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Legal Aspects of Finance
Slide Set 2
The Role of Regulation on the Markets
Matti Rudanko
Why Regulate the Markets?
• Mere policing purposes
– investor protection
– market functioning (efficiency): fair trading, codes of conduct,
transparency, confidence
• guidance intervention
– scope and breadth of the markets
– cannot be justified (Zufferey)
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Indications for regulation?
• Financialisation (over-developed financial markets):
financial bubbles, “bancocracy” ?
– No link to the underlying economy: too abstract for attempts to
determine the proper size (guidance function)
• Increased volatility (no clear trend recently)
– no regulation can control price fluctuations
– markets include inherent risks
– volatility may be advantageous for investors
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Episodic volatility
• Hypervolatility and disorder of the markets undermine
conditions of reasoned decisions
• Target for policing intervention aiming at normal volatility
limited to market risks
– domino effects
– investor reliance, market psychology
– impact on the underlying economy
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Episodic volatility, cont´d
• Policing intervention
–
–
–
–
market stability through investor protection
price formation mechanism
trading halts in the event of a crisis
efficiency of clearing systems
• Target for guidance intervention?
– Slowing down the market, increasing transaction
costs (e.g. margin deposits imposed on investors on
credit)
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Investor Protection
• Direct protection: eg. ensuring transparency
– sanctioned disclosure duties
– anonymity of the market prevents investors from “contractual”
information seeking
• Indirect protection
– protection of the weaker (cf. institutional investors)?
– Often a by-product of other (e.g. insider) rules
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No Investor Protection?
• E.g. disclosure regulation:
– capacity of investors to evaluate information is unequal and
limited (cf. also the role of psychological “irrational” factors)
– market forces take care of sufficient information by affecting
prices (risk averse) investors are willing to pay
– on efficient markets, prices reflect all information
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Investor protection / market functions?
• Market efficiency may require
– minimum quality standards of operators having access to the
markets
– codes of conduct for all participants to avoid malpractice
– quality standards of traded products
– the quality of market support systems (marketplaces,
information and clearing systems etc.)
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Insider offences: damages to whom ?
•
•
•
•
•
•
Concealing information?
Trading?
These aspects together?
Disclose or abstain rule
Existence of damage?
Would have purchased
anyway? Consider the
hypothetic impact of
– insider abstaining / disclosure
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(De)regulation?
• Pros and cons:
• Reliance on the market
– fair play -rules
– cf. (bad) luck -argument
(random / regular gains)
• efficiency
• ethical aspects
• investor protection:
damages?
• the position of the issuer
and its management
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Background: market efficiency
EFFICIENCY CONCEPTS OF THE MARKETS
Efficiency of the
securities
markets
Informational
efficiency
Allocative
efficiency
(allocation of
capital)
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Operational
efficiency
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Informational efficiency
• Efficient Capital Markets Hypothesis (ECMH)
• making use of inside information - disclose or
abstain - duty to disclose ?
–
–
–
–
Efficiency of information production
incentive effects
accuracy and speed of information production
protective measures within companies: costs of
insider trading / costs of disclosure (procedure costs /
secrets)
– self regulation / public regulation
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Issuer company and management
• Part of remuneration and
incentive systems of
management
– moral hazard?
• Increased capital costs ?
– Increased spread because
of management activity
and outsider reactions
• monitoring costs (agency
costs)
• internal efficiency
– information flows
– misuse of management
position e.g. in thwarting a
takeover
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Ethical aspects
• The unfairness of the
possibility to make use of
one’s position
• ethics / efficiency
• distributive aspects
– impact on distribution of
wealth
– not based on productive
work
– cf. Labor and capital as
factors of production
(Marx)
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Protection of the Market Function
• Technical efficiency
– computerization: support by legal measures ensuring system
reliability (responsibility of sponsors)
• Information efficiency (ECMH)
• Institutional efficiency
– investor confidence leads to
– liquidity and resistance to fluctuations
– trading halts and suspensions
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Protection of the Market Function, cont’d
• competition of systems, intermediaries and
products
• pricing mechanisms, operator access and listed
issuers
• self regulation based on general compulsory
principles in law
– avoidance of unfair competition
– globalization of trading systems
– moreover governed by competition rules
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Conclusions
• Regulation should not eliminate market risk
– cf. the Finnish investor compensation fund safeguarding the
cash and claims of clients in case of insolvency or other nonperformance of an investment firm
• important to seek optimal level of protection
costs
• risk of “moral hazard” should be eliminated
• imperative of minimal intervention based on
economic analysis
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Increased competition
• Globalization increases competition between
marketplaces (exchanges)
– computerization leads to global dissemination of information
– from “public service” exchanges to “enterprise” exchanges:
diversification of products offered, campaigns
• increased competition of intermediaries
– cf. e.g. online brokerage: customers’self service
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Competition and Regulation
• International imperative: non-intervention
– only self-regulation can support the really needed technical
improvements
– state regulation for increased competitiveness is economically
inefficient
– liquidity cannot be reached by regulation
– regulation to increase international competitiveness would lead
to a “race to the bottom” in e.g. investor protection
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National competitiveness
• National imperative: intervention increasing
competitiveness of domestic marketplaces
– e.g. France, Germany, Austria, Switzerland
• guaranteeing a competitive level of competition is a
legitimate cause for intervention
– must be limited to the needs of investor protection and market
function
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Concentration
• Acceptable target for policy regulation when affecting
market functions (the price formation ability)
– e.g., concentration of intermediaries increases the risk of conflict
of interests
– codes of conduct
• no need for guidance intervention
– e.g. growth, survival of the national branch
– cf. competition law
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