Clemente L. del Valle Lead Capital Markets Specialist April 30 th 2010 The Future of Self-Regulation in Securities Markets

Agenda 1.Main Objective and Scope 2.International Regulation Models 3.International Trends –Conflicts of Interest 4.Reforming SRO Systems 5.Lessons for the EMC 2

Main Objective and Scope Presentation based on a ongoing research being lead by the SMG (and John Carson main consultant) to develop a policy framework for use in advising the World Banks clients on employing self-regulation in capital markets. Towards this objective, the paper 1.Analyzes major experiences in developed and developing countries with respect to employing self-regulation 2.Focuses on issues such as level of reliance on SROs, division of responsibilities with regulator, managing the COI, governance and government oversight 3.Indentifies dominant trends and extracts key lessons for the developing world 3

Reliance on SROs – Continuum 4

Reliance on SROs – Models GOVERNMENT MODEL LIMITED EXCHANGE SRO MODEL STRONG EXCHANGE SRO MODEL INDEPENDENT SRO MODEL Public authority performs most or all regulatory functions. Exchanges have very limited role Exchange performs front-line regulatory functions for its market Exchange as SRO performs extensive regulatory functions SRO that is purely a regulator, not a market operator, performs extensive regulatory functions UK France Emerging model in EU Trend towards this model Most prevalent model Trend away from this model Only developed in a few countries US (NYSE) Hong Kong (HKE) Singapore (SGX) Sweden (OMX) Dubai (DIFX) US (CME) Brazil (BSM) Japan (TSE) Malaysia (BM) Australia (ASX) US (FINRA, NFA) Canada (IIROC) Japan (JSDA) Colombia (AMV) 5

Corporate Governance of SROs Exchange SROs (Listed model) Independent SROs Public, Shareholder ownership For-profit corporation SRO functions may have separate or special governance system Private, Member organization Non-profit entity 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 independent of regulated firms Board Nominating Committee nominates candidates for election by shareholders at AGM Regulator applies fit and proper test Board Nominating Committee nominates candidates for election by Members at AGM Regulator applies fit and proper test Regulator sets principles for governance structure and policies Regulator reviews effectiveness of governance periodically Regulator sets principles for governance structure and policies Regulator reviews effectiveness of governance periodically Ownership & Structure Composition of Board Regulatory Oversight Selection of Directors 6

Strong Exchange SRO Model DescriptionProsCons Exchange performs extensive regulatory functions that extend beyond its market operations. Examples US (CME) Brazil (BSM) Malaysia (Bursa Malaysia) Australia (ASX) Japan (TSE) Based on existing institution and capacity Greater use of industry expertise and resources in regulating markets and member firms. Reduces burden on Government regulator and resource requirements Potentially serious conflict of interest problems Exchange is not focussed on core mandate of business and market development Regulatory costs may reduce Exchanges competitiveness Regulator has less control over regulation issues and operations 7

Independent SRO Model DescriptionProsCons Independent SRO that is not a market operator performs extensive regulatory functions Examples US (FINRA) Canada (IIROC) Colombia (AMV) Japan (JSDA)* Minimizes conflicts of interest between business of exchange and SRO functions SRO has clear mission: its only job is to provide effective regulation SRO is seen as a neutral and unbiased regulator Supports business mandate of exchange and competition among exchanges / market operators Greater use of industry expertise and resources in regulating markets and member firms Reduces burden on government regulator and resource requirements Potentially less efficient than full Government model due to duplication and need for coordination Regulator has less control over detailed regulation or day-to-day operations of markets and member firms 8

Division of Responsibilities USUKAustralia Market Regulation Exchanges are primary regulators of their markets (FINRA on contract for some) SEC sets high level anti- fraud rules Several authorities regulate debt markets FSA is responsible for market conduct and surveillance Exchanges monitor trading on their markets LSE lists all types of bonds ASX sets trading rules. Full market surveillance responsibility for ASX: rules + identifying breaches of law. Debt is not traded on ASX Listings SEC regulates offers. Exchanges (mainly NYSE and Nasdaq) set listing requirements and approve listing. Sets some Listing Rules. Issuer regulation shared with SEC FSA sets listing rules and approves listing FSA regulates offers. LSE has minor admission to trading standards. ASIC regulates offers ASX sets listing requirements and approves listing. Sets Listing Rules. Issuer Disclosure & Governance Mainly SEC. Exchanges monitor compliance with timely disclosure. FSA ASX sets some rules and monitors compliance with timely disclosure 9

Key International Trends 1.Value of self-regulation has increasingly been questioned 2.Reduced reliance on SROs (esp. in Europe) 3.Exchange SROs roles cut back due to conflicts –Independent SRO units in Exchange retain 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.SROs must be responsive to broader stakeholder interests 7.Stronger oversight and direction from statutory regulators 10

Exchange SROs Reduced Role Why have Exchange SROs roles been cut back? Reduces conflicts of interest in self-regulation Positions exchanges to focus on product and market development, and competitiveness –Business focus –Reduced costs –Relationship with participants and issuers is mainly as customers Public regulators are often more effective –Broader jurisdiction and power Public regulators may impose higher and more consistent standards of regulation 11

Exchange SROs - Conflicts of Interest Type of ConflictDescription 1. Conflict between Business and Regulation Mandate 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 regulation needs Desire to drive down costs puts pressure on non-revenue-producing areas such as regulation 3. Integrity of Regulation Program Maintaining high regulatory standards and rules may negatively impact business development and customers Thoroughness of regulatory programs could be reduced Conflicts could result in biased administration of rules Pressure on independence of investigations and enforcement program Misuse of regulation to stifle competition 4. Ownership and Governance Conflicts Regulation of significant owners (e.g. members or listed companies) is difficult Directors duty to shareholders vs. public duty as a regulator 12

Managing SRO Conflicts of Interest Separate governing body to oversee regulatory operations Separate organizational structures for regulatory and business operations Firewalls to separate regulatory operations from business or advocacy operations Separate and secure premises for SRO operations Contract out all or part of the SROs regulatory responsibilities Establish policies and procedures on managing conflicts of interest 13

SRO Oversight – Overview REGULATORSRO Approves rulesAdopts rules Sets principles for corporate governance Adopts corporate governance policies and procedures Review reportsFiles financial and other reports Ongoing monitoring and communication Administers & enforces rules and supervision programs Inspection of operationsPrepares self-assessment of operations MOU oversight process 14

Oversight Examinations of SROs FULL AUDITRISK-BASED COMPLAINT / EVENT - DRIVEN Regular inspections, tending to review all areas, or the same pre-identified areas, each time. Differentiation in scope is often limited for different areas reviewed. Targeted inspections, focused on higher risk areas. The areas reviewed and scope of review often changes from one inspection cycle to the next. Ad hoc inspections to address specific issues. Used in both models. Preferred model 15

Reforming SRO Systems - Policy Issues 1.What are the imperatives for change? Positioning capital markets to be competitive Address exchanges conflicts of interest and core mandate Need for greater supervision and compliance capacity Unregulated sectors or products 2.Strategy for capital markets development How should exchanges and markets be positioned? 3.Public policy on reliance on self-regulation 4.Capacity, resources and credibility of potential SROs 5.Legal framework 6.Stakeholders views and commitment 16

Main Lessons for the EMC 1.SRO frameworks could be a valuable addition to an effective regulatory framework 2.However, there is no single right approach 3.Each market has to find its right solution based on its size, complexity and history 4.The traditional closed club approach is no longer valid 5.Demutualization does not preclude the exchanges involvement but does require a new framework 6.The Independent SRO model has advantages but also big challenges (e.g., costs, regulatory capture) 17

Main Lessons for the EMC ctd. 7.The relationship between the SRO and the regulator has also changed 8.However, a strong regulator is a must for all models 9.Deciding what model to follow demands a serious strategic analysis (cost/benefit, political commitment) 10.The implementation of a new framework relying on SROs also presents risks that need to be managed 11.The recent crisis has highlighted the vulnerability of regulatory frameworks and the need for good governance and effective management of the COI 12.NO concluding answers and need for ongoing improvements 18

Thank you. Questions? 19