E-encyclopedia of banking, stock exchange and finance

Selected letter: R


    Random Walk derives from the martingale theory. The simplest definition of random walk implies that the variation of the variable is also associated with the IID (Independently and Identically Distributed) definition of the distribution of ?t.
    In the probability theory, a sequence of random variables is IID only if each of these variables has a probability distribution equals to the other and mutually independent. The random walk with IID assumption of a stock price variable can be represented as:

    Pt = ? + Pt-1 +?t

    where ?t ?IID (o,?2)
    In the previous equation, ? is the expected price variation called "drift". The presence of the drift implies that the average is non-zero. The negative or positive drift is associated with the non-stationary hypothesis. The IID (o,?2) implies that the variation of ?t is with 0 mean and ?2 (if we assume a normal distribution of ?t, the equation is an arithmetic Brownian motion observed at regular unitary intervals of regular length).
    The definition of random walk given so far is the most restricted one (RW1). If we free the initial hypothesis, it is possible to compare the random walk that is closer to the financial market dynamics.
    If we assume that the identically distributed variation is not plausible if we refer to the extended time length, we can define RW2. In the same way, if we only hold the uncorrelated increments we can define RW3; with this set up, we do not exclude the possibility that the square of the variation is correlated.
    The main difference between RW and martingale lies in the fact that the random walk process is more restrictive than the martingale in that it requires that the value following the first (e.g. the variance) be statistically independent. Even if the martingale defines the random variation of a generic variable, it allows the possibility of foreseeing the conditioned variance on the basis of previous value.

    Campbell, J. Y., Lo, W. A., MacKinlay, A. C., 1997, The Econometrics of Financial Markets, Princeton University Press, Princeton New Jersey;
    Lo, W. A., MacKinlay, A. C., 1988, Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test, in The Review of Financial Studies, Vol. 1, No. 1 (Spring), pp. 41-66.

    © 2009 ASSONEBB


    The expectation on the future realisation of an economic variable is rational if the agent uses all the available and useful information to predict it. The Rational expectation hypothesis (REH), originally proposed by Muth (1961), is one of the main features of the so-called New Classical Macroeconomics and assumes that economic agents do not make systematic errors when predicting the future. According to the REH, the expectation at time t of the realisation of x at time t + 1 can be written as follows:

    where the subjective expected level of a variable held by economic agents is equal to
    the mathematical expectation of the probability distribution conditional on the information set available at time t . It is worth noticing that includes all the information concerning the policies to be carried out by the government in the future. Under the REH, agents formulate unbiased forecasts of future values of an economic variable and their forecast error is on average equal to zero:

    The REH assumes the best use of available information and that the agents’ subjective distribution of expectations corresponds to the objective probability distribution of the true model describing the economy.
    Muth J.F. (1961) "Rational Expectations and the Theory of Price Movements", Econometrica, Vol. 29(3), pp. 315-335
    Sargent T.S. (1987), "Rational expectations" The New Palgrave: A Dictionary of Economics, Vol. 4, pp. 76-79.
    Editor: Lorenzo CARBONARI
    © 2009 ASSONEBB


    The real estate business plan is a good tool that allows to make an assessment of a building project through a systematic and organic presentation where all elements are detailed. The purpose of this plan lies in its ability to reach a defined project planning, thus allowing to highlight and analyse in a critical perspective all its critical points and strengths. The subject of a REBP can be an investment in a single building or multiple buildings, the income or the development / renovation and subsequent sale of a property. An analysis of a business plan, or rather a comparison between two or more projects of property investment, can go through a rapid screening by a comparison focused on the contents, characteristics and expectations of future projects. The real estate business plan can be used to launch a new initiative, as a document to substantiate a claim for credit for a transaction to buy or sell one or more real estate items or even as a tool to monitor the progress of a project already started. Following the recent renewed interest in the property sector that saw a boom in 2001 and which has suffered the financial crisis since August 2007, REBPs have increasingly become an essential tool in transactions submitting credit applications to financial institutions. Banks have indeed taken their point of view by favouring the ability to generate revenue streams and constant positive growth as compared with the logic of a guarantee based on the tangible good that is financed.
    Even if among the different business plans currently produced it is not possible to identify some uniformity of procedures in drafting a structured and pre-index paper, it is easy to define some macro-areas which should be articulated in a business plan to ensure its completeness and efficiency in reaching its ultimate goal.
    A business plan must therefore cover the following areas: 1. Executive summary; 2. Property description; 3. Market analysis; 4. Project Development; 5. Investment Estimate; 6. Management and Organization; 7. Financial business plan.
    The Executive Summary must include a concise synthesis to propose a quick understanding of the proposal in order to attract attention and arise immediate interest for other sections of the BP through a short yet comprehensive version of the project. In this context, the executive summary should not include information from other sections but should prove to be only a synopsis of the BP.
    Under the second point (Description of the real estate property), the characteristics and technical specifications of the project are to be represented, such as the description of the location, description of the current state of the buildings, development plans drawn up, the plan dictated by regulators, any existing explicitation of different bindings (architectural, urban planning, legal, etc.).
    Under the third point (Market Analysis), the basis of the development plan for the property is articulated. This section includes the macro-economic characteristics of the place where the project is developed through a detailed analysis of the conditions of the specific context and of the development plans that are also in adjacent areas. This section also shows a detailed analysis of current and past values of similar real properties to provide a comprehensive understanding of the market in question, more representative as larger volumes are examined. In this section, also the condition of the financial market should be reviewed, the reference being that only in areas with a developed financial market it will then be possible to generate income to the building plan.
    The fourth point (Development Project) usually tends to spell out the reasons which led to the development of the proposal, the structure of its evolution over time and its expected uses. In such a context it is also important to report the possible consequences that might result from difficulties in financial terms … the so-called risks related to problems of bureaucracy, increased raw materials cost, labour, etc. that, by making more uncertain the success of the project within a specified time, could result in delays in the execution and a serious impact on the cost-effectiveness of the entire operation. Hence, the risks must be analysed and reported through a structured plan that includes their effective and efficient management.
    The fifth point (Investment estimate) must include a proactive analysis of the feasibility of the project that cannot ignore an estimate of the costs for its implementation. An estimate that must be, as explained in the previous section, likely to consider a variable percentage of the risks depending on the level of detail of the project.
    Under point six (Organization and Management), the management of the project is described in detail. It is now common practice to envisage the creation of a special company (SPV) that is established with the specific purpose of implementing the project. The characteristics of the new company, its financial structure, organisational structure, and the maturity of its management are reported in this context.
    The seventh point (Economic/Financial Plan) will provide a quantitative representation of the project, by highlighting in particular its expected performance. The Economic and Financial Plan is made up of the income balance sheet and of the Assets/Liabilities statement, as well as of the cash flow perspective and the perspective of performance indicators. In particular, what is important is the definition of the timeframe projection with a clear indication of the project completion date. Among the assumptions are those that indicate general forecasts on inflation, on taxation applied by the country, on evolution of the exchange rate of the currency if the project is located in a country with a currency different from that of reference, and on the average cost of personnel management and of the project organisation. A plan of investment and the definition and estimation of costs and expected revenues are also reported in this context. Crucial to any REBP is also the "sensitivity analysis" that covers the variation in critical factors, such as the vacancy rate, the interest rates, the economic situation, etc., which may change the results of the project and more generally its sustainability over time. All of the above contribute to creating a realistic and credible business plan to provide a broader analysis and a clearer understanding of the interrelationships between the variables considered and any subsequent action. The most frequently used performance indicators are: Net Present Value (NPV), Internal Rate of Return (IRR), ROE (Return on Equity), ROI (Return on Investment), the financial autonomy index (long-term debt / equity) and the debt ratio.


    Linneman P. (2004), "Real Estate finance and investments: risks and opportunities". Philadelphia.
    Tronconi O., A. Ciaramella, B. Pisani (2007). "La gestione di edifici e patrimoni immobiliari". Milano. Il sole 24 ore.
    AA.VV. (2007). "Società di investimento immobiliare quotate". Milano. Il sole 24 ore.

    Editor: Alberto Maria SORRENTINO

    © 2009 ASSONEBB

  • REAL ESTATE COMPANY (Encyclopedia)

    A company is defined as real estate company if its main object is the management/development of a portfolio of real estate assets that own the property title. With reference to the evaluation of a real estate company, it is possible to use different methodologies: 1. Financial method; 2. EVA Method EVA (Economic Value Added); 3. Method of multiples; 4. Asset Method.
    In the first case, the real estate company value is based on the value of its cash flows and the value is calculated by discounting the expected cash flows. The main difficulties of this method are determining the explicit forecast of cash flows, estimating the cost of capital, and calculating the terminal value (TV) and the proper discount rate.
    In the second case, the real estate company value is obtained by using a methodology1 designed to highlight the effective ability to produce wealth. A company creates value if the difference between the operating income after tax and the cost of capital employed to achieve it is positive (EVA> 0). The main difficulties of this methodology are: the determination of the explicit forecast period of EVA, the estimated cost of capital, the calculation of terminal value at the end of the explicit forecast horizon, and the proper discount rate. The real estate company value is equal to the capital invested plus the sum of all future EVA discounted, plus the discounted TV.
    In the third case, it is possible to infer that the value of a real estate company is based on the price of securities listed on a regulated market that represents shares of comparable companies. The goal of the method is to develop relationships (multiple), based on the report of the actual stock prices of companies with comparable business economic variables. The multiple thus obtained are applied to the same economic variables of the company being evaluated in order to obtain its value. The difficulties of this methodology are the growth prospects and the risk specific to the real estate company being evaluated.
    In the fourth case, the value of a real estate company is given by its assets, by quantifying the price recovery of assets from the perspective of a business operation. The value corresponds to the net investment that is necessary to start a new company with an identical structure to the one being evaluated. The difficulties of this method lie in the analytical estimate of each element at current values .
    1The introduction of the euro and the divergence between measured and perceived inflation. The methodology that introduced the EVA concept is a registered trademark of the consulting firm Stern & Stewart, which proceeded to implement it and to spread it in the 1980s.


    Milano F. (2005), "Corso di Finanza Aziendale", Luiss University Press.
    Monti E. (2005), "Manuale di Finanza per l'impresa. Teoria e pratica.", UTET.
    Linneman P. (2004), "Real Estate finance and investments: risks and opportunities", Philadelphia.
    Tronconi O., A. Ciaramella, B. Pisani (2007). "La gestione di edifici e patrimoni immobiliari". Milano. Il sole 24 ore.
    AA.VV. (2007). "Societa di investimento immobialire quotate". Milano. Il sole 24 ore.

    Editor: Alberto Maria SORRENTINO

    © 2009 ASSONEBB


    The definition of real estate investment fund1 in Italy is found under section j), first paragraph, of article 1 in the decree law D.lgs. 24 February 1998, n. 58, so-called ‘TUF’: "autonomous real estate property, self-divided into units, attributable to several participants, managed in trust [...] the trust's assets, either open or closed, can be assembled in one or more issues of shares", while art. 36 expresses the characteristics of funds: division into shares, property autonomy, collective management delegated to a professional intermediary, a plurality of participants.
    Real estate funds are managed and operated by a third party, defined as a saving management company (Italian acronym SGR)2, different from those contributing with money and/or assets to the establishment of a single property fund with the aim of investing assets exclusively or predominantly in real estate, real property rights and equity on interests in real estate companies. The fundamental feature of real estate funds is to transform the property investment from non-liquid, non-standardised and non-transparent items in financial assets (through the issuance and purchase of shares) that allow to generate cash without any obligation for the investor to acquire the direct property of a building. Real estate funds are exclusively of the closed type3. The subscription of shares is done through the payment of money or, in the case of contribution funds, by means of contributions or of transfers of real estate properties, real estate property rights or quotas in real estate companies.
    The investment fund can be defined as real estate when investments in real estate activities are no less than two thirds of the total value of the fund; this requirement should be met by each fund within 24 months from its start and must be constantly honoured (the percentage is reduced to 51% whenever the fund assets are also invested, for no less than 20% of its value, in financial means representative of securitisation transactions relevant to real estate property, real estate rights or credits secured by mortgage guarantee).
    The real estate fund can play both directly or indirectly and without limitation activities of real estate development and enhancement; however, it cannot directly carry out construction activities (it can sign a contract with a construction company to build or restore properties). Indirectly, the real estate fund can undertake construction activities by investing up to 10% of its value in real estate companies that have the conduct of such activities as part of their social goal. Regarding their activities, real estate funds can: borrow up to 60% of the value of their properties, real estate rights and real estate holdings in real estate companies, borrow up to 20% of the value of other properties invested in the fund, borrow to make early repayments of its shares up to an amount not exceeding 10% of the total net value of the fund.
    1The first mutual funds were established in Italy by law no. 77 of 23 March 1993
    2The S.G.R. are regulated by Legislative Decree 24 February 1998, n. 58, so-called TUF and the Bank of Italy’s decision of 14 April 2005; authorised SGRs are listed in the register kept by the Bank of Italy.
    3Closed-end funds envisage that the right to redeem units is recognised only to the participants at predetermined intervals and that shares may be subscribed, subject to availability, only during the bidding stage, while reimbursement takes place normally at maturity only, with the option, if so allowed, of purchasing or selling the relevant shares on a regulated market. Income Revenue Agency circular of 27 December 2007 n. 74/E .


    D. M. 24 May 1999, n. 228.
    D. M. 14 October 2005, n. 256 .
    D.lgs. 24 February 1998, n. 58.
    Bank of Italy’s circular of 14 April 2005.
    D.L. 25 June 2008, n. 112, converted with amendments, from law 6 August 2008, n. 133.

    Editor: Alberto Maria SORRENTINO

    © 2009 ASSONEBB


    The REICs were introduced in Italy with Law 296/2006. A REIC is a company with residence in Italy and its aim is mainly renting property with some constraints: the value of the property must be at least 80% of assets, revenues arising from the rental activities must constitute at least 80% of total revenues, the shares must be traded on regulated markets (Italian, one of the Member States of the European Union or one of the countries of the European Economic Area), no member shall hold more than 51% of the voting rights and more than 51% of the participation in profits, at least 35% of the shares must be held by shareholders who do not have more than 1% of the voting rights and 1% of the profit participation. The REICs have the following characteristics: a) they decide independently the maximum percentage of debt (as opposed to German REITs that may borrow up to a value equal to 55% of the real estate); b) they decide themselves the limits to the concentration of risks (in respect of certain parameters: maximum 20% of revenues coming from the same tenant, as determined by the management company and approved by the Italian Consob); c) direct governance: the management of the company and, therefore the property, is carried out directly by shareholders; e) plurality of subscribers; f) prevalence of real estate activities. The introduction of REICs has increased the competitiveness, transparency and liquidity of the Italian real estate market.


    Linneman P. (2004), "Real Estate finance and investments: risks and opportunities". Philadelphia.
    Tronconi O., A. Ciaramella, B. Pisani (2007). "La gestione di edifici e patrimoni immobiliari". Milano. Il sole 24 ore.
    AA.VV. (2007). "Società di investimento immobiliare quotate". Milano. Il sole 24 ore.

    Editor: Alberto Maria SORRENTINO

    © 2009 ASSONEBB


    The real estate market consists of all real property assets with a destination to any use that may be subject to a payment transaction between two or more economic agents. The REM consists of a variety of markets that can be distinguished on the basis of their uses: residential, industrial, commercial, office use, tourist-receptive. The primary category of real estate is the land that can be described as building and not building; only the land defined as building can be considered in the development of the REM. The REM is different from other markets such as equity and/or bonds, due to certain characteristics like the fact of being a less liquid market, with little standardisation and little transparency. However, although characterised in such a way, it is influenced not only by the behaviour of economic agents that make up the demand and supply of real estate, but also by macro-economic aspects of the country in which it is considered. Among the factors that influence the dynamics of the values of real estate assets a dominant role applies to the environmental context where they are located, the housing density and the revaluation speculation. Among the factors that characterise the current REM, and in order to have points of contact with the stock market, is the process of "financialisation" of the sector, which has seen a gradual introduction of innovative tools (real estate funds, securitisation, REIT Real Estate Investment Trusts and Real Estate Investment Companies). The term "financialisation" identifies the process of integration between the financial market and real estate sectors, by highlighting in particular a new approach to the evaluation of real estate assets no longer exclusively based on natural and architectural features of the asset but on its economic and financial capacity to generate cash flows. Financialisation has the effect of partially increasing the standardisation and the liquidity in this market. With this approach, a real estate may be subject to a certain securitisation process with securities whose value depends on the ability to generate income in the future. The process has also led to deep changes in both the demand side, through the entry of new investors such as pension funds; and the supply side, through the use of the practice of securitisation, real estate funds, REITs , and spin-off.


    Linneman P. (2004), "Real Estate finance and investments: risks and opportunities". Philadelphia.
    Tronconi O., A. Ciaramella, B. Pisani (2007). "La gestione di edifici e patrimoni immobiliari". Milano. Il sole 24 ore.
    AA.VV. (2007). "Società di investimento immobiliare quotate". Milano. Il sole 24 ore.
    Degennaro E. (2008). "La finanziarizzazione del mercato immobiliare". Cacucci.

    Editor: Alberto Maria SORRENTINO

    © 2009 ASSONEBB


    Real estate taxation includes tax regimes applicable to physical persons, who undertake buying and selling operations or leasing of real estate items, and to legal entities engaged in economic transactions involving real estate. In Italy, there are precise rules that refer to the taxation of real estate investment companies (REICs), the taxation of real estate funds, as well as the tax regime applicable to the buying and renting of houses.

    1. REIC (listed real estate investment company) taxation

    The REIC is placed under a special taxation model that envisages the imposition of dividends only upon their distribution to shareholders. Capital gains are subject to ordinary taxation or, at the option of the taxpayer, to a 20% imposition as a substitute of IRES and IRAP (in this case, it is required that the REIC hold the property for at least three years). For VAT purposes, the transfer to a REIC of several leased properties is equivalent to the transfers of business companies and they are therefore excluded from the scope of VAT, but are subject to the application of stamp duties, as well as mortgage and cadastral fixed fees (€ 168.00 each). Special rules are envisaged as to the maintenance of separate accounts for the real estate business.

    2. Taxation of Real Estate Funds

    The asset management company (Italian acronym SGR) that manages a property fund applies a withholding tax at a rate of 20% by way of advance or by way of final imposition,that, depending on the nature of the income beneficiary, is taken either on the capital gains arising from the participation in the real estate investment fund, subject to the statutory exemptions provided for, or on the difference between the redemption value or liquidation of the shares and of their subscription or acquisition cost.

    3. Taxation in cases of buying, selling and leasing property

    In case of sale and rental of residential and commercial properties, as well as for the transfer of agricultural land and related appliances, the following taxes apply according to established modalities, rates and detailed amounts: a) the registration fee; b) the value added tax (VAT); c) the mortgage and land taxes.
    The registration fee is configured to be of three different types: a) primary (collected by the Income Revenue Agency at the time of registration); b) supplementary (required by the Income Revenue Agency following an error in the liquidation of the imposition); c) complementary (required by the Income Revenue Agency on the basis of adjustments in the declared value). The registration fee is applicable to instrumental acts subject to registration and to those voluntarily submitted for registration and, according to established rules, as a percentage of the declared value or on a fixed amount basis.
    The value added tax (VAT) applies to the transfer of supplies or goods and to services performed in the country of activity in the exercise of trades and professions, and on imports effected by anybody involved in such activities. The VAT applies, as appropriate, always on a percentage basis.
    The mortgage tax is applicable in case of transcription, registration, renewal and remark made in public property registers, while the cadastral tax is due on documents relating to the transfer of property or the creation or transfer of real estate property rights. Both taxes apply on a percentage basis either to the cadastral value (in case of transfer of real estate property via inter vivos acts vis-à-vis private individuals or private entities operating under VAT exemption, or in case of mortis causa inheritance), or to the value of the transferred asset/right and the real value stated in the instrument of transfer (in cases other than those for which it is imposed on the cadastral value) or in terms of a fixed fee.


    L. 27 dicembre 2006, n. 296.
    L. 24 dicembre 2007, n. 244.
    Decision by the Director of the Income Revenue Agency 28.11.2007.
    D.M. 24 maggio 1999 n. 228.
    D.M. 14 ottobre 2005 n. 256.
    D.lgs. 24 febbraio 1998 n. 58 and following amendments.
    D.L. 25 giugno 2008 n.112 converted, with amendments, from law 6.08.2008 n. 133.
    D.L. 25 settembre 2001, n. 351, converted, with amendments, from law 23.11.2001, n. 410.
    D.P.R. 26 aprile 1986, n. 131.
    D.P.R. 26 ottobre 1972, n. 633.
    D.lgs. 31 ottobre 1990 n. 347.

    Editor: Alberto Maria SORRENTINO

    © 2009 ASSONEBB


    In Market Micro-structure, the realized half-spread is the difference between the transaction price and the mid-price at some time after the transaction (typically 5 or 10 minutes, depending on market transparency). This time interval should be enough large to take into account any market quotes' adjustment in order to reflect the price impact of the transaction.

    Editor: Maria Francesca NUZZO

  • Realized Spread

    In Market Micro-structure, the realized half-spread is the difference between the transaction price and the mid-price at some time after the transaction (typically 5 or 10 minutes, depending on market transparency). This time interval should be enough large to take into account any market quotes' adjustment in order to reflect the price impact of the transaction.

    Editor: Maria Francesca NUZZO


    In behavioral finance the regret theory states that economic operators, in making choices, try to limit the risks of a future regret. The operators try to keep the choice even in the event of losses, with the hope of recovery

    The theory of regret (in English regret theory) plays a relevant role within behavioral finance, as it seeks to provide a further interpretation of individual decision-making processes under conditions of uncertainty.
    The Regret Theory, formalized for the first time by Loomes and Sugden (1982) states that, when investors are faced with a choice in a state of uncertainty, they evaluate and analyze in advance the possible consequences that this choice entails. Individuals are aware of the fact that if their decision leads to a positive outcome, they will experience satisfaction (rejoicing), while in the opposite case, they will be affected by regret for having made that choice. They, therefore, at the time of making a decision, prefer and try to limit as much as possible the risks of a future regret to avoid the displeasure resulting from a wrong choice. In fact, for individuals, this regret is greater than the regret that they feel for not having carried out a specific action that would have led to satisfactory results (regret by omission). Moreover, investors try to defend their choices and to avoid the stress associated with admitting their mistake, they maintain their position at a loss with the hope of a possible recovery.
    Often individuals find themselves in a situation of mental conflict facing the evidence that one of their convictions is wrong: this phenomenon is called cognitive dissonance. Mc Fadden (1999) explains that based on the theory of cognitive dissonance, individuals tend to perform irrational behavior to try to reduce this dissonance. Furthermore, they have a tendency to seek only information about the options taken into consideration, avoiding new information and neglecting the possible alternatives that could have been better, maintaining old opinions in order to avoid mental conflict.

    Loomes G., Sugden R. (1982). Regret Theory: An Alternative Theory of Rational Choise Under Uncertainty. The Economic Journal, Vol. 92, No. 368, pp.805-824. Royal Economic Society.
    Mc Fadden D. (1999). Rationality for Economists? Journal of Risk and Uncertainty, vol. 19, no. 1-3, pp. 73-105.


    An organised trading venue that operates under Title III of MiFID.

    ©2012 Editor: House of Lords


    (See also the renminbi yuan - encyclopedia)

    The Renminbi is the official currency of the People’s Republic of China and it issued by People's Bank of China (PBOC). The yuan is the basic unit of the Renminbi, and in international contexts the ISO 4217 standard code for renminbi is CNY but is also used RMB. The renminbi symbol is . One Renminbi is divided into three basic units: yuan, jiao and fen.

    The Renminbi was introduced in 1949 with the advent of the Chinese Communist regime and it means "people's currency". Since 1950 have been issued several series of coins and today is the fourth series. With the reforms of 1978 for the Socialist Market Economy was created, for a brief period, a dual system currency. It allowed the use of the renminbi only for domestic transactions and foreign exchange certificates provided for foreign transactions. Until 2005, the Renminbi has been anchored to the dollar but after has been anchored to international currencies basket.

    Editor: Giovanni AVERSA


    (See also the definition of renminbi yuan)

    The renminbi is the official currency of the People’s Republic of China and it issued by People's Bank of China (PBOC). The yuan is the basic unit of the renminbi, and in international contexts the ISO 4217 standard code for renminbi is CNY but is also used RMB. The renminbi symbol is . One renminbi is divided into three basic units: yuan, jiao and fen.

    The renminbi is the monetary unit of China's Banking System with effect from June 1969. Before this date was called Jen Min Piao, Yuan of the people, that Mao Tse Tung in 1948 he circulated in the regions occupied by his armies. In April 1949, the People's Bank fixed the course of 600 Jen Min Piao per U.S. dollar. This equality was review monthly and soon the new Chinese currency is devalued against the dollar, the price not official quoted in 1950 surpassed the 47,000 Jen Min Piao. In 1955 there was a change of currency was issued and the new Jen Min Piao against 10,000 old tickets. The course with the dollar was fixed at 2.46 new Jen Min Piao. The inflation erodes this course against the dollar, which in 1969 resulted not officially increased by nearly 20 times that of 1955. In 1969 it was decided to give a new name to the coin. It was so the renminbi , always divided like the old Jen Min Piao Tsjao in 10 and 100 Fung. It was also retained the old course of the dollar. The term Yuan is still alive and is still represented by the renminbi. Since 1969 the international currency crisis and with the energy crisis, this course presented some of the Chinese currency appreciation, which later has evaporated. At the end of the 80s the dollar was quoted at not officially 11 renminbi, against 2.04 of a official established on February 20, 1973. In December 1971, after the events of the dollar Beijing declared that the Chinese currency would have the U.S. dollar as reference currency of Hong Kong and the pound sterling. From 1973, he was again made ??reference to the U.S. dollar. The economic apparatus so-called "democratic centralism", connected with the apparatus of exchange control, did not allow the Chinese currency to take an important role in the context of international trade and financial transactions. With the reforms of 1978 for the Socialist Market Economy was created, for a brief period, a dual system currency. It allowed the use of the renminbi only for domestic transactions and foreign exchange certificates provided for foreign transactions. Until 2005, the Renminbi has been anchored to the dollar but after has been anchored to international currencies basket. Since 1950 have been issued several series of coins and today is the fourth series.

    Editor: avf, Giovanni AVERSA

  • Replicating portfolio

    It is a planned portfolio with the same properties (i.e. cash flows) of the target asset/portfolio at maturity or in continuous time.


    A repurchase agreement (repo) is the sale of securities (usually government debt or other liquid and safe asset) tied to an agreement to buy the securities back later. A reverse-repo is the purchase of a security tied to an agreement to sell back later.

    These agreements can be viewed as loans secured against the security. The effective interest rate is called the repo rate.

    Which transactions are called repos and which are called reverse repos varies between markets. The transaction may be looked at from the point of view of a dealer dealing with a customer or vice verse. What is called a repo in one country may be called a reverse repo in another country.

    Generally, whether an agreement is called a repo or reverse repo depends on which party initiates the transaction. In the UK, a repo between a dealer and the Bank of England or between a dealer and an individual investor is looked at from the dealers' perspective. If a retail investor buys securities from a dealer, the transaction is termed a repo as the dealer sells the security with the agreement to buy it back. Similarly the purchase by a dealer from the central bank it is called a reverse repo.

    A central bank's repo rate is an important instrument of monetary policy, as the central bank is the lender of last resort. The repo rate in the UK is set by the MPC (Monetary Policy Committee of the Bank of England).

    Source: http://moneyterms.co.uk/repo/

    The repo is a relevant transaction in the so called SHADOW BANKING system and is present in large portfolios of non financial investors (INTERNATIONAL CASH POOL - ICP).


    Technical Analysis. A level of prices at which the selling pressure increases enough to halt an upward movement in prices. It can be static or dynamic. In the latter case, it is represented by a trend line. The term breakout indicates the moment in which the level of resistance is penetrated, and it is generally accompanied by an increase in trade volume. See also support level.
    Editors: Antonio SERRA, Liliana PINTUS, Bianca GIANNINI
    © 2010 ASSONEB


    Investors who are not professional investors, primarily private individuals.

    ©2012 Editor: House of Lords

  • RING

    Location on the floor of an exchange where trades are executed. The circular arrangement where traders can make bid and offer prics is also called a pit, in particular when commodities are traded.

    Source: dictionary of finance and investment terms, 1998.


  • RISK

    Risk is a subjective situation where objective uncertainty becomes effective. Risk can be measured in a probabilistic manner or in terms of frequency. The probabilistic manner to measure risk depends on the probability assigned to a certain number of future events, whereas frequency is associated with the number of possible cases divided by the total number of future events.
    From an economic point of view, risk can take on diverse forms: the risk of bankruptcy, exchange, maturity, country, systematic and non-systematic risk. Each of these categories of risk has its own specific field of application. Risk is also associated with risk aversion through the expected utility theory. Risk aversion is a subjective situation which agents in the market face each time they have to choose between alternatives: one is certain and the other is uncertain. Depending on risk aversion, individuals choose one of the two alternatives by analysing the utility associated with it. Moreover, each agent’s attitude towards risk defines a value where he/she is indifferent between the two. This value is called the certainty equivalent. It is the lowest value that will compensate an individual for participating in a venture with uncertain outcome.
    After defining the aversion/propensity risk situation and the certain equivalent, it is possible to define another risk measure used in the economic analysis: risk premium. Risk premium is the extra-value requested by individuals with different levels of risk aversion, to face an uncertain event instead of a certain one. This value can be estimated through theoretical models such as CAPM.
    Risk premium can also be used to define excess return. Excess return is the difference between the expected return of a risky investment and a risk-free investment. It depends on non-diversifiable risk measured by in the CAPM model, and the market risk premium.
    isk aversion defines how individuals request extra-return to compensate for the higher level of uncertainty. This is crucial in defining the risk aversion of each individual. Moreover, each investment must be assessed by using the return-risk valuation in order to be considered worthy with respect to the other investment. Each expected return can be assessed by using the risk-free rate and the extra-return (risk premium) used to compensate the higher level of uncertainty. We can distinguish between two fundamental risk components:
    systematic risk;
    - specific risk.
    Systematic risk, also known as non-diversifiable risk, is related to the exogenous situation non-directly related to the specific asset (in the CAPM model, this risk is measured by ). This is the reason why stocks show co-movements in the trend. This is common in the market and is called market uncertainty. It is not related in any way to any particular stock or portfolio.
    Specific risk is directly related to the characteristics of a specific investment. It can be reduced by the diversification process of financial assets when creating portfolios (see CML, and SML). It can be measured by using a variability index such as the average square root.
    Risk is also taken into consideration when speaking of the premium puzzle. This phenomenon is hard to resolve from an economic perspective. Why did the US stock market have such a higher return (8% on areal base) for most of the 20th century? This enigma is called equity premium puzzle. Other questions that may arise are of the following kind: "why is the volatility of stock returns higher than the pro-capita consumption growth rate?", or "why is the real interest rate in the real market lower than 1%?".
    Using a rational expectation model, it is difficult to generate an economic system characterised by contained volatility for consumption and high volatility in stock returns, with a low interest rate in real terms. Through the years, economists have tried to understand either why only few investors buy stocks or why individuals with long-term investment strategies hold fixed income assets.
    It is known that financial asset returns in real terms can differ consistently even if they are evaluated in the long run. By using the different intensity of stock return covariance with the standard consumption function, it is possible to theoretically define these differences. If covariance is high, the supply of stocks determines a reduction in the variance of standard consumer consumption flow.
    Saltari, E., 1997, Introduzione all’Economia Finanziaria, NIS (La Nuova Italia Scientifica), Roma;
    Brealey, R. A., Myers, S. C., 2000, Principles of Corporate Finance, Irwin/Mc Graw Hill, New York;
    Sharpe, W. F., 1964, Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk, in Journal of Finance, Vol. 19(3), pp. 425-442;
    Mehra, R., Prescott, E. C., 2003, The Equity Premium in Retrospect, in NBER Working Paper No. W9525, Marzo;
    Mehra, R., Prescott, E. C., 1985, The Equity Premium: A Puzzle, in Journal of Monetary Economics, Vol. 15, pp. 145-161.
    Editor: Rocco CICIRETTI
    © 2009 ASSONEBB


    RARORAC (Risk-adjusted Return on Risk-adjusted Capital) is an indicator measuring efficiency in value creation as a function of risk. It belongs to the category of Risk-adjusted Performance Measures (RAPMs) together with the Return on Risk Adjusted Capital (RORAC) and the Risk-Adjusted Return on Capital (RAROC), among other indicators.

    The RAPM approaches, aim to improve traditional valuation measures for business unit or portfolio profitability by quantifying the risk elements associated to uncertain factors. The terminology used for the definition of this methodological framework is wide and sometimes confusing (Saita, 2007). Frequently, this is just the result of using different names for the same indicator, although occasionally the same indicator is defined and implemented in different forms.

    Generally speaking, the RORAC (Matten, 2000) and the RAROC are halfway measures of the risk profile, correcting for risk only the return or the economic capital, respectively (Wolfgang and Von Wendland, 2009). The former is commonly used to evaluate projects or investments involving a high risk element relative to the capital required. The latter measures risk-based profitability comparing risky financial returns over a range of investment alternatives.

    The RARORAC combines RAROC and RORAC to propose a measure accounting for the risk dimension corresponding in the returns of a business line or on the profitability of investments (typically the RARORAC numerator) and in the economic capital allocated (typically the RARORAC denominator).

    In the context of risk management the RARORAC supports the process of capital allocation among different business lines - or investment alternatives … allowing the achievement of the optimal proportion of equity to assets that minimizes the cost of funding. Similarly, in the context of performance measures it allows the evaluation of each project value (and therefore the comparison of mutually exclusive investment decisions) or the performance of each business line relative to the overall risk contribution and to the target performance to be reached. Therefore, this ratio is very useful as it offers a unified tool to compare any transaction to each other, on the same basis.

    The formula used for the RARORAC calculation is the following:

    In the numerator:

    (rprf) is the excess return given by the difference between the portfolio return and the risk-free return;

    ?P is the systematic risk;

    rm is the market return;

    I0 is the initial project investment at time t = 0, e.g., the Utilized Capital at Risk.

    Notice also that rp= CF/I0-1, where CF is the expected cash flow at time t = 1 of the specific project.

    For what concerns the denominator, the Economic Capital or Allocated Capital at Risk is normally calculated using - and referred to as - the Value at Risk (VaR). VaR represents another relevant measure in the context of investment projects evaluation. It became popular soon after the Basel Committee on Banking Supervision began requiring credit institutions to apply adjustments to performance measures by considering the risk underlying the amount of capital allocated for the business activity.1

    Specifically, the VaR (Jorion, 2007) is represented by the maximal expected loss (tail loss or ETL) for the line of business or portfolio. In the context of a bank, for example, by representing the unanticipated losses occurring in extreme situations or market conditions, VaR is the buffer required, above the average loss, for the credit institution to remain solvent in the case of extreme losses. This absolute measure of risk is calculated relatively to i) a defined time horizon; ii) a specific confidence interval consistent with the bank credit-rating target which assures the on-going survival of the business; iii) and a probability distribution for losses, generally obtained by Monte-Carlo simulations.

    By construction the RARORAC increases as the value creation raises and decreases as assumed risk goes up. The risk dimension involves considerations on market risk, credit risk, operational risk within a unique comprehensive indicator. Hence, RARORAC “rewards” those enterprises operating prudent management and risk differentiation of their business, while it “penalizes” those showing a low asset quality due to the use of the leverage effect on returns in high-risk activities, or adverse selection situations.

    Traditional accounting measures such as the Return on Investment (ROI) and the Return on Equity (ROE) calculating firms’ profitability and evaluating competing investment options present the shortfall of neglecting the overall risk connected with underlying projects or business activity. However, the omission of business risks, such as social, political, regulatory, reputational, environmental, and other “intangible” risks may translate in erroneous decisions. This lack in traditional performance measures has called therefore for the implementation of alternative indicators also in the light of the recent financial crisis where many financial and non financial intermediaries actually underestimated the risk they were running, especially in complex structured products or projects.

    In this respect RAPMs measures represent a step forward in overcoming this limitation. Although organizations have been slow to adapt their risk measurement systems and to incorporate these “advanced” RAPM frameworks (mostly given to the lack of data on political, social, and other “intangible” hazards) the RARORAC is today widely used, especially for the evaluation of complex portfolios or operations. Indeed, it incorporates the benefits of portfolio diversification, and can be defined therefore as an approach which is consistent with the Markowitz Portfolio Theory (1952, 1959).

    As other RAPM measures, the RARORAC evaluation has been recently attracting more and more attention becoming an important indicator especially in the field of corporate finance and in the broader context of investment decisions. On the one side its relevance has grown as a result of the Basel Committee on Banking Supervision regulation, given its use of the Basel II capital adequacy guidelines. On the other hand, creditors have begun requiring a proper risk management process to ensure debt financing at a fair cost.

    Other RAPM frameworks based on returns which are worth to be mentioned are the following:

    i) The Sharpe Ratio (Sharpe, 1966, 1975, 1994);

    ii) The Treynor Ratio (Treynor, 1965);

    iii) The Jensen’s Alpha (Jensen, 1967).

    The former indicator can be interpreted as the risk premium for taking one unit of overall risk. It puts in a relation of proportionality the excess return and the overall risk, represented as the portfolio volatility, ?, which expresses both systematic and unsystematic risk. For this aspect, compared to the measures which follow, the Sharpe ratio presents the advantage that undiversified portfolios can be compared. Though, given that portfolios are normally well diversified this advantage is not actually relevant:

    Also, the standard deviation is claimed, sometimes, not to be a good measure of risk, given that it accounts not only for downward movements (losses), but also for upward ones (gains).

    The Treynor ratio substitutes ? with the ? factor, being equal to the ratio ?m,p/?m2 (where ?m,p is the covariance between market and portfolio returns, while ?m2 is the variance of the market return). In addition to still accounting for both directions movement (downward and upward) this measure is subject to the critique that only systematic risk is accounted for, meaning that portfolios comparison is generally not allowed:

    In opposition to these first two measures which are relative, the Jensen’s Alpha is an absolute performance indicator. It assumes that profits can be gained out of a situation of market disequilibrium. J? can be expressed as:

    Where (rp-rf) can be seen as the realized excess return and ?p(rm-rf) as the theoretical (e.g., based on a factor model) or expected one.

    Summarizing, while the Sharpe Ratio and the Treynor one standardize the excess return with some measures of risk, the Jensen’s Alpha also takes into account market risk in its calculation. In this regard, the latter indicator resembles the RARORAC measure.

    Overall, these three measures normally generate as outcomes dimensionless figures which make difficult the overall risk control and management (Rachev et al., 2007). Also, the Treynor and the Jensen’s Alpha have been developed based on the market line of the Capital Asset Pricing Model or CAPM (Sharpe, 1964), and for this reason are subject to the same criticisms of the CAPM.

    Comparing RAPMs with other similar performance indicators, such as the Net Present Value (NPV) which is based on the Discounted Cash Flows method (DCF), it can be noticed that whereas the NPV accounts for the systematic risk of a project or investment decision, RAPM indicators include the evaluation of both systematic and unsystematic risk. However, it has been claimed that while the traditional NPV calculation ensures the maximization of the shareholder’s value, the adoption of the RARORAC indicator does not, given that it maximises the excess return “conditional on an overall risk limit”. By using the Monte Carlo simulation technique Lampenius (2012) investigates whether the criterion for selecting alternative investment opportunities is consistent between RAPM-based approach and NPV calculations. He concludes that results from the two approaches are often inconsistent, producing different project rankings. Indeed, NPV cannot be substituted with the RARORAC framework in evaluating investment decisions. Also, he states that the definition of the RAPM-based denominator (VaR) produces significant differences in terms of maximization of shareholder’s value. Specifically, the existing literature distinguishes between two ways of calculating the VaR, which is either defined as the maximum expected loss relative to the expected value of the risky position or relative to the I0. The first formulation is found to systematically outperform the latter one. As a result, the RARORAC which is based on the use of the first VaR calculation should be preferred whenever the aim is that of maximising shareholder’s value.

    It should be said that for credit and financial institutions the RARORAC indicator is of great use given its ability to reduce the debt cost translating it into higher shareholder’s value. In this perspective, RARORAC should be seen as an efficient risk management tool. Additionally, by using this measure rather than traditional profit and loss calculations enables to award managers oriented towards risk minimization, a precautionary behaviour which is more consistent with long term decision-making than with a short term view which normally favours risky profits.
    1Find more on the Basel Banking Supervision regulations at:http://www.bis.org/bcbs/index.htm


    Lampenius, N. (2012). Journal of Risk N. 15/2, pp. 77-101.
    Jensen, M. C. (1967). The performance of mutual funds in the period 1945-1964. The Journal of Finance, 23(2), 389-416.
    Jorion, P. (2007). Financial risk manager handbook (4 ed.). Hoboken, New York: John Wiley & Sons, Inc.
    Markowitz, H.M. (1952). Portfolio Selection. The Journal of Finance 7 (1): 77…91.Markowitz, H.M. (1959). Portfolio Selection: Efficient Diversification of Investments. New York: John Wiley & Sons.
    Matten, C. (2000). Managing bank capital: Capital allocation and performance measurement (2 ed.). New York: John Wiley & Sons, Ltd.
    Rachev, S., Prokopczuk, M., Schindlmayr, G. and Trueck, S. (2007). Quantifying Risk in the ElectricityBusiness: A RAROC-based Approach. Energy Economics, Vol. 29, No. 5, 2007.
    Saita, F. (2007). Value at Risk and Bank Capital Management. Risk Adjusted Performances, Capital Management, and Capital Allocation Decision Making. Academic Press Advances Financial Series, 2007, Elsevier Inc.

    Sharpe, W.F., (1964). Capital Asset Prices: a Theory of Market Equilibrium Under Conditions of Risk. Journal of Finance 19(3), 425-442;

    Sharpe, W. F. (1966). Mutual fund performance. Journal of Business, 39, 119-138.
    Sharpe, W. F. (1975). Adjusting for risk in portfolio performance measurement. Journal of Portfolio Management, 29-34.
    Sharpe, W. F. (1994). The Sharpe ratio. Journal of Portfolio Management, 49-58.
    Treynor, J. (1965). How to rate management of investment funds. Harvard Business Review, 63-75.
    Wolfgang S., M. Von Wendland (2009). Pricing, Risk, and Performance Measurement in Practice: The Building Block Approach to Modeling Instruments and Portfolios. Elsevier Science Publishing Co Inc. Academic Press Inc , 2009.

    Editor: Melania MICHETTI

  • Risk-neutral measure or Equivalent martingale measure

    It is the value of the probability distribution of future payoff. It’s used in asset pricing by fundamental paradigm that in a complete market a derivative's price is the discounted expected value of the future payoff under the unique risk-neutral measure.


    Risk-weighted assets (RWA) represents an aggregated measure of different risk factors affecting the evaluation of financial products. All the risk components are considered together to “correct” the nominal value of financial assets. In this way, a proper measure of the extent to which the underlying risk is increasing or decreasing the accounting value of financial assets is generated. This assessment attributes a high weight-coefficient to high-risk financial assets, and a low-weight coefficient to low-risk ones. For example, let’s consider two financial assets with the same nominal value:

    - a corporate bond with a medium/long-term duration of a company presenting negative losses during the last three years, and a BBB rating;
    - a sovereign bond with a short-term duration of a country presenting a low systemic risk, and a AAA rating.

    Hence, the first financial asset will produce higher RWA compared to the second one.

    As the Basel Committee points out, RWA play a very important role in the banking sector, helping banks monitoring their efforts in achieving capital adequacy goals (see Basel I1, Basel II2, Basel III3). RWA quantification affects the amount of capital the bank will have to retain to be compliant with the imposed capital adequacy requirements. This amount, which cannot be invested in risky projects, will be indeed a non-interest bearing money-sum. In light of this, banks have arranged internally RWA monitoring and reduction strategies to contain risk, e.g., to minimize expenses on otherwise greater capital provisions. These strategies, which mainly focus on the improvement of asset quality, imply the choice of those counterparties showing the lowest risk profile for a given level of return on investments.

    Major risk components of the RWA calculation are Credit risk, Market risk, and Operational risk.4 Assets, weighted by these components and taken altogether, represent the RWA.

    Assuming a lender and a borrower, Credit risk can be seen as the borrower-default risk (counterparty risk), taking place when the he is no longer solvent, i.e., when he is not able to return money back. This risk could relate to the interest rate-quota of the loan, to the capital-quota, or both. Credit risk generates from every financial transaction and weighs on the lender, whatever the technical form of the loan is (e.g., a mortgage loan granted to buy a house, a credit card, a personal loan, or a credit line provided to a company to finance its productive activity).

    Other two risks can be included into the broader category of credit risk. The first refers to the risk that the borrower delays his payments related to both interest and capital quotas (i.e., Past-due credit risk). The second, refers to the so called Country risk, applying when the borrower operates in a country with a high systemic risk. In this case, the lender may suffer from foreign currency problems.

    Generally, the lender implements actions to reduce credit risk. For example, he may want to incorporate the risk directly into the transaction price (risk-based pricing) which consequently increases to account for borrower’s probability of default. Similarly, he can also ask for transaction collaterals, or he can eventually buy an insurance policy to protect himself from the credit risk (credit default derivatives). Despite all these possibilities, if the lender evaluates that he is not sufficiently covered against credit risk, then negative effects on lending activity could arise, such as credit crunch effects, resulting in either the provision of a smaller amount of money to the borrower vis-à-vis the required amount, or the request for a higher collateral.

    Market risk is represented by the probability that the value of a financial asset, traded on a sufficiently liquid marked, changes due to not predictable market factors. These factors can be linked to the uncertainty connected to some financial indicators such as the interest rates (e.g. Euribor and Libor), the spread between risky and risk-free government bonds, exchange rates, and real indicators like inflation or unemployment rates. Typically, risk market evaluation aims to quantify the unexpected loss for a financial asset, by using ad hoc models (e.g., Value at Risk models). These models quantify the maximum potential loss, to which a confidence interval applies, that can be generated by the above-mentioned market factors during a specific time horizon.

    The Basel Committee defines Operational risk as “the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events”.5 In other words, it represents the probability that the value of a financial asset is influenced by unpredictable factors, resulting from running the bank activity. Bank employees can incur into calculation errors, or into procedural blocks that could temporarily prevent the correct execution of financial transactions (business disruption & systems failures, execution, delivery & process management mistakes). On the other hand, they can face internal and external fraud problems or robberies causing a loss in financial resources. Other risks belonging to this category involve all legal issues (clients, products, & business practice), as well as the loss of physical goods underlying any transaction (damage to physical assets).

    Like market risk, a proper evaluation of operational risk is provided by advanced statistical models. Among others, the AMA - Advanced Measurement Approaches6 - is perhaps the most diffused model type and bases on the modelling of all the events from which operational risks derive. This is done by first collecting frequency data and by considering variables with a predictive power in terms of future incident occurrence. The final aim is that of evaluating the size of operational risks to be included into the RWA calculation, and mitigate therefore the risk as much as possible.
    4However, in the RWA regulation also other minor risk components are contemplated: in particular, also RWA generated by securitization exposure risks have to be considered, and other less relevant types of RWA. For a more complete detail of different risk types to consider into the RWA calculation, see Basel III official regulation and FAQs. http://www.bis.org/bcbs/qis/qiscompfaq.pdf

    Editor: Melania MICHETTI

  • ROME CONVENTION (Encyclopedia)


    General principles

    The Rome Convention of 1980 on the law applicable to contractual obligations (Convention) is a private international law convention which entered into force for Italy on 1 April 1991, pursuant to ratification through Law No. 975 of 18 December 1984. It applies in all EU Member States1.
    Following the entering into force of Regulation (EC) 593/20082, also known as "Rome I", the Convention will not apply within the European Union to contracts entered into from 17 December 20093, as they will be ruled according to the new Regulation. The law applicable to extra-contractual obligations has already been regulated since 11 January 2009 by Regulation (EC) 864/20074, also known as "Rome II".
    The Convention applies to contractual obligations concerning a conflict of law situation, thus not involving more than one legal system. Matters listed in paragraphs 1 and 2 of Article 1 are excluded by its application5. It is to be noted that Article 57 of Law No. 218/1995, regulating Italian private international law, refers contractual obligations to the Convention. This has lead scholars to conclude that even the matters excluded by Article 1 of the Convention follow its rules for the identification of the applicable law6.
    The convention is universal (Article 2), as it applies even when the law identified according to its principle is not the law of a contracting state. In case of incompatibility with EU legislation, the latter prevails (Article 20).

    Main provisions of the Convention

    Choice of law

    The fundamental principle of the Convention is the freedom to choose the applicable law, as established by Article 3. This is an absolute freedom, as it is possible to choose also a law completely unrelated to the parties and to the contract. Scholars wonder whether it is possible to choose a system of non-legislative rules - such as the Unidroit principles - or uniform law conventions … such as the Wien Convention … independently from the implementing national legal systems.
    Still according to Article 3 of the Convention, the choice of law can be tacit, as long as it is "[…] demonstrated with reasonable certainty by the terms of the contract or the circumstances of the case." As this formulation is quite generic, the possibility to obtain different results in different countries has developed, with a tendency … generally criticised by scholars … to identify the applicable law with the one of the jurisdiction. Negative choices, where parties - while not choosing a law - directly or indirectly exclude a law, are considered admissible7.
    Parties can also modify their choice of law, with the only limit that the new choice cannot lead to invalidity of the contract or to prejudice against the rights of third parties.
    It is also allowed to apply the so-called depeçage, i.e. the application of different laws to different parts of the contract, which can allow to better respond to the juridical needs of the parties and can simplify contractual negotiations, where often each party exerts the application of its own legal system (Article 3, paragraph 1).
    In a system so clearly characterised by the principle of free choice of law, the only limitation of this principle derives from Article 3, where it is established that where all other elements relevant to the situation at the time of the choice are connected with one country only, the mandatory law of said country cannot be derogated8.

    Applicable law when no choice is exercised

    When the parties have not explicitly chosen a law and no implied choice can be identified, the subsidiary principle of Article 4, referring to the country with which the contract is most closely connected, will apply first. A number of presumptions are provided:
    (i) In general, the closest connection is presumed to exist with the country where the party which has to perform the characteristic obligation of the contract has its habitual residence or central administration;
    (ii) For contracts concerning rights in immovable property, the closet connection is presumed to exist with the country where the property is located;
    (iii) For freight transport contracts, the closest connection is presumed to exist with the country where the carrier had its principle place of business at the time when the contract was entered into, but only if this is also the place of loading or discharge or the principal place of business of the consignor.
    As for the presumption under (i), it is clearly decisive to identify the characteristic obligation. The Giuliano and Lagarde Report on the Convention9 clarifies, on this issue, that in contracts with reciprocal obligations the characteristic obligation is the non-monetary one10.
    The discipline of presumptions is completed by the last paragraph of Article 4, according to which the main presumption is not applied when it is not possible to identify a characteristic obligation, while the other presumptions are not applied when "it appears from the circumstances as a whole" that a closer connection exists with a country different from the one resulting from the application of the presumptions, which are therefore not absolute.
    Articles 5 and 6 establish specific rules on the identification of the applicable law, when no choice has been made, for consumer contracts and individual employment contracts.

    Specific cases

    Specific cases concern:

    - Incapacity proceedings concerning contracts entered into between persons who are in the same country (Article 11);
    - Voluntary assignment (Article 12);
    - Subrogation (Article 13);
    - Burden of proof (Article 14).

    Law applicable to the validity of the contract and to the form

    Article 8, paragraph 1 establishes that, for the existence and validity of the contract, the governing law is the one that would govern the contract or clause if it were valid. However, according to paragraph two, the party who intends to demonstrate that it did not consent can rely upon the law of the country where it has its habitual residence, if it appears from the circumstances that it would not be reasonable to determine the effects of its conduct according to the law resulting from paragraph 1.
    As for the form of the contract, Article 9 establishes several rules based on the principle of the favor negotii, according to which the contract is valid if it complies with the requirements of at least one of the laws alternatively applicable.

    Scope of applicable law

    The law identified according to the above principles rules on (Article 10): interpretation of the contract, execution of its obligations, consequences of total or partial breach, extinction of the obligations, prescriptions and limitations of actions, and consequences of nullity of the contract. Manner of performance and measures for the case of incorrect execution are ruled by the law of the country in which the performance takes place.


    Interpretation of the Convention is ruled by Article 18, according to which the internationality of its provisions and the opportunity of a uniform interpretation are to be considered. While this is normal in international conventions, it is important the specific possibility, established with the Brussels protocols of 19 December 1988 (applicable since 1 August 2004) to revert to the European Court of Justice for interpretation of the Convention11.

    The "Rome I" Regulation … main differences with the Convention

    Following the introduction in Article 65 of the Treaty of Rome, as modified by the Treaty of Amsterdam, of the principle of judicial cooperation, EU law has incorporated various provisions of private international and judicial law, beginning with the substitution of the 1968 Brussels Convention with Regulation (EC) 44/2001. Regulation (CE) 593/2008 ("Rome I", Regulation), which substituted the Convention with regards to contractual obligations and Regulation 864/2007 ("Rome II") on non-contractual obligations, completed the process.
    As already mentioned, the Regulation will apply to contracts entered into from 17 December 2009. This section is focused on the main differences with the Convention.

    Applicable law

    The rules concerning the governing law are relevantly changed by the Regulation. Instead of a general principle concerning the closest connection, supported by some presumptions and specific cases, the Regulation contemplates:
    - specific rules for various kinds of contracts in Article 4, paragraph 112;
    - that when the above principles do not apply, the principle of the habitual residence of the party shall render the characteristic performance;
    - that the principle of the law of the country with which the contract has the closest connection is just residual.
    Articles 5 to 8 provide for specific rules on transport contracts, consumer contracts, insurance contracts and individual employment contracts, based on the protection of the weaker party, with some limitation to the general principle of the freedom of choice.

    The concept of overriding mandatory provisions

    As mentioned, the Convention provides for the application of the mandatory provisions of the country where all other elements relevant to the situation at the time would lead to, had the parties not chosen a different law. The Regulation limits the application of mandatory provisions only to those necessary to safeguarding its public interests (Article 9). Two additional requirements are also necessary for the application of the mandatory provisions of another country: the contract shall be performed in that country and in case of violation of these rules, the contract must be illegal. Thus, application of the principles in the Regulation is more precise and narrow than in the Convention.
    1In Germany, the rules of the Convention apply through their incorporation in a domestic law substantially identical to the Convention within the EGBGB (Einführungsgesetz zum Bürgerlichen Gesetzbuch).
    2Official Journal of the European Union, L 177/6 of 4 July 2008.
    3As per its Article 24, the Regulation substitutes the Convention in the Member States, except for the territories of the Member States which are under the territorial scope of the Convention and to which the Regulation is not applicable by virtue of article 299 of the Treaty of Rome.
    4O.J.E.U. L 199/40 of 31 July 2007.
    5The matters excluded are:
    (a) questions involving the status or legal capacity of natural persons, without prejudice to Article 11;
    (b) contractual obligations relating to wills and succession, rights in property arising out of a matrimonial relationship, rights and duties arising out of a family relationship, parentage, marriage or affinity, including maintenance obligations in respect of children who are not legitimate;
    (c) obligations arising under bills of exchange, cheques and promissory notes and other negotiable instruments to the extent that the obligations under such other negotiable instruments arise out of their negotiable character;
    (d) arbitration agreements and agreements on the choice of court;
    (e) questions governed by the law of companies and other bodies corporate or unincorporate such as the creation - by registration or otherwise - legal capacity, internal organization or winding up of companies and other bodies corporate or unincorporate and the personal liability of officers and members as such for the obligations of the company or body;
    (f) the question whether an agent is able to bind a principal, or an organ to bind a company or body corporate or unincorporate, to a third party;
    (g) the constitution of trusts and the relationship between settlors, trustees and beneficiaries;
    (h) evidence and procedure, without prejudice to Article 14.
    6The effective application of this rule is limited by the fact that it does not apply where the matter excluded by Article 1 of the Convention is ruled by other provisions of Law No. 218/1995, by special laws or by other international conventions ratified by Italy.
    7The issue of how to identify the applicable law, once the excluded law is identified, remains open.
    8Because of the uncertainty that the rule can cause on contractual law, the United Kingdom, Luxemburg, Germany, Ireland and Portugal have expressed a reserve on Article 7, paragraph 1, as allowed by Article 22 of the Convention.
    9O.J.E.U., C 282 of 31 October 1980.
    10This rule, apparently clear, can be difficult to apply, for instance, in the case of franchising, which has in fact been specifically regulated in Article 4, paragraph 1, letter e), of the Regulation.
    11The interpretation by the European Court of Justice can be requested by the supreme jurisdictions of the Member States (in Italy Corte di Cassazione and Consiglio di Stato) and by other jurisdictions ruling on appeal.
    12More specifically:
    “(a) a contract for the sale of goods shall be governed by the law of the country where the seller has his/her habitual residence;
    (b) a contract for the provision of services shall be governed by the law of the country where the service provider has his/her habitual residence;
    (c) a contract relating to a right in rem in immovable property or to a tenancy of immovable property shall be governed by the law of the country where the property is situated;
    (d) notwithstanding point (c), a tenancy of immovable property concluded for temporary private use for a period of no more than six consecutive months shall be governed by the law of the country where the landlord has his/her habitual residence, provided that the tenant is a natural person and has his/her habitual residence in the same country;
    (e) a franchise contract shall be governed by the law of the country where the franchisee has his/her habitual residence;
    (f) a distribution contract shall be governed by the law of the country where the distributor has his/her habitual residence;
    (g) a contract for the sale of goods by auction shall be governed by the law of the country where the auction takes place, if such a place can be determined;
    (h) a contract concluded within a multilateral system which brings together or facilitates the bringing together of multiple third-party buying and selling interests in financial instruments, as defined by Article 4(1), point (17) of Directive 2004/39/EC, in accordance with non-discretionary rules and governed by a single law, shall be governed by that law.”

    Editor: Lucio LANUCARA

    © 2009 ASSONEBB

  • ROME TREATY (Encyclopedia)


    The Treaty of Rome (Treaty) was signed in the Italian capital on 25 March 1957 and is the decisive step in the assemblage process of the European Communities. The six signing States (France, Germany, Italy and the Benelux countries) entered the Treaty instituting the European Economic Community 1 and … on the same day … a treaty instituting a European Atomic Energy Community (Euratom). In 1951, they had also established a European Coal and Steel Community (ECSC) with a treaty that expired on 23 July 2002. Euratom remains in force, although its institutions are in common with the European Union.


    After the Second World War, the need was felt to begin an integration process in Europe, in order to prevent new conflicts, particularly between France and Germany, which had been the two main continental opponents in the two world wars. The first result was the institution of the ECSC, through which the strategic activity of the production of coal and steel was put in common under a shared authority and open to access by other States. Thus, with the Treaty signed in Paris on 18 April 1951 by France, Germany, Italy and the Benelux countries, the Member States relinquished part of their sovereignty, although in a single sector. This initiative is to be seen in a context of several projects aiming at a closer European integration2, which led, among others, to the institution of the OEEC in 1948, the Council of Europe in 1949 (and the subsequent adoption of the European Convention of Human Rights), and the OECD in 1960. The process of European integration came to a halt with the failure of the European Defence Community (EDC), as its Treaty did not enter into force due to the opposition of the French Parliament, which was concerned with the rearming of Germany, even within the Community. New impetus for the European integration came from the Messina Conference of June 1955, where foreign affairs ministers of the future six founding states of the European Economic Community revamped the integration project, focusing on market liberalization and common policies, particularly in the fields of transport and atomic energy. In order to develop the project, in 1956 a preparatory committee was entrusted with the drafting of a report on the creation of a European common market. In April 1956 the Committee submitted two drafts, which corresponded to the two options selected by the Member States and which reflected the choice to avoid the issues that had doomed the EDC: (i) the creation of a general common market; and (ii) the creation of an atomic energy community. The two projects led to the signing in Rome of the Treaties establishing the European Economic Community (EEC) and the European Atomic Energy Community (Euratom) in 1957. Member States relinquished part of their sovereignty in the fields interested by the Communities. As for their structures, the three Communities then existing (ECSC, EEC and Euratom) had institutions partially separated: the Court of Justice and the Assembly were common, while the High Authority of the ECSC and the two Commissions of the EEC and of Euratom were separated. Only in 1967, the Council and the Commission became common institutions to the three communities.

    Structure of the Treaty

    The Treaty, as it results from the reforms of the subsequent modifying treaties up to the Nice treaty 3, consists of 314 articles in six separate parts, preceded by a preamble.
    - The first part is devoted to the principles which underline the establishment of the Community, initially based on the common market, the customs union and the common policies. The Treaty on European Union … also known as Maastricht Treaty … and the Treaty of Amsterdam deeply affected this part, by adding fundamental principles, such as monetary union, social equality and between the genders, employment policies, training, subsidiarity and enhanced cooperation.
    - The second part, as modified by the Treaty on European Union, concerns the rights related to the European citizenship.
    - The third part concerns the economic foundations of the Community; it initially comprised four titles devoted respectively to the free movement of goods; agriculture; the free movement of persons, services and capital; and finally transport. In time, with the extension of the competences of the Community, this part has been relevantly enlarged, also by absorbing policies previously regulated elsewhere in the Treaty, particularly with the Single European Act and the Treaties of Maastricht and Amsterdam.4
    - The fourth part is devoted to the association of overseas countries and territories;
    - The fifth part is devoted to the Community institutions, with one title on the institutional provisions and another on the financial provisions. The institutions are currently the European Parliament, the Council, the Commission, the Court of Justice and the Court of First Instance, the Court of Auditor, the European Economic and Social Committee, the Committee of the Regions, and the European Investment Bank.
    - The final part of the Treaty concerns general and final provisions.
    The original Treaty also included various attached documents organised in three parts 5 and which comprised: four annexes relating to certain tariff positions, agricultural products, invisible transactions and overseas countries and territories, a total of twelve protocols and 6 a Convention on the association of the overseas countries and territories were also annexed. These annexes have been relevantly modified in the years.

    Main provisions


    The institutional balance of the Treaty is based on the relationship between the Council 7, the Commission and the European Parliament, all three of which are called upon to work together. The original text provided for clearly distinct roles, with the Commission drafting proposals, the Council approving them and the Parliament playing an advisory role 8. However, in time the role of the Parliament has been greatly enhanced as, coherently with its transformation in a body of elected representatives 9 (instead of representatives designated by the Governments) the legislative procedure of co-decision … which provides for two readings both from the Council and the Parliament … has been first introduced and later expanded 10. The Commission, an independent college of the governments of the Member States, appointed by common agreement, represents the common interest. It has a monopoly on initiating legislation and proposes Community acts. As guardian of the treaties, it monitors the implementation of the treaties and secondary law. In the framework of its mission, the Commission has the executive power to implement Community policies, manage the programs of the Union and manage the budget 11. The Council is made up of representatives of the governments of the Member States and is vested with decision-making powers. It is assisted by the Committee of Permanent Representatives (COREPER), which prepares the Council's work and carries out the tasks conferred on it by the Council. Among the other institutions, the Court of Justice … and the Court of First Instance since 1988 - is particularly important. The Court has a wide range of competences, the most relevant being the reference for a preliminary ruling for the interpretation of the Treaty 12. The Court, often through an extensive interpretation of the Treaty, has played a pivotal role in the European integration process.

    Fundamental goals

    The original Treaty was based on the establishment of a common market, a customs union and common policies. Articles 2 and 3 directly address these three issues. They stated that the Community's primary mission is to create a common market and they specified the measures to be undertaken to achieve this objective. Article 2 specified that "The Community shall have as its task, by establishing a common market and progressively approximating the economic policies of member states, to promote throughout the community a harmonious development of economic activities, a continuous and balanced expansion, an increase in stability, an accelerated raising of the standard of living and closer relations between the states belonging to it". The common market was founded on "four freedoms", namely the free movement of persons, services, goods and capital. It created a single economic area establishing free competition between undertakings. It laid the basis for approximating the conditions governing trade in products and services over and above those already covered by the other treaties (ECSC and Euratom). Article 8 stated that the Common Market was to be established during a transitional period of twelve years, divided into three stages of four years each. Each stage contemplated a set of actions to be initiated and carried through concurrently. Subject to the exceptions and procedures provided for in the Treaty, the expiry of the transitional period constituted the latest date 13 by which all the rules laid down had to enter into force 14. The customs union was implemented by abolishing quotas and customs duties between the Member States. A common external tariff was established substituting the preceding tariffs of the different states. This customs union was accompanied by a common trade policy, managed at Community level and no longer at state level, which differentiated the customs union from a mere free-trade association. The market being based on the principle of free competition, the Treaty prohibited restrictive agreements and state aids (except for the derogations provided for in the Treaty) which can affect trade between Member States and whose objective is to prevent, restrict or distort competition 15. While certain policies are explicitly provided in the Treaty, others may be launched depending on needs, as specified in Article 235 16, according to which: "If action by the Community should prove necessary to attain, in the course of the operation of the common market, one of the objectives of the Community and this Treaty has not provided the necessary powers, the Council shall, acting unanimously on a proposal from the Commission and after consulting the Assembly, take the appropriate measures 17." A European Social Fund was also created, with the aim of improving job opportunities for workers and of raising their standard of living. Finally, a European Investment Bank was set up in order to facilitate the Community's economic expansion by creating new resources 18. As already mentioned, the scope of the Community and the number of policies explicitly regulated in the Treaty have been greatly expanded in time, by including new sectors as well as principles of great social relevance, such as equality and non discrimination, employment and European citizenship. While a full examination of the provisions of the Treaty falls outside the scope of this work, a brief description of the treaties that, in time, have amended it is proposed in order to help understand the general developments.

    Amendments to the Treaty

    The Treaty has been amended by the treaties of accessions for 21 new Member States 19 and by the following other treaties:
    - Treaty of Brussels, known as the "Merger Treaty" (1965)
    It replaced the three Councils of Ministers (EEC, ECSC and Euratom) on the one hand, and the two Commissions (EEC, Euratom) and the High Authority (ECSC) on the other hand, with a single Council and a single Commission. This administrative merger was supplemented by the institution of a single operative budget.
    - Treaty amending Certain Budgetary Provisions (1970)
    It replaced the system of financing the Communities with contributions from Member States with that of own resources. It also put in place a single budget for the Communities.
    - Treaty amending Certain Financial Provisions (1975)
    It gave the European Parliament the right to reject the budget and to grant a discharge to the Commission for the implementation of the budget. It established a single Court of Auditors for the three Communities to monitor their accounts and financial management.

    - Treaty on Greenland (1984)
    It established that the Treaties would no longer apply to Greenland and provided for special relations between the European Community and Greenland, modelled on the rules that apply to overseas territories.
    - Single European Act (1986)
    It was the first major reform of the Treaties. It extended the areas of qualified majority voting in the Council, increased the role of the European Parliament through the cooperation procedure and widened Community powers. It set the objective of achieving the internal market by 1992.
    - Treaty on European Union, known as the "Maastricht Treaty" (1992)
    It brought the three Communities (Euratom, ECSC, EEC) and institutionalized cooperation in the fields of foreign policy, defence, police and justice together under the single framework of the European Union. The EEC was renamed as EC. It also created the economic and monetary union, put in place new Community policies (education, culture) and increased the powers of the European Parliament though an expansion of the codecision procedure.
    - Treaty of Amsterdam (1997)
    It increased the powers of the Union by creating a Community employment policy, transferring to the Communities some of the areas which were previously subject to intergovernmental cooperation in the fields of justice and home affairs, introducing measures aimed at bringing the Union closer to its citizens and enabling closer cooperation between certain Member States (enhanced cooperation). It also extended the codecision procedure and qualified majority voting and renumbered the articles of the Treaties.
    -Treaty of Nice (2001)
    It dealt with the institutional problems linked to enlargement which were not resolved in the Amsterdam Treaty. It dealt with the make-up of the Commission, the weighting of votes in the Council and the extension of the areas of qualified majority voting. It simplified the rules on the use of the enhanced cooperation procedure and made the judicial system more effective.
    - Treaty of Lisbon (2007, in force since December 2009)
    The latest treaty amending the Treaty is the result of difficult developments. In October 2004, a treaty establishing a Constitution for Europe was signed. It was designed to repeal and replace all the existing treaties (with the exception of the Euratom Treaty) with a single text, and consolidate 50 years of European treaties. To enter into force, the Treaty establishing the Constitution had to be ratified by all Member States in accordance with each one's constitutional rules. Following the difficulties in ratifying the Treaty in some Member States, the Heads of State and Government decided, at the European Council meeting on 16 and 17 June 2005, to launch a period of reflection on the future of Europe. At the European Council meeting on 21 and 22 June 2007, European leaders reached a compromise and agreed to convene an intergovernmental conference to draft, instead of a Constitution, a reform treaty for the European Union. The result was the Treaty of Lisbon, which entered into force on 1 December 2009, after ratification by all the 27 Member States, and includes relevant institutional and procedural reforms aimed at conforming the Union to its enlargement to 27 States and preparing it for the current economic and geopolitical challenges.
    1The Community was renamed European Community (EC) with the Treaty of Maastricht, pursuant to the expansion of its competences.
    2Until the end of the Cold War, only Western European countries were concerned.
    3The original Treaty consisted of 240 Articles and an additional 8 Articles of final provisions.
    4This part is now composed of sixteen sections.
    5Nine additional declarations were also annexed.
    6The first one concerned the European investment bank, while the others treated matters regarding a specific Member State or specific products.
    7The Council, as a EC institution and an actor of the legislative process, is not to be mistaken with the European Council, formed by the Heads of State and Government of the Member States and which has a political role, specified in Article 4 of the Maastricht Treaty.
    8A supportive role is also provided for the European Economic and Social Committee.
    9Council Decision 76/787/ECSC, CEE and Euratom
    10See Article 251 of the EC Treaty, introduced by the Maastricht Treaty.
    See Article 211 of the EC Treaty.
    11See Article 211 of the EC Treaty.
    12See Article 234 of the EC Treaty.
    13The Single European Act of 1986 provides for the common market to be established by 31
    December 1992.
    14The overseas countries and territories are also part of the common market and the customs union.
    15Competition law originated in North America. The European model partially differed, both in the assessment of anti-competitive practice and in the regulation of State aids, as the goal of protecting the development of the common market was added to the typically northern American one of consumer protection.
    16This article was later renumbered as 308.
    17This provision has allowed, since the Paris meeting of 1972, the development of policies in the fields of environment protection, regional development and social and industrial matters.
    18The European Social Fund acts based on cooperation between the competent Departments, the European Commission, the Regions and the social parties. In time, other structural funds have been created: the European Regional Development Funds (ERDF), the European Agricultural Guarantee Fund (EAGF), the Financial Instrument for Fisheries Guidance (FIFG).
    The United Kingdom, Denmark and Ireland in 1972, Greece in 1979, Spain and Portugal in 1985, Austria, Finland and Sweden in 1994, Cyprus, Estonia, Hungry, Latvia, Lithuania, Malta, Poland, Czech Republic, Slovakia and Slovenia in 2003, Bulgaria and Romania in 2005. As of 30 January 2010, Croatia, Macedonia and Turkey are candidate Member States.

    Editor: Lucio LANUCARA

    © 2010 ASSONEBB

Selected letter: R English version

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