Catalog

	Table of Contents
p. 39 of 58 BACK | NEXT Purpose and Structure of the Toolkit Part One: Introduction and Overview Part Two: Preconditions and Infrastructure for Financial Sector Development Part Three: Financial Regulation and Supervision I. Financial Stability, Development and Institutional Design II. Financial Regulation: General Principles III. Financial Regulatory Structure IV. Banking Regulation V. Bank Insolvency and Depositor Protection VI. Securities and Derivatives Regulation A. International Standards B. Guidance and Recommendations VII. Insurance and Pensions Regulation VIII. Regulation of Financial Conglomerates Part Four: Regional Financial Integration Part Five: ADB's Intervention in the Financial Sector Bibliography Glossary and List of Abbreviations Acknowledgements

Financial Sector Legal and Regulatory Toolkit : Part Three: Financial Regulation and Supervision : VI. Securities and Derivatives Regulation

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A. International Standards

1. Objectives and Principles of Securities Regulation
2. Other International Standards
3. Implementation

The leading international standard-setting body in the securities area is the International Organization of Securities Commissions (IOSCO).

Objectives and Principles of Securities Regulation

As part of the G-7/G-10 initiative following the Asian financial crisis, IOSCO was instructed to develop internationally acceptable principles and standards for securities regulation and was able to release such document in September 1998. The Objectives and Principles of Securities Regulation [ PDF ] was further updated and revised, most recently in 2008. The Principles are the key standard in securities regulation and reflect its members' agreement that certain principles form the basis for an effective system of regulation of securities and derivatives markets.

The IOSCO Objectives and Principles sets out three main objectives of securities regulation:

1. the protection of investors;
2. ensuring that markets are fair, efficient, and transparent; and
3. the reduction of systemic risk.

To achieve these objectives, IOSCO has developed principles to be implemented as part of a legal framework for securities and capital markets.

At the outset, the responsibilities of the securities regulator should be clear and objectively stated, with the regulator operationally independent and accountable in the exercise of its functions and powers. The regulator must have adequate powers, proper resources, and the capacity to perform its functions, including staff who are required to observe the highest professional standards, appropriate confidentiality and disclosure of personal interests. In addition, the regulator must adopt clear and consistent regulatory processes in the exercise of its functions. In order to support proper enforcement, the regulator must have comprehensive inspection, investigation, and surveillance powers.

As part of the regulatory regime, appropriate use should be made to the extent appropriate to the size and complexity as the relevant market of self-regulatory organizations (SROs), which might include such institutions as securities exchanges, that would exercise direct oversight responsibility for their respective areas of competence. Any SRO would, however, be subject to the oversight of the regulator to observe standards of fairness and confidentiality when exercising any powers and delegated responsibilities.

Regardless of the division of responsibilities between the regulator and any SROs, the regulatory system should ensure an effective and credible use of inspection, investigation, surveillance, and enforcement powers and implementation of an effective compliance program. As one aspect, clear and appropriate authority and mechanisms need to be established for information-sharing and cooperation with domestic and foreign counterparts.

With regard to market intermediaries, regulation must provide for minimum entry standards, initial and ongoing capital requirements and other prudential requirements (such as those dealing with market risk and off-balance sheet activities). Market intermediaries must also be required to comply with standards for internal organization and operational conduct that aim to protect the interests of clients and under which management of the intermediary accepts primary responsibility for these matters. Appropriate areas include risk management and controls and custody arrangements. In addition, procedures for dealing with the failure of a market intermediary need to be created in order to minimize damage and loss to investors and to contain confidence shocks that might pose a systemic risk to the financial system through contagious panic. More specific requirements address the special risks posed by collective investment schemes (e.g., unit trusts or mutual funds), including the establishment of licensing and regulation of those who wish to market such schemes. Legal rules must exist governing the legal form and structure of such schemes, including the segregation and protection of client assets. Disclosure of risks and asset valuation, pricing, and redemption of units must also be delineated.

In order to provide adequate market information, issuers of securities must meet requirements for full, timely, and accurate disclosure of financial results and other information material to investor decisions. Legal safeguards should exist to ensure that holders of securities in a company are treated in a fair and equitable manner. In addition, accounting and auditing standards need to be of a high and internationally acceptable quality. Beyond the primary market, the secondary market also requires attention. Trading systems including securities exchanges must be subject to regulatory authorization and oversight, including ongoing supervision to ensure maintenance of trading integrity and transparency through detection and deterrence of manipulation and unfair trading practices. In addition, proper management of large exposures, default risk and market disruption is essential, as is regulatory oversight of the clearing and settlement system.

The objectives of the Principles thus extend beyond the traditional arena of financial regulation and supervision (i.e., protection of investors and reduction of systemic risk) to cover fairness, efficiency, and equity of markets. Historically, securities regulation has not been accorded similar prominence that is accorded to banking. However, experience has shown (both in the United States and increasingly in Europe) that requirements for adequate disclosure and transparency in securities markets increase investor confidence in such markets, thereby encouraging development and expansion.

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Other International Standards

Like the FSF standards in banking, the Compendium also includes a variety of standards beyond the key Objectives and Principles. The FSF framework for securities regulation includes standards in six areas:

1. General. Covers the Objectives and Principles, the key standard for securities settlement [ PDF ] and a general commitment to high regulatory standards and mutual cooperation as reflected in the Report on the Self-Evaluation Conducted by IOSCO Members Pursuant to the 1994 IOSCO Resolution on Commitment to Basic IOSCO Principles of High Regulatory Standards and Mutual Cooperation and Assistance (November 1997)
2. Capital adequacy. Capital adequacy is covered by a single standard, the IOSCO Methodologies for Determining Minimum Capital Standards for Internationally Active Securities Firms which Permit the Use of Models Under Prescribed Conditions (May 1998).
3. Cross-border information sharing. The FSF includes guidance on information sharing, cooperation, and memoranda of understanding (MoUs).
4. Disclosure and transparency. The FSF provides guidance on public disclosure of trading and derivatives activities of banks and securities firms [ PDF ] and disclosure for cross-border securities offerings and listings [ PDF ].
5. Risk management. Risk management standards address internal controls and related supervisory issues, client assets and OTC derivatives.
6. Market functioning. This covers a range of issues not addressed in the related infrastructure category (discussed in the following part). These include exchange traded derivatives [ PDF ], the Internet [ PDF ], and collective investment schemes.

In addition (and not included in the FSF Compendium), IOSCO has produced a methodology for implementation of the IOSCO Objectives and Principles [ PDF ].

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Implementation

A December 2002 review of 48 assessments in the areas of securities regulation under the FSAP identified a number of key common weaknesses:

1. Institutional weaknesses, particularly, limited supervisory resources
2. Distribution of authority among several bodies, often with lack of clarity of roles
3. Lack of budgetary independence of the regulator
4. Weaknesses in enforcement powers
5. Lack of adequate powers to prevent issue of a prospectus if content requirements were not met
6. Shortcomings in continuous disclosure regimes
7. Weaknesses in protection of minority shareholders
8. Weaknesses regarding auditors in ensuring disclosure
9. Weaknesses in regulation of intermediaries, including risk management, internal organization, capital adequacy, and failure resolution
10. Weaknesses in detection of manipulation and other unfair trading practices
11. Weaknesses in oversight of clearing and settlement systems

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