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

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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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