Special Topics in Securities Market Development and Regulation
Three key topics in securities market regulation and development are discussed in this section: (a) demutualization of stock exchanges, (b) creation of integrated regulator or supervisor, and (c) enforcement and exchange of information.
The past decade has witnessed tremendous changes in the structure of securities markets as lawmakers, regulators, and market participants try to contend with the effects of globalization and the development of advanced technology. New forms of markets have been created, and traditional markets have struggled to stay competitive. Regulators have been forced to face difficult questions of what constitutes the essential elements of a market and how they should be regulated going forward. The viability of self-regulation, which, in fact, in many countries predated stand-alone securities regulators, has also come into question.
One increasingly common consequence of those developments is a worldwide trend toward the demutualization of stock exchanges. Many stock exchanges began as mutual— or member—organizations where, in exchange for the privilege of membership, an individual or a securities firm was (a) given certain benefits, including the right to trade on the exchange and to make a market in certain securities, and (b) certain responsibilities, including the obligation to act in accordance with the membership rules for the benefit of the exchange at large. This system worked effectively for many years, and, indeed, many would argue that it still does. However, others believe that this membership structure served to constrain the exchanges from competing effectively with their rivals, including fast and efficient electronic systems that could execute trades rapidly at little cost. To marshal greater resources that would enable them to compete more aggressively, a significant number of exchanges decided to transform themselves into for-profit stock companies in which shares would be offered to the public and even, in some cases, listed on the exchange itself. In a number of cases, government authorities initiated the demutualization of domestic exchanges, believing that this action would improve the competitiveness and efficiency of their markets. According to the World Federation of Exchanges, a total of 42 exchanges had demutualized as of March 2003. This figure includes exchanges in both developed and emerging markets, including, for example, the London Stock Exchange, Australian Stock Exchange, Deutsche Borse, Athens Stock Exchange, Philippines Stock Exchange, and Kuala Lumpur Stock Exchange, among others.
The transformation of stock exchanges into for-profit share companies raises significant issues for securities regulators. Although many of the issues exist in the case of traditional stock exchanges, demutualization served to highlight the potential conflicts of interest.38 In particular, exchanges that have demutualized may have a heightened con
flict of interest between their business and regulatory functions, including in the administration of their own operating rules. For example, when operated by a management team whose main goal is to create a profit, an exchange may have less interest in devoting resources to its regulatory functions. Furthermore, as a for-profit enterprise, an exchange may come into conflict in regulating its own competitors. Regulators have handled those potential conflicts in a variety of ways. Some regulators have removed regulation from the exchange function entirely, giving it to an independent self-regulatory organization or even assuming all or part of the functions themselves. In other cases, improving internal controls at the exchange—coupled with enhanced regulatory oversight or strengthened corporate governance—has been considered sufficient.
From an assessor’s perspective, the key issue is to be aware of the market structure that exists in the country being assessed, to recognize the regulatory implications of that structure, and to have a comprehensive understanding of the way in which the regulatory authorities have addressed those implications. When assessing a market with a demutualized exchange, the assessor should consider how the regulatory responsibilities of the exchange are being handled, what procedures the exchange or other parts of the regulatory system have in place to address potential conflicts of interest, and whether the regulator has an effective program of oversight.