HKU International MBA Programme Regulation of Securities Markets Andrew Sheng Chairman Securities and Futures Commission Hong Kong 16 July 2002
Global Backdrop • Since Asian financial crisis, there is better understanding of the causes of crisis, the need for financial system resilience, and higher international accounting and regulatory standards. • Regulators need to enhance surveillance, share information on emerging risks and make contingency plans for crisis management. • Regulatory environment is changing rapidly due to globalization, technology, competition and restructuring. P.2
The Changing Financial Landscape • All financial markets are networks - Metcalfe’s Law • On-line trading and globalization enable 7x24 hours markets - contagion can be global • Technology & Globalization changing market structure & nature of competition • Financial regulation needs to encompass changing environment - this means that regulatory policies and processes need to change • How do we build a flexible regulatory structure that responds to such dramatic changes? P.3
Environmental Impact • Technology - regulators need to understand technology & its impact on risks – How to define property rights & risks in online environment? e.g. operational risks post 9.11 • Globalization - jurisdictional lines are blurred, both within domestic markets and cross-border – How do regulators co-operate cross-jurisdictionally along functional and geographic lines? • Competition - intensive competition through innovation & consolidation – Complex financial groups emerging - markets structure changing • Restructuring - As old franchises erode, losses in financial system occur, eg NPLs and intermediary failure – Who bears loss in such transition - investor or state? P.4
Objectives of Financial Regulation • The goal of financial regulation is to influence the behaviour of intermediaries so that the policy objectives are achieved. Regulatory Cycle • Policy Objectives ⇒ Processes ⇒ Policy Outcomes ⇒ Policy Review • Ability to clearly define objectives, lay down effective processes and achieve desired policy outcome critical to credibility of regulator. P.5
Malcolm Sparrow - the Regulatory Craft “Pick important problems, fix them and then tell everybody.” “The essence of the [regulatory] craft lies in picking the right tools for the job, knowing when to use them in combination, and having a system for recognizing when the tools are inadequate so that new ones can be invented.” Professor Malcolm Sparrow, The Regulatory Craft , Harvard University P.6
Regulations as Contracts • Goodhart views laws and regulations as contracts between regulators and regulatees that carry important incentive structures – if badly-designed, moral hazard behaviour increases systemic risk (e.g. open-ended deposit insurance, policy lending directives, market intervention) – if well-designed and enforced, financial managers behave in ways that avoid systemic risk, without unintended side effects • Incentive Structure Key to Market Stability P.7
Regulatory Objectives • IOSCO’s objectives – Protection of investors (+ consumers of financial services) – Ensuring fair, efficient and transparent markets – Reduction of systemic risk • UK FSA’s objectives in Financial Services & Markets Act 2001 – Market confidence – public awareness – the protection of consumers – the reduction of financial crime • SEC - “We are the Investor’s Advocate” • Regulators job is “to make the market work better ” P.8
Four Functions of Capital Markets • Price discovery - are prices reflecting risks? • Resource allocation - is there market distortion? • Risk management - are there products to hedge risks and are intermediaries managing risks well? • Corporate governance - Are markets playing role to improve corporate governance? P.9
Quality of Markets Seven “I’s” of market quality: • information • incentives • issuers • intermediaries • infrastructure • investors • I- the regulator P.10
Information and Markets • Timely and accessible information is a market fundamental • Markets cannot function well without reliable information • Inaccurate, untimely or misleading information undermines fairness, integrity and level playing field • Information important for sound regulation • IAS and good auditing standards important for good information • Bad accounting = bad information = bad risk management = financial crisis • Markets punish brutally when information on financial position is opaque or doubtful • International pressure to strengthen accounting, auditing and disclosure standards P.11
Incentives • If a market manipulator thinks he won’t be caught, he will rob the market blind • What deters manipulation is whether we can catch the perpetrators • Co-operation with other agencies in enforcement field needed to minimise financial misconduct and crime • Incentives must be balanced between risks and rewards; otherwise markets would be distorted by greed without fear of being caught • Pay structures affect competitiveness, innovativeness, ability to attract talent, and risk appetite of staff • Incentives also important for regulators, who tend to be underpaid relative to market, while powers to enforce and coordination between regulators may not be well developed Lawrence Liu: “Asian regulators tend to over-regulate and under-enforce” P.12
Issuers • Quality of market determined by quality of listed companies • Ultimately responsibility for quality rests with management and controlling shareholders • Good companies attract more investors, enhance liquidity of stocks • Liquidity begets liquidity, attracting quality issuers, financial intermediaries and investors in virtuous circle that improves market quality • Quality of companies determined by quality of governance • Good corporate governance is about self-discipline, regulatory discipline and market discipline P.13
Using Different Levels of Discipline • Self Discipline - self regulation, using standards and codes • Regulatory Discipline - can be imposed by SROs or by statutory regulator - with civil or criminal sanctions • Market Discipline - contractual discipline through courts, openess to market competition and clear exit mechanisms • All three disciplines are necessary to achieve good corporate governance and efficient markets Increasing calls for more regulation to strengthen governance of issuers and intermediaries, in order to restore faith of investors in markets P.14
Intermediaries • Perform front-line regulatory work in capital markets – Investment banks advise and underwrite IPOs – Accountants and lawyers ensure due diligence of information disclosure • The higher the quality of intermediaries, the more they can exercise market discipline on issuers and market participants • If quality of intermediaries poor, greater burden falls on securities regulators • Excessive protection of domestic intermediaries and barriers to foreign entry could retard market development • Large complex financial institutions make regulation difficult. Standards, and regulatory cooperation important P.15
Infrastructure • Trading, clearing, settlement and payment processes transact across networks • Quality of infrastructure determines size of operational risks arising from human error, hardware or software failure, or terrorist attacks • Good Infrastructure builds in checks and balances • Infrastructure comprises platforms, processes, legal framework and efficient and fair judiciary that protects property rights or market participants • IOSCO and CPSS stress need for robust systems in managing market risks, post 9.11 • Building robust infrastructure to global standards part and parcel of sectoral and national risk management • Balanced and complete markets, with adequate product choice important for risk management P.16
Investors • Quality of markets depends on quality of investors • Uneducated investors chase rumours and if served by poor quality intermediaries, investors and market lose • Investor education is an important supervisory tool to promote investor protection • Investors need to understand concept of risk and return, know their rights, ask the right questions of their brokers and financial sales persons, and where to verify information • Shareholder activism imposes market discipline • HKeRIC provides essential ABCs of investment, games to test knowledge, and 550 links to over 400 websites around the world P.17
Recommend
More recommend
