Self-Regulatory Organizations Principles and Issues Anjali Kumar World Bank

2 Self-Regulatory Organizations and 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)

3 Self-Regulatory Organizations Recognized 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

4 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

5 Self-Regulatory Organizations The 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

6 Self-Regulatory Organizations Preconditions 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

7 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 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

8 Self-Regulatory Organizations Applicability 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

9 Self-Regulatory Organizations In 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