to vote on certain dematerialized shares is exercised by a third party and not by the shareholder himself is the one in which, if this is provided for in a special pledge agreement, the pledge creditor under the contract exercises the voting right to the pledgor in his own name, but at his expense.

It is also characteristic of public companies that in view of the protection of the minority owners of the company’s capital, the law provides for the so-called minority rights. Examples of such a right are the right of shareholders holding five per cent or more of the capital of a public company to bring certain claims against the company; to ask the court to appoint controllers to check all the accounting documentation of the company; to initiate the convening of a general meeting with a certain agenda, etc. Unlike the ordinary joint-stock company under the CA, which only keeps and stores its book of shareholders, in public companies the book of shareholders is kept and stored by the Central Depository.


A bond is a basic type of debt security that can be classified as a family of financial instruments. The bond could be viewed from two angles:

1. as a security;
2. as a cash loan granted to a joint stock company (AD), limited partnership with shares (KDA), the state or the municipalities;

As a security, the bond is issued by AD (respectively KDA) and materializes the right of receivable of its holder to receive within a certain period of time appropriate interest and nominal value and is transferred to the regulated and unregulated capital markets.

The bond is a bond-disposal security because it certifies a subjective right that arose outside and regardless of its issuance.

The only financial instrument is the dematerialized, public and freely transferable bond, ie the one under LPOS. A specific type of bonds are convertible bonds. This type of bond can be converted into shares under certain conditions.

Viewed through the prism of the related cash loan agreement, which is concluded between the issuer of the bond and its original borrower, the bond does not replace the loan contractual relationship itself, but only certifies its conclusion.

The bond gives its holders two types of rights – individual and collective rights under the bond. The individual rights under the bond are the right of its holder on a certain date to receive from the issuer the nominal value provided in the bond, as well as a predetermined remuneration interest calculated at the nominal value of the bond. Collective rights of the bondholders are the rights that the CA provides for the general meeting of bondholders on a given bond issue, the right to participate in an advisory vote in the general meeting of shareholders through its specially elected representative.

Bondholders on one issue are the bondholders on a separate bond loan. Like stocks and bonds, they are available and non-cash. The available ones, in turn, are subdivided into registered and bearer. Registered bonds are transferred by giro, while available bearer bonds are transferred by their actual transfer (tradition).

The Central Depository keeps a book of dematerialized bonds of all issuers. With few exceptions, only dematerialized bonds can be financial instruments. Corporate in practice are the bonds issued by AD and KDA. Mortgage bonds, on the other hand, are bonds issued by commercial banks on the basis of their loan portfolios secured by one or more mortgages. The Bank may issue mortgage bonds only up to the volume of the mortgages established in its favor on the mortgage loans granted by it. The real estate subject to these mortgages can only be built-up real estate.

Another type of bonds are municipal bonds. They can only be dematerialized securities offered under the POSA. Each individual bond issue forms a separate bond class. In contrast, in the case of shares, a separate class forms all shares that give the same privileges.

Speaking of different types of bonds, government securities (government securities) cannot be ignored. Public are those bonds that are issued by a public issuer – the state and municipalities.

Government securities are:

A) government securities in connection with the management of domestic government debt:

  • Treasury bills;
  • treasure tickets;
  • treasury bonds;

B) government long-term bonds to finance losses in the financial sector in the course of structural reform:

  • Government securities for settlement of non-performing loans of state-owned companies to banks (the so-called ZUNK-bonds);
  • Government securities issued under the Bank Deposit Guarantee Act (especially current in current events with Corporate Commercial Bank);

C) Government securities issued for the restructuring of the external government debt – the so-called Brady bonds

Depending on the length of the period between the issuance of government securities and their maturity, government securities are subdivided into short-term, medium-term and long-term. An example of short-term government securities are treasury bills with a maturity of up to 1 year. Only treasury bills are a type of financial instruments under MFIA. Medium-term government securities are treasury bills with a maturity of 1 to 5 years. Long-term government securities are treasury bonds with a maturity of more than 5 years. The advantage of government securities over ordinary bonds issued by joint stock companies is that, unlike one a joint stock company that can easily go bankrupt, the bankruptcy of an entire municipality or state is a much rarer phenomenon, which presupposes a higher security of government securities.

The official depository of government securities is the BNB. Only credit institutions may be sub-depositaries. Government securities transactions are settled only with sub-depositors.

Subscription rights for shares
from the capital increase
of public companies

This type of rights must be issued upon increase of the capital of a public company by issuing new shares and represent an independent type of securities, different from the securities, the right to purchase which they give. The subscription rights of part of the shares from the capital increase of a public joint stock company have the characteristics of derivative securities, equity securities and financial instruments.


The warrant as a separate type of security expresses the right to subscribe for a certain number of securities at a predetermined or determinable issue value until the expiration of a certain period. A distinction should be made between a warrant as a security with the characteristics described in the previous sentence and a warrant as a concept found in our old commercial law, which under our current commercial law is called a pledged record (Art. 577, para. 2 CA) . The warrant is a derivative security and, unlike the option, the rights to one warrant cannot be exercised on a specific date. The price at which the shares will be purchased under one warrant can be determined or determined.

In terms of content and essence, the warrant is closest to the call option, but there are a number of essential differences between these two types of financial instruments. The warrant, on the one hand, is a derivative security that is also a financial instrument. The call option, on the other hand, is a derivative financial instrument, which, however, does not have the characteristics of a security. The warrant gives the holder the right to subscribe for newly issued securities on the primary market, while the call option carries the right to purchase securities that it is traded on the secondary market. The warrant gives the right to purchase only securities, while the call option can give its holder the right to buy other financial instruments. The warrant can be exercised only within a certain period. The call option, in contrast, could be envisaged to be exercised either within a given period or on a specific date.

Bulgarian depository receipt

Another type of derivative security is the Bulgarian depository receipt. In essence, it is a security issued in Bulgaria, providing rights derived from the rights under another (underlying) security, as the rights under the underlying security are exercised in favor of the holder of the derivative security. The Bulgarian depository receipt gives all rights under the underlying security with the exception of the right to vote. The issuer of the Bulgarian depository receipt sells it to its buyer and by virtue of a second order contract with it buys the name of the underlying security by immobilizing / locking it in a depository bank. The issuance of Bulgarian depository receipts is allowed by the Central Depository only after the issuer has purchased and concluded the underlying security. It is important for the Bulgarian depository receipts that they are subject to repurchase from their issuer.

Depository receipt

Depository receipts are derivative securities issued outside Bulgaria. With the exception of this – the place of their issuance, they are similar to the above-mentioned Bulgarian depository receipt. The issuer of the depository receipts and the issuer of their underlying securities have their registered offices in different countries. The main application of depository receipts as a separate type of securities is that they facilitate the cross-border trading of securities.

Financial instruments that are not valuable books

Within the framework of this statement, it is appropriate to pay attention to those financial instruments under MFIA, which, although they have the quality of financial instruments, do not have the characteristics of securities.

These generally include:

  • money market instruments;
  • shares of collective investment undertakings;
  • options, futures, swaps, forward contracts and other derivative contracts with different underlying assets;
  • derivative financial instruments for credit risk transfer;
  • contracts for difference;

Before making a brief overview of the types of financial instruments that are not securities, it should be noted that, like securities, non-securities financial instruments are divided into underlying financial instruments and derivative financial instruments. The underlying financial instruments are the holders of primary rights for their holders – such are the money market instruments and the shares of collective investment undertakings. The value of derivative financial instruments depends on a specific underlying asset (securities or other financial instruments). Examples of such derivative financial instruments are options, futures, forward contracts and swaps. Unlike derivative securities, which have another security as their underlying asset, derivative financial instruments may also have commodity rights as their underlying asset.

Money market instruments

Money market instruments are:

  • short-term government securities (treasury bills);
  • certificates of deposit;
  • commercial securities;

Determinant for money market instruments is the concept of maturity, or in other words it is the period from the issuance to the maturity of an instrument on the money market. It depends on the duration of the maturity whether a money market instrument is a security or a financial instrument that is not a security. If the maturity of one money market instrument is longer than 12 months, then the respective money market instrument has the characteristics of a security under the POSA.

Shares of enterprises for collective investment

This type of financial instruments is issued by collective investment undertakings and represents the rights of the participants over the assets of the collective investment undertaking. Shares in such an enterprise may be repurchased by the enterprise at the request of the holders at a price based on the net asset value of the enterprise. A collective investment undertaking is a generic term that covers both open-ended collective investment undertakings and closed-end collective investment undertakings. The term collective investment scheme could also be used as a synonym for an open-ended collective investment undertaking. The shares issued by collective investment undertakings are not securities within the meaning of MFIA.

The shares of this type of enterprises could be:

  • shares issued by open-end investment companies (the legislator treats them as financial instruments that are not securities);
  • units issued by contractual funds.

The units issued by a closed-end collective investment undertaking are financial instruments securities (shares) and are traded under the rules of the Public Offering of Securities Act for public offering and admission of securities to a regulated market.

The mutual fund is a separate property for the purpose of collective investment (in securities and other liquid financial assets) of funds raised through public offering of units. Mutual fund units are not a variant of company shares. Membership between the mutual fund and the unit-holders does not arise as in the case of capital companies.


An option is a type of derivative financial instrument and generally contains the right to buy or sell a certain number of securities or other financial instruments at a pre-fixed price until the expiration of a certain term or on a certain date. The option could be viewed from two aspects – as a contract and as a right. According to the type of right that the options secure are: call options – when the holder has the right to purchase the asset provided in them; put options – when the holder has the right to sell the asset provided in them. As a type of right, option law should be defined as a testamentary subjective right. The option is from the group of financial instruments that are not securities. Invariably related to the option and the option contract is the option premium – this contract usually means the price of the option under the option contract.

The options are divided into:

  • American option – characteristic of this type of options is that the right to them can be exercised within a certain period;
  • European option – the right to them can be exercised only on a certain date.

Depending on the underlying asset over which the option is upgraded, it is:

  • option on a security;
  • option on stock indices;
  • option on futures;
  • currency option;
  • covered / uncovered option – depending on whether the underlying asset is owned by the respective party to the option transaction at the time of concluding the option contract.


Futures, like the option, are a derivative financial instrument, which, however, expresses the obligation to buy or sell a certain number of securities or other financial instruments at a pre-fixed price and on a certain date. Futures are used both as a means of risk management (hedging) and as a weapon for the realization of market speculation. In most cases, futures do not reach their performance at all. This is because even before its maturity, the parties to the futures contract agree to “neutralize” the futures contract concluded between them, whereby they enter into a new transaction – the so-called offset transaction, which is concluded with the participation of p. so-called clearing house intermediary. Both the option and the futures could be seen as both a contract and a right negotiated under that contract. The execution of the futures contract is secured by the so-called margin – deposit. A significant difference between the option and the futures is that, unlike the option, the right to which may not be exercised by the party having it, the obligation under the futures contract must be fulfilled. An analogy could be successfully made between the futures contract and the preliminary contract under Art. 19 CPA. However, in case of non-fulfillment of the obligation under the futures contract, unlike the preliminary contract, the party does not have the testamentary right to conclude a final contract. Both the option and the futures belong to the group of financial instruments that are not securities. As stated above, futures must be exercised on a specific date, not within a specific period. Depending on the underlying asset, we distinguish between financial futures and commodity futures.

The futures buyer undertakes to acquire the underlying asset and the futures seller undertakes to transfer it to maturity. The price of the futures is different from the price of the underlying futures asset.

Forward contract

A forward contract is a forward transaction for the delivery of an underlying asset at a specified future date and location. With some reservations, the forward contract could be classified as a non-standardized futures contract.

Contract for difference

In a contractual financial instrument, the parties pay each other the difference between the value initially determined by them and the future market price of a certain underlying asset.