Self-Regulatory OrganizationsPrinciples and Issues

Anjali Kumar

World Bank

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Self-Regulatory Organizationsand IOSCO Principles (Sept. 98)

IOSCO Principle 6:Principle 6: “The regulatory regime should make appropriate use of Self-Regulatory Organizations (SROs) that exercise some direct oversight responsibility for their respective areas of competence, to the extent appropriate to the size and complexity of their markets”

IOSCO Principle 7:Principle 7: “SROs should be subject to the oversight of the regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities”

Underlying premises: self interest (to attract capital and investors); competition (among intermediaries)

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Self-Regulatory OrganizationsRecognized benefits…

Potentially valuable complement to regulator: More depth and expertise on market operations /

practices Potentially greater adaptability and flexibility Sometimes higher ethical standards than legal

mandates Greater willingness of members to comply voluntarily Lower direct costs of regulation – cost savings

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Self-Regulatory Organizations…potential limitations

Conflicts of interest due to:– Conflicts between business and market development goals

Examples - listing requirements– Dangers of collusive behavior – tendency to limit

competition and protect members – Access to valuable information about market participants– Responsibility for both market segment regulation and

member supervision – industry interest first and public interest next.

– Avoid confrontations with members which affect business– Costs: may be especially important in emerging markets

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Self-Regulatory OrganizationsThe Regulator should require the SRO to…

Set standards and maintain ongoing scrutiny to ensure interests of public

Ensure adequate enforcement authority Cooperate with regulator on investigations Ensure fair treatment for all members and avoid

uncompetitive rules Maintain confidentiality Regardless of degree of self regulation the regulator

should retain oversight and authority for direct intervention

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Self-Regulatory OrganizationsPreconditions for Success

Accepted preconditions: Strong overall legal and regulatory framework

including enforcement and conflict resolution Appropriate contractual relationship with members

Transparency, accountability, information sharing – public awareness

Debatable preconditions: Size – large but not too large? Externalities of bad

behavior Motivation - Willingness to pay? Industry financing

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Self-Regulatory Organizations Historical Evolution in the USA

Frequently true that self-regulation existed before statutory regulation – major role in US and UK markets – but precedence is not as important as maturity and relative roles

NYSE already over 100 years old when SEC was established in 1934

Consensus regarding need for oversight after market crash of 1929 - yet NYSE was allowed to maintain its own rules

Exchange Act provided that SRO should meet a number of standards (Sections 6(b) and 15A)

But SEC was given an important oversight role A disciplined member of an SRO can appeal to the SEC SEC can enforce rules if SRO is “unable or unwilling” SEC can also bring enforcement actions against SRO itself

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Self-Regulatory OrganizationsApplicability to Emerging Markets

Limitations in competition can imply that SRO model cannot ensure fair and efficient markets

Long term benefits of compliance with rules may conflict with short term costs

Moral Hazard issues Need for parallel development in framework of

accounting etc to ensure transparency Wide difference in approaches taken by various

emerging markets

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Self-Regulatory OrganizationsIn Latin America – themes to discuss

SROs in Latin America may have greater role compared to many emerging markets – eg East Asia

In some cases, formal recognition of SRO may be accompanied by limited role – sometimes due to for-profit nature eg of exchanges

Consequently, role may be substantially promotional or informational, and supportive to regulator

Secrecy provisions and limits to sharing of information Extending the role implies an examination of market conditions –

examine the extent to which preconditions are met – are we ready? Examine also scope for formalizing the role of some trade associations

into SROs