Self-Regulation in Securities Markets International Trends and New Directions after the Financial Crisis John Carson World Bank Consultant MD, Compliax Consulting Inc. ANDIMA / CETIP Sao Paulo, Brazil March 2009 (selected slides only)
Agenda 1. International Trends in Reliance on Self- Regulation 2. Models of SROs 3. Country Examples of SRO Systems 2
Self-Regulation Definition SRO A nongovernmental organization that has the power to create and enforce industry regulations and standards 3
International Trends in Self-Regulation
Key International Trends 1. Value of self-regulation has increasingly been questioned 2. Reduced reliance on SROs (esp. in Europe) 3. Exchange SROs roles cut back due to conflicts Independent SRO units if Exchange retains important role 4. Self-regulation is stronger and more credible in many countries that rely on it. 5. Move to more independent governance and away from Member control 6. SROs must be responsive to broader stakeholder interests 7. Stronger oversight and direction from statutory regulators 5
International Landscape Strong SRO systems Government authority model Medium - strong SRO systems Government authority model Wide range of systems Weak SRO systems Strong SRO systems 6
International Trends: SROs Why are Exchanges SRO roles being reduced? 1. Reduces conflicts of interest in self-regulation. 2. Positions Exchanges to focus on product and market development, and to be more competitive. 3. It fosters competition among markets. 4. Public regulators are often more effective regulators. much broader jurisdiction and power 5. Public regulators may impose higher and more consistent standards of regulation. 7
Reliance on SROs continuum Centralized Government control Strong reliance on Self-Regulation Government model Limited Exchange SRO model Industry Association SRO model Strong Exchange SRO model Independent Member SRO model 8
Reliance on SROs Models GOVERNMENT MODEL LIMITED EXCHANGE SRO MODEL STRONG EXCHANGE SRO MODEL INDEPENDENT MEMBER SRO MODEL Public authority performs most or all regulation functions. Exchanges have very limited role Exchange performs front-line regulation functions for its market Exchange as SRO performs extensive regulation functions SRO that is purely a regulator, not a market operator, performs extensive regulation functions Trend towards this model Most prevalent model Trend away from this model Only developed in a few countries UK France emerging model in EU US (NYSE, ISE) Hong Kong (HKEx) Singapore (SGX) Sweden (OMX) Dubai (DIFX) US (CME) Brazil (BMS) Japan (TSE) Malaysia (BM) Australia (ASX) US (FINRA, NFA) Canada (IIROC) Japan (JSDA) Colombia (AMV) 9
Corporate Governance of SROs Exchange SROs (Listed model) Independent SROs Ownership & structure Public, Shareholder ownership For-profit corporation SRO functions may have separate or special governance system Private, Member organization Non-profit entity Composition of Board Corporate board mainly from financial sector and customer groups Directors elected by shareholders Majority of directors are independent of the Exchange and regulated firms Stakeholder-based representatives of Members and independent directors from financial sector, academia, professional services etc. 50% of directors should be independent of regulated firms Selection of Directors Board Nominating Committee nominates candidates for election by shareholders at AGM Regulator applies fit and proper test Board Nominating Committee nominates candidates for election by Members at AGM Regulator applies fit and proper test Regulatory Oversight Regulator sets principles for governance structure and policies Regulator reviews effectiveness of governance periodically 10
Conflicts of Interest (Exchange SROs) Type of Conflict 1. Conflict between Business and Regulation Mandate Description Business interest in maximizing revenue often conflicts with duties as a regulator Regulation of major customers such as members and listed companies produces tensions between business interests and regulation responsibilities 2. Funding of Regulation Competition for resources between business and regulation needs Desire to drive down costs puts pressure on non-revenue producing areas like regulation 3. Integrity of Regulation Program 4. Ownership and governance conflicts Maintaining high regulatory standards and rules may negatively impact business development and customers Thoroughness of regulatory programs could be reduced Conflicts could result in biased administration of rules Pressure on independence of investigations and enforcement program Misuse of regulation to stifle competition Regulation of significant owners (e.g. members or listed companies) is difficult Directors duty to shareholders vs. public duty as a regulator 11
Managing SRO Conflicts of Interest 1. Separate governing body to oversee regulatory operations 2. Separate organizational structures for regulatory and business operations 3. Firewalls to separate regulatory operations from business or advocacy operations 4. Separate and secure premises for SRO operations 5. Contract out all or part of the SRO s regulatory responsibilities 6. Establish policies and procedures on managing conflicts of interest. 12
Examples of Models 1 UK France Australia Major driver of model of regulation Govt. policy to establish one statutory body as a central financial regulator, and eliminate SROs. Exchanges seen as licensed, competitive businesses. Govt. policy to establish AMF as central regulator and to position Bourse as competitive business. Regulation should be performed by a public body. Govt. policy to require market operators to perform SRO responsibilities. Extensive checks and balances adopted to address conflicts of interest. Regulatory Model Government model universal regulator Exchanges have limited market supervision functions. Government model Exchanges have limited market supervision & listing functions. Strong Exchange SRO (ASX) 13
Examples of Models 2 US Canada Hong Kong Major driver of model of regulation Long-established structure is based on existing exchanges, FINRA, NFA under SEC / CFTC oversight. Separate legal framework for securities and commodity futures industries. Industry pushed for consolidation of exchanges and SROs. Independent SROs provide uniform, neutral regulation and foster competition to TSX. Also TSX wants to focus on its business and offload regulation costs.. Government policy to establish Commission as primary regulator, and to establish HKEx as a dynamic business to foster a globally competitive capital market. HKEx retains front-line regulation role. Regulatory Model Independent SRO (FINRA) Strong Exchange SRO (CME) Limited Exchange SRO (NYSE, Nasdaq, others) Independent SRO (IIROC, MFDA) Limited Exchange SRO (HKEx) 14
Examples of Models 3 Brazil Colombia Chile Major driver of model of regulation CVM revised SRO system in 2007. BSM created to provide BM&F Bovespa SRO functions. Financial regulation consolidated in SFC. SRO system mandated by law in 2006 to cover all intermediaries dealing in markets. Securities Markets Act and SVS Regulations. Regulatory Model Strong Exchange SRO (BM&F Bovespa) Industry Association SRO (ANDIMA, ANBID) CSD / OTC SRO (CETIP) Independent SRO (AMV) Limited Exchange SRO (SSE) 15
Division of Responsibilities INDEPENDENT SRO GOVERNMENT EXCHANGE SRO US UK Australia Member / Intermediary Regulation FINRA is primarily responsible. NFA and Exchanges in futures arena. FSA ASX shares role with ASIC. ASX focus on operations related to ASX markets. Enforcement SROs for SRO rules. SROs can also enforce members compliance with securities laws. FSA (Exchanges can enforce their trading rules.) ASX for breaches of ASX rules. CSD Regulation Independent CSD (DTCC) Independent CSDs ASX subsidiary sets rules 16
Division of Responsibilities US UK Australia Market Regulation Exchanges are primary regulators of their markets. (FINRA on contract for some.) SEC sets high level anti-fraud rules. Several authorities regulate debt markets. FSA is responsible for market conduct and surveillance. Exchanges monitor trading on their markets. LSE lists all types of bonds.. ASX sets trading rules. Full market surveillance responsibility for ASX rules + identifying breaches of law. Debt is not traded on ASX. Listings SEC regulates offers. Exchanges (mainly NYSE and Nasdaq) set listing requirements and approve listing. Set some Listing Rules. Issuer regulation shared with SEC. FSA sets listing rules and approves listing. FSA regulates offers. LSE has minor admission to trading standards. ASIC regulates offers. ASX sets listing requirements and approves listing. Sets Listing Rules. Issuer Disclosure & Governance Mainly SEC. Exchanges monitor compliance with timely disclosure. FSA ASX sets some rules and monitors compliance with timely disclosure 17