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S lf R l ti iSelf-Regulation inSecurities Markets
International Trends
J h C W ld B k C lt tJohn Carson – World Bank ConsultantMD, Compliax Consulting Inc.
AMV Americas SRO MeetingB tá C l biBogotá, ColombiaNovember 2008
Agenda
1. International Regulation Models2. Examples of Models
• Strategic positioning of capital market• Division of responsibilities
3. International Trends• Conflicts of Interest
4. Reforming SRO Systems
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International Regulation Models
Model Description ExamplesPublic body performs most or all UK (FSA)
GOVERNMENT MODEL
y pregulation functions. Exchanges perform very limited supervision of their markets.
France (AMF) and EU
LIMITED Exchange performs front line US (NYSE) Chile (SSE)LIMITED EXCHANGE SRO
MODEL
Exchange performs front-line regulation functions for its market
US (NYSE), Chile (SSE)
Hong Kong (HKEx), Sweden (OMX Stockholm), Dubai (DIFX)
STRONG EXCHANGE SRO
MODEL
Exchange performs extensive market and member regulation functions
US (CME), Brazil (BSM)
Japan (TSE), Australia (ASX)
Malaysia (Bursa Malaysia)y ( y )
INDEPENDENT MEMBER SRO
MODEL
SRO that is purely a regulator, not a market operator, performs extensive regulation functions
US (FINRA), Canada (IIROC)
Colombia (AMV)
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Japan (JSDA)*3
Reliance on SROs – continuum
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Reliance on SROs – Models
GOVERNMENT MODEL
LIMITED EXCHANGE SRO MODEL
STRONG EXCHANGE SRO INDEPENDENT SRO
MODELMODEL SRO MODEL MODEL MODEL
• Public authority performs most or all regulation functions
• Exchange performs front-line regulation functions
• Exchange as SRO performs extensive regulation functions
• SRO that is purely a regulator, not a market operatorregulation functions.
Exchanges have very limited role
regulation functions for its market
regulation functions market operator, performs extensive regulation functions
UK
Trend towards this model
Most prevalent model
Trend away from this model
Only developed in a few countries
US (NYSE) US (CME) US (FINRA NFA)• UK
• France
• emerging model in EU
• US (NYSE)• Hong Kong (HKE)• Singapore (SGX)• Sweden (OMX)
• US (CME)• Brazil (BSM)• Japan (TSE)• Malaysia (BM)
• US (FINRA, NFA)
• Canada (IIROC)
• Japan (JSDA)
C l bi (AMV)
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( )• Dubai (DIFX)
y ( )• Australia (ASX)
• Colombia (AMV)
Corporate Governance of SROs
Exchange SROs(Listed model)
Independent SROs
Public Shareholder ownership Private Member organizationPublic, Shareholder ownership
For-profit corporation
SRO functions may have separate or special governance system
Private, Member organization
Non-profit entity
C t b d i l f fi i l St k h ld b d t ti
Ownership & structure
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% or more of directors should be
Compositionof Board
the Exchange and regulated firms 50% or more of directors should be independent of regulated firms
Board Nominating Committee nominates candidates for election by shareholders at AGM
Board Nominating Committee nominates candidates for election by Members at AGMSelection of
Di t shareholders at AGM
Regulator applies fit and proper test
Members at AGM
Regulator applies fit and proper test
Regulator sets principles for governance structure and policies
Regulator reviews effectiveness of
Regulator sets principles for governance structure and policies
Regulator reviews effectiveness ofRegulatoryO
Directors
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Regulator reviews effectiveness of governance periodically
Regulator reviews effectiveness of governance periodically
Oversight
Government Model
Description Pros Cons
Regulation performed by a public authority. Exchanges perform very limited supervision of th i k t
Simple: all regulation centralized in one body with full powers
Reduces confusion of market
Regulator requires greater resources
Regulator may not have capacity to deal with detailedtheir markets.
Examples
UK (FSA)
France (AMF)
Reduces confusion of market participants – one regulator to contact
Efficient: reduces duplication and need to coordinate
capacity to deal with detailed and technical rules governing markets and intermediaries.
Securities industry has reduced input andFrance (AMF) and need to coordinate
activities
Reduces costs to individual participants and the whole market
reduced input and involvement in regulation.
May reduce overall available expertise and resources
market
Public functions are carried out by public body, not a private body.
Government regulator may become too powerful or bureaucratic
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Limited Exchange SRO Model
Description Pros Cons
Exchange performs certain regulatory functions tied to operation of its market
Examples
Based on existing institution and capacity
Exchange as front-line l t i l t it
Potentially serious conflict of interest problems
May deflect Exchange f it d t fExamples
US (NYSE)
Chile (SSE)
Hong Kong (HKEx)
regulator is close to its market and has detailed expertise
Exchange has a business i ti t id d
from its core mandate of business and market development
Less efficient due to d li ti dHong Kong (HKEx)
Sweden (OMX Stockholm)incentive to provide sound regulation
Reduces some of burden on Government regulator
d i t
duplication and coordination
Regulator has less control over detailed regulation or d t d tiand resource requirements day-to-day operations
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Strong Exchange SRO Model
Description Pros Cons
Exchange performs extensive regulatory functions that extend beyond its market operations.
Based on existing institution and capacity
Greater use of industry ti d i
Potentially serious conflict of interest problems
Exchange is not focussed d t fits market operations.
Examples
US (CME)
Brazil (BSM)
expertise and resources in regulating markets and member firms.
Reduces burden on G t l t d
on core mandate of business and market development
Regulatory costs may d E h ’Brazil (BSM)
Malaysia (Bursa Malaysia)
Australia (ASX)
Japan (TSE)
Government regulator and resource requirements
reduce Exchange’s competitiveness
Regulator has less control over regulation issues and
tiJapan (TSE) operations
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Independent SRO Model
Description Pros ConsIndependent SRO that is not a Minimizes conflicts of interest Potentially less efficient pmarket operator performs extensive regulatory functions
Examples
US (FINRA)
between business of Exchange and SRO functions
SRO has clear mission: its only job is to provide effective
l ti
ythan full Government model due to duplication and need for coordination
Regulator has less control US (FINRA)
Canada (IIROC)
Colombia (AMV)
Japan (JSDA)*
regulation
SRO is seen as a neutral and unbiased regulator
Supports business mandate of
gover detailed regulation or day-to-day operations of markets and member firms
Japan (JSDA) Exchange and competition among Exchanges / market operators
Greater use of industry expertise and resources in regulating
k t d b fimarkets and member firms
Reduces burden on Govt. regulator and resource requirements
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Examples of Models 1
UK France AustraliaMajor driver of model of
l ti
Govt. policy to establish one t t t b d
Govt. policy to establish AMF as
t l l t d
Govt. policy to require market
t t fregulation statutory body as a central financial regulator, and eliminate SROs. Exchanges seen as
central regulator and to position Bourse as competitive business. Regulation should
operators to perform SRO responsibilities. Extensive checks and balances adopted to address g
licensed, competitive businesses.
gbe performed by a public body.
pconflicts of interest.
Regulatory Model Government model i l l t
Government model i l l t
Strong Exchange SRO– universal regulator
Exchanges have limited market supervision
– universal regulator
Exchanges have limited market supervision & listing
SRO
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pfunctions.
p gfunctions.
11
Examples of Models 2
US Canada Hong Kong
Major driver of model of regulation
Long-established structure is based on existing exchanges
Industry pushed for consolidation of exchanges and SROs
Government policy to establish Commission as primary regulatorregulation existing exchanges,
FINRA, NFA under SEC / CFTC oversight. Separate legal framework for securities
exchanges and SROs. Independent SROs provide uniform, neutral regulation and foster competition to
as primary regulator, and to establish HKEx as a dynamic business to foster a globally competitive capital
and commodity futures industries.
TSX. Also TSX wants to focus on its business and offload regulation costs..
market. HKEx retains front-line regulation role.
Regulatory Model Independent SRO Independent SRO Limited ExchangeRegulatory Model Independent SROStrong Exchange SRO(CME)Limited Exchange SRO(NYSE N d th )
Independent SRO (IIROC, MFDA)
Limited Exchange SRO (HKEx)
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(NYSE, Nasdaq, others)
12
Examples of Models 3
Brazil Colombia ChileMajor driver of model of
l ti
CVM revised SRO system in 2007 to dd
Financial regulation consolidated in SFC
Securities Markets Act and SVS R l tiregulation address
demutualization. BSM created to provide BM&F Bovespa SRO
SFC.SRO system mandated by law in 2006 to cover all intermediaries
Regulations.
pfunctions.
intermediaries dealing in markets.
Regulatory Model Strong Exchange SRO
Independent SRO Limited Exchange SRO
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Division of Responsibilities
INDEPENDENTSRO
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 toin futures arena. operations related to ASX markets.
Enforcement SROs for SRO rules.SROs can also enforce members’
FSA (Exchanges can enforce their trading
ASX for breaches of ASX rules.
enforce members compliance with securities laws.
enforce their trading rules.)
CSD Regulation Independent CSD(DTCC)
Independent CSDs ASX subsidiary sets rules
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(DTCC)
14
Division of Responsibilities
US UK AustraliaMarket Regulation Exchanges are
primary regulators ofFSA is responsible for market conduct and
ASX sets trading rules. Full marketprimary regulators of
their markets. (FINRA on contract for some.)SEC sets high level anti-fraud rules.
market conduct and surveillance.Exchanges monitor trading on their markets. LSE lists all t f b d
Full market surveillance responsibility for ASX rules + identifying breaches of law.D bt i t t d dSeveral authorities
regulate debt markets.types of bonds..
Debt is not traded on ASX.
Listings SEC regulates offers. Exchanges (mainly
FSA sets listing rules and approves listing.
ASIC regulates offers.ASX sets listingExchanges (mainly
NYSE and Nasdaq) set listing requirements and approve listing. Set some Listing Rules
and approves listing. FSA regulates offers. LSE has minor admission to trading standards.
ASX sets listing requirements and approves listing. Sets Listing Rules.
some Listing Rules. Issuer regulation shared with SEC.
Issuer Disclosure & Governance
Mainly SEC. Exchanges monitor
FSA ASX sets some rules and monitors
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gcompliance with timely disclosure.
compliance with timely disclosure 15
Market Regulation – WFE Trading rules - 97% of 38 exchanges; usually shared with Commission
Real-time and post-trade surveillance - 97% of 36 exchanges; mostly shared with Commission
Enforcement - 83% of 36 exchanges enforce their own trading rules
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Source: WFE Survey of Regulation 2004
Source: WFE Survey of Regulation 2004
Member Conduct of Business – WFE Conduct of Business Rules - 80% of 35 exchanges; mostly shared with Commission
Monitoring - 77% of 35 exchanges; mostly shared with Commission
Enforcement - 81% of 27 exchanges used Fines, 96% of 26 exchanges used Bars & Suspensions
COMPLIAX 17Source: WFE Survey of Regulation 2004
Listing Standards– WFE
79% of 34 exchanges; mostly shared with Commission
Corporate Governance Standards - 69% of 35 exchanges; mostly shared with Commission
Monitoring of compliance - 86% of 36 exchanges; sometimes shared with Commission
.
COMPLIAX 18Source: WFE Survey of Regulation 2004
International Trends in Reliance on Self-Regulation
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Key International Trends
1. Value of self-regulation has increasingly been questioned2. Reduced reliance on SROs (esp. in Europe)3. Exchange SROs’ roles cut back due to conflicts
• Independent SRO units if Exchange retains important role• 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 independent governance and away from Member control
6 SRO t b i t b d t k h ld6. SROs must be responsive to broader stakeholder interests
7. Stronger oversight and direction from statutory regulators
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7. Stronger oversight and direction from statutory regulators
20
International Trends
Why have Exchanges’ SRO roles been cut?R d fli t f i t t i lf l tiReduces conflicts of interest in self-regulationPositions Exchanges to focus on product and market development, and competitivenessdevelopment, and competitiveness• Business focus• Reduced costs
R l ti hi ith ti i t d i i i l t• Relationship with participants and issuers is mainly as customers
Public regulators are often more effective regulators • much broader jurisdiction and powerj p
Public regulators may impose higher and more consistent standards of regulation
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Conflicts of Interest (Exchange SROs)Type of Conflict Description
1. Conflict between Business and Regulation Mandate
Business interest in maximizing revenue often conflicts with duties as a regulator and Regulation Mandate g
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 regulation2. 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 Maintaining high regulatory standards and rules may3. Integrity of Regulation Program
Maintaining high regulatory standards and rules may negatively impact business development and customers
Thoroughness of regulatory programs could be reducedConflicts could result in biased administration of rulesPressure on independence of investigations and enforcementPressure on independence of investigations and enforcement
programMisuse of regulation to stifle competition
4. Ownership and governance conflicts
Regulation of significant owners (e.g. members or listed companies) is difficult
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conflicts p )Directors’ duty to shareholders vs. public duty as a regulator
22
Managing SRO Conflicts of Interest
Separate governing body to oversee regulatory operationsS t i ti l t t f l t dSeparate organizational structures for regulatory and business operationsFirewalls to separate regulatory operations from businessFirewalls to separate regulatory operations from business or advocacy operationsseparate and secure premises for SRO operationsContract out all or part of the SRO’s regulatory responsibilities Establish policies and procedures on managing conflictsEstablish policies and procedures on managing conflicts of interest.
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Exchanges: Managing Conflicts
1. Formal separation of business and regulation units is now best practice
• Separate company with independent governance and management
• Organizational separation with Chinese wallsOrganizational separation with Chinese walls• Independent committees to oversee SRO functions• SRO functions must be non-profit
2. Transfer of regulation responsibilities• Transfer of functions to public regulator or independent SROs
3 Board level Conflicts Committee to oversee conflict management3. Board level Conflicts Committee to oversee conflict management4. Conflict of interest policies to handle specific conflicts (e.g., listings
applications or issues where Exchange has a business conflict)5 S lf li ti S i l d f lf li ti f E h
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5. Self-listing: Special procedures for self-listing of Exchange
SRO Oversight – Overview
REGULATOR SROMOU oversight process
Approves rules Adopts rules
Sets principles for corporate governance
Adopts corporate governance policies and procedures
Review reports Files financial and other reportsp p
Ongoing monitoring and communication
Administers & enforces rules and supervision programs
Inspection of operations Prepares self-assessment of operations
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Oversight examinations of SROs
FULL AUDIT RISK-BASED
R l i tiPreferred model
Regular inspections, tending to review all areas, or the same pre-identified areas, each ti Diff ti ti i
Targeted inspections, focused on higher risk areas. The areas reviewed and scope of review often changes fromtime. Differentiation in
scope is often limited for different areas reviewed.
review often changes from one inspection cycle to the next.
COMPLAINT / EVENT -DRIVEN
Ad hoc inspections to
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Ad hoc inspections to address specific issues. Used in both models.
Reforming SRO Systems
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SRO Reform: Key Policy Issues
1. What are the imperatives for change?P iti i it l k t t b titi• Positioning capital markets to be competitive
• Address Exchanges’ conflicts of interest and core mandate• Need for greater supervision and compliance capacityg p p p y• Unregulated sectors or products
2. Strategy for capital markets development• How should Exchanges and markets be positioned?
3. Public policy on reliance on self-regulation4. Capacity, resources and credibility of potential SROs5. Legal framework
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6. Stakeholders’ views and commitment28
Regulatory Structure Issues
1. Scope of SRO regulation in capital markets
> Division of responsibilities with Regulator
2. Number of SROs• Centralization vs. specialization
3. Types of SROs• Exchanges
• “Independent” SROs
I d t i ti• Industry associations
4. Ownership and Governance structures for SROs
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SRO Consolidation – Benefits
1. More competitive capital market due to a more streamlined regulatory structure g y
2. Simpler system: Investors, members deal with 1 SRO
3. One set of rules for 1) all members and 2) all markets) )
4. Consistent regulatory approach5. Efficiency: no need for coordination among several bodiesy g
6. Central SRO sees full picture of members’ operations and market activity
7. More comprehensive risk-based regulatory approach
8. Reduced potential for split jurisdiction and regulatory gaps
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9. Deeper and broader capacity at SRO
Canadian SRO consolidation
1995 5 SROs in Canada: IDA and 4 stock exchanges• All regulated a number of member investment dealers and markets
1997 TSX transfers member regulation functions to IDA
1999 – 2000 Exchanges restructure• TSX demutualizes• TSX acquires Canada’s venture exchange• TSX acquires Canada s venture exchange• Montreal Bourse (MX) becomes the sole derivatives exchange
2001 TSX spins off market regulation to create RS
2001 MFDA recognized as SRO to regulate mutual fund dealers
2005 MX transfers member regulation functions to IDA
2006 IDA splits SRO and industry association functions2006 IDA splits SRO and industry association functions
2007 IDA and RS merge to create IIROC
2008 TSX acquires MX to create TMX Group
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q p
Thank you
Questions?
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