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Berkeley Business Law Journal
Volume 4 | Issue 2
Article 1
September 2007
Which Way for Market Institutions: The
Fundamental Question of Self-Regulation
Cally Jordan
Pamela Hughes
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Recommended Citation
Cally Jordan and Pamela Hughes, Which Way for Market Institutions: The Fundamental Question of Self-Regulation, 4 Berkeley Bus. L.J.
205 (2007).
Available at: http://scholarship.law.berkeley.edu/bblj/vol4/iss2/1
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http://dx.doi.org/https://doi.org/10.15779/Z38PS2G
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Which Way for Market Institutions:
The Fundamental Question of Self-Regulation
Cally Jordant & Pamela Hughestt'
ABSTRACT: It is a fundamental question: how should financial market
institutions be regulated? Is self-regulation alive and well, at least in some
parts of the world,for some marketfunctions? Or, despite a last gasp here and
there, is self-regulation shuffling towards extinction? In particular,the wave of
demutualizations and consolidations of exchanges has prompted questions as
to traditional roles, governance models, and the nature of regulation of
exchanges. Demutualizationof exchanges has been a catalystfor these debates,
but the debates are not new. Although numerous studies have discussed the
advantagesand disadvantagesof a self-regulatory structurefor exchanges and
other market institutions, few have considered the interaction offactors that
have determined the traditional allocations of regulatory powers: market
history, business culture, legal system, the concept of public interest, the
corporateform, the political system, forces of internationalization.How have
these factors affected the allocation of regulatory power? Will the selfregulatorymodel of market institution, where it has been dominant, be pushed
to the margins by the interplay of these various factor, as in the United
Kingdom? Do unitary regulators oust self-regulatory principles? Is selfregulation in the United States merely a faqade? Are small and emerging
markets adopting outdated self-regulatory models at the behest of the
internationalfinancial institutions? Do self-regulatory organizations have a
new role to play as liaison between national and supranationalregulators? It
may be too soon to definitively answer the questions posed by this paper, but
for the moment, self-regulation is here to stay; it just might not be staying
where it used to.
t Formerly Senior Counsel, The World Bank (Washington, DC); Associate Professor, University of
Melbourne (Melbourne, Australia).
tt Partner, Blake, Cassels & Graydon LLP (Toronto, Canada).
1. The authors would like to thank Amanda J. Simpson of Blake, Cassels & Graydon LLP
(Toronto, Canada), in particular, for her able and continuing assistance in the preparation of this paper.
In addition, for their able assistance, the authors would like to thank Ryan Zalis of Blake, Cassels &
Graydon LLP (Toronto, Canada) and Ehsan Zargar of Paul, Weiss, Rifkind, Wharton & Garrison LLP
(New York, USA). The usual disclaimers apply. This work was originally prepared as a background
paper for a project on "The Governance of Infrastructure Institutions in the Financial Markets,"
undertaken by the Oxford Finance Group, led by Ruben Lee. The project report will be published in
2007. The views in this paper are the views of the authors and do not represent the views of The World
Bank or its Board of Directors.
Berkeley Business Law Journal
Vol. 4.2, 2007
TABLE OF CONTENTS
207
I. Introduction ..................................................................................................
209
II. Focus On Exchanges ...................................................................................
III. Market History, Business Culture, Legal System and Self Regulation ..... 213
214
IV. The Concept of the Public Interest ............................................................
215
V. The M arket Institution as Corporation ........................................................
217
VI. The Political Process .................................................................................
219
VII. Internationalization of M arkets ................................................................
222
VIII. Conclusion ..............................................................................................
Which Way for Market Institutions
Which Way for Market Institutions:
The Fundamental Question of Self-Regulation
I. INTRODUCTION
It is a fundamental question: how should financial markets be regulated? Is
self-regulation alive and well, at least in some parts of the world, for some
market functions? 2 Or, despite a last gasp here and there, is self-regulation
shuffling towards extinction, heading the way of the dodo? Is there a
discemable optimal allocation of regulatory powers to emerging market
institutions?
The wave of demutualization of exchanges and the recent merger of the
New York Stock Exchange and Euronext have triggered the fundamental
question. Exchanges are the interface between capital seekers and capital
providers and between buyers and sellers of financial products of all kinds. Of
the existing market infrastructure institutions, exchanges are the most visible
(and vocal). Other market infrastructure institutions, essential as they may be to
the market, are masked from view to the general public. Clearing and
settlement systems are out of sight, relegated to the "back office." The
community of professional market intermediaries, a clannish group wherever
they are found, operates behind the high walls of professional associations.' In
2. To judge by the smile on Mary Schapiro's face the week of November 29, 2006, the answer
might appear to be a resounding yes.
Tuesday's announcement that the NASD and the New York Stock Exchange will combine
regulatory functions not only fulfills a long-term Wall Street goal but also stands as testament
to the perseverance and integrity of one woman: NASD chairwoman Mary Schapiro, who will
become CEO of the merged operation ... The combination of the two private regulators
culminates more than a decade of work by Ms. Schapiro.
Schapiro to Lead Merged US Watchdog, FIN. TIMES, Nov. 29, 2006, at 30; see also Randall Smith &
Kara Scannell, NASD, NYSE Agree to Merge Some Oversight-Supporters Foresee Streamlining in
Market Regulation as Foes Fear Less Protection for Individuals, WALL ST. J., Nov. 29, 2006, at C 1, C4:
The new 'self-regulatory' organization, or SRO, will be responsible for all broker
examination, enforcement, arbitration and mediation functions. It will handle 'market
regulation by contract' for Nasdaq, the Amex, ISE, Chicago Climate Exchange and the OTC
Bulletin Board. NYSE Regulation will continue to oversee the NYSE market. A 23-person
board of governors will oversee the new SRO's activities, with II seats held by public
governors. Large firms, consisting of 500 or more brokers, and small firms (150 brokers or
fewer) will each be guaranteed three seats on the board. Medium size firms will be guaranteed
one seat.
3. On November 15, 2006, seven investment banks in Europe announced that they would form a
new company to create a pan-European equities trading platform to enhance the current market-trading
infrastructure in Europe. The seven investment banks are: Citigroup, Credit Suisse, Deutsche Bank,
Goldman Sachs, Merrill Lynch, Morgan Stanley, and UBS. However, Euronext may be partially
shielded from this new source of competition, as BNP Paribas and Societ6 G~n~rale did not participate
in the formation of this new company. The formation of this new equities trading platform has become
possible as a result of changes to be introduced by European member states once the directives of
Markets in Financial Instruments Directive are implemented. For further details, see Norma Cohen, Ivar
Berkeley Business Law Journal
Vol. 4.2, 2007
addition, implicitly or explicitly, exchanges are imbued with a "public interest,"
given the relationship between their activities and the related issues of
economic growth, systemic financial stability and investor protection. And, as
capital markets have grown in importance, the prominence of exchanges has
extended beyond their strictly market function; modem-day exchanges may
also play a political role as national symbols, thus eliciting regulatory responses
which are not based entirely on market considerations.
So although the great upheavals of recent years have raised numerous
issues which radiate beyond the perimeters of the exchanges, the debates have
remained firmly focused on the exchanges themselves. 4 In particular, the wave
of demutualizations and consolidations of exchanges has prompted questions as
to traditional roles, governance models and the nature of exchange regulation.
Demutualization of exchanges has been a catalyst for these debates, but the
issues being raised preceded demutualization. 5 As Professor Roberta Karmel
points out, the prevalent self-regulatory model of exchange governance in the
United States has been susceptible to abuses and scandal for decades. There
have been notable failures in the areas of self-regulators policing their
6
members, anti-trust violations, and conflicts of interest.
This is a time of flux and transition for market institutions, more so for
some than for others. Over the last several years, what are currently the two
major stock exchanges in the United States have undergone some profound
structural changes in their organization and governance, with more to come.
There have been consolidations, demutualizations, diversification of financial
instruments traded, and new service lines, all amidst a blizzard of technological
change. And, in the United States, the stock exchanges are only one part of a
complex of market institutions trading a dazzling variety of financial
instruments. 7
Simensen, Gillian Tett & Gerrit Wiesmann, Banks to Clash with European Exchanges, FIN. TIMES, Nov.
15, 2006, at I. The implications of this new trading system for traditional exchanges may be farreaching, as the banks account for about half of all trading in European equities, with trading tariffs far
below those of the London Stock Exchange, Euronext, and Deutsche Borse.
4. A closely-related debate, regarding the regulation of Alternative Trading Systems ("ATSs"),
ensued approximately 15 years ago. ATSs are privately-operated, computerized systems that perform
many of the functions of an exchange by centralizing and matching buy and sell orders and providing
post-trade information. At that time, ATSs were considered a significant source of competition to
exchanges. Among other countries, Australia, Canada, and the United States have developed specific
rules to regulate the activities of ATSs in their respective capital markets. For further details, see Ruben
Lee, What is an Exchange? A Discussion Paper (1992) (unpublished discussion paper, on file with
Nuffield College, Oxford University). See also TRANSPARENCY ON SECONDARY MARKETS, A
SYNTHESIS OF THE IOSCO DEBATE, 1992 IOSCO TECHNICAL COMMITTEE WORKING PARTY ON THE
REGULATION
OF
SECONDARY
MARKETS,
available
at
http://www.iosco.org/library/
index.cfm?section=pubdocs&year- 1992.
5. Roberta S. Karmel, What Should Market Infrastructure Institutions Regulate?, in OXFORD
FINANCE GROUP, THE GOVERNANCE OF INFRASTRUCTURE INSTITUTIONS IN FINANCIAL MARKETS
(forthcoming 2007) (manuscript on file with author, at 29).
6. Id. at 12, 22.
7. The creation of such new financial instruments has threatened the prominence of equity
Which Way for Market Institutions
At present, there is no obvious optimal allocation of regulatory powers to8
market institutions. There are too many variables and not that many players.
Commentators have contented themselves with pointing to the diversity of
models and responses to the allocation of regulatory powers by market
institutions as well as by regulators. As the International Organization of
Securities Commissions (IOSCO) Consultation Report - Regulatory Issues
Arising from Exchange Evolution concludes, "steps taken have tended to be
on an assessment of the particular
customized and pragmatic, based
9
circumstances in a jurisdiction.
Though it may be too soon to definitively answer the question posed by this
paper, will this change? Is there one optimal allocation of regulatory powers to
market institutions? Are there discernible or dominant trends? What are the
factors that have determined the traditional allocations and how are they
changing? Will the self-regulatory model of market institutions, where it has
been dominant, be pushed to the margins by a new interplay of these factors?
There is no doubt that there have been remarkably swift shifts in the
allocation of regulatory powers in the last few years. The United Kingdom,
once the heart of a self-regulatory approach to market institutions, presents one
case in point. In a recent speech, Howard Davies, former Chairman of the
Financial Services Authority (FSA) in London, asked, "What's left for selfregulation?" His "rapid answer" to this question could have been "not much,"
he admitted. "We could then all 0have a relaxed lunch and go home. But the
answer is a little more complex."'
The following discussion will attempt to tease out some tentative answers
to these questions and identify the factors at work in determining various
outcomes.
II. Focus ON EXCHANGES
As noted above, demutualization and consolidation of exchanges has put
the focus of the debate about governance and regulatory powers of market
exchanges. For example, increased trading in derivative products linked to performance of individual
equities, basket of equities, equity indices, and baskets of indices has diverted trading away from
equities themselves and to derivatives exchanges to a limited extent, but mainly to over-the-counter
markets.
8. The International Council of Securities Associations has commented on the relatively small
number of self-regulatory organizations in the world. See, e.g., Working Group on the Governance of
Market Infrastructures of the International Council of Securities Associations, Principles for the
Governance of Market Infrastructures, Oct. 2006, available at http://www.icsa.bz/pdf/
ICSAPrinciplesGovemanceMarketlnfrastructure.pdf.
9. Technical Committee of the International Organization of Securities Commissions, Consultation
Report, Regulatory Issues Arising from Exchange Evolution, March 2006, available at
http://www.iosco.org/library/pubdocs/pdf/IOSCOPD212.pdf, at 28.
10. Howard Davies, Director, London School of Economics, Address at Hong Kong Theatre (Mar.
26, 2004), What's Left for Self-Regulation?, available at http://www.lse.ac.uk/collections/
meetthedirector/pdf/whatsLeftForSelfRegulation04Feb27.pdf.
Berkeley Business Law Journal
Vol. 4.2, 2007
institutions squarely on exchanges." Despite the wave of demutualization and
consolidation, exchanges and their regulation remain highly diverse, if not
idiosyncratic. Even where similar structural reorganizations have occurred in
different exchanges, the underlying factors prompting such moves, and
potentially the ongoing operations of the exchanges, are often dissimilar.
Exchanges differ considerably amongst themselves. Markets are not
monolithic. There is a definite hierarchy with a few major exchanges at the top
(NYSE, LSE, NASDAQ, Deutsche B6rse (DB), Euronext, the Tokyo Stock
Exchange (TSE), and now, NYSE Euronext). These exchanges share in the
headlines but differ greatly among themselves. The LSE is the most
internationalized. The NYSE is the largest in the biggest domestic market. DB
is the largest in Europe. NASDAQ is the major alternative to the NYSE in the
United States market. The TSE is the largest in Asia, yet still primarily a
domestic market. Euronext, after several marriages of convenience, has surged
to prominence due to its negotiations with the NYSE. These exchanges can
afford tailor-made regulatory regimes to suit the complex business and
regulatory environments in which they operate. Certainly, recent indications are
that LSE sees its own particular principles-based regulatory model as having a
competitive advantage over the NYSE. 2 There is no convergence to an optimal
model going on here.
In the second tier are smaller exchanges, some regional, others national,
and some specialized, including the various commodities and futures exchanges
in the United States, the TSX in Canada, the OMX in the Nordic/Baltic region,
the ASX in Australia, the SEHK in Hong Kong, and the KSX in Korea. Again,
although roughly similar in size (that is to say, smaller than the big guys), each
is very different in its own way. Nevertheless, these exchanges appear to
"punch above their weight." They have significance and play a role greater than
their size might otherwise warrant, especially over the last decade or two.
These second-tier exchanges have been innovators, open to technology, quick
to change, and adept at seizing opportunities. Of course, not all experiments
have been successful as the demise of the Neue Markt13, a victim of the
11. Canada and the United States have developed specific rules to regulate the activities of ATSs in
their respective capital markets. In the United States, ATSs are governed by Regulation ATS. In Canada,
Canadian securities regulators have introduced National Instrument 21-101-Marketplace Operation
("NI 21-101"), which applies to ATSs due to its definition of "marketplaces." The definition of
marketplaces include exchanges, an entity that maintains a market for bringing together buyers and
sellers of securities and a dealer that executes a trade of an exchange-traded security outside of a
marketplace.
12.
Clara Furse, Sox is Not to Blame-London is Just Better as a Market, FIN. TIMES, Sept. 17,
2006, at 15 ("London's principles-based regime ... continues to prove itself as a model that facilitates
pro-competitive
innovation
in
a
tough
but
sensible
regulatory
environment."),
available at
http://search.ft.com/searchArticle?queryText=london+is+just+better+as+a+market&y=6&javascriptEna
bled-true&id=060917003996&x
=
18.
13. The Neue Markt was a new market, as its name suggests. Although innovative and wellsupported by the major German stock exchange, it nevertheless failed.
Which Way for Market Institutions
technology bubble of the 1990s, will attest. But these exchanges have been
learning from each other as well as innovating for themselves, creating models
responsive to their particular circumstances.
Exchanges such as the ASX, TSX and SEHK have a long history of selfregulation; however, in different ways and in response to different pressures,
each has moved sharply away from a self-regulatory model. The TSX, buoyed
by a strong Canadian economy and the national primacy, which resulted from
the sudden consolidation of most Canadian equity markets, happily shed much
of its regulatory role to focus on product innovation and its primary role as a
marketplace. Additional factors in Canada's very pragmatic and open approach
to the allocation of regulatory authority have been the competitive pressures
from its large southern neighbor and ironically, the lack of a federal securities
regulator.
Hong Kong's SEHK relinquished most of its regulatory authority more
reluctantly, only after years of skirmishes with a relatively new regulator. 14 The
resistance to realignment of regulatory authority in Hong Kong, however, could
not withstand the combined pressures of the Asian financial crisis of 1997
(which gave government regulators the upper hand), the dramatic shift in
regulatory authority in the United Kingdom from the LSE to the FSA in 2000
(the United Kingdom market had long provided inspiration and technical
expertise for Hong Kong) and the upsurge in mainland Chinese listings (which
prompted heightened regulatory concerns). The longstanding potential for
conflicts of interest, endemic in small financial communities such as Hong
Kong or Singapore, was not sufficient, in and of itself, to prompt a major
realignment of regulatory authority.
Australia's ASX, one of the first exchanges to demutualize, has trodden a
more tortuous path in trying to delineate the boundaries of regulatory authority
between exchange and government regulator. Now, many years after the
demutualization of 1988, the mechanisms designed to separate commercial and
regulatory affairs within the exchange structure, as well as the relationship of
exchange to regulator, are still being rebalanced. As this process of shedding
self-regulatory authority by the exchange may still be evolving,' 5 it is hard not
to consider the tentativeness of the situation in Australia, in part at least, as a
manifestation of the prevailing political ideology with its general bias against
government intervention.
And then there are the rest, the small players and the emerging transitional
or frontier markets, ranging from Johannesburg to Shanghai, from Jakarta to
14. The Securities and Futures Commission (SFC) in Hong Kong was created in 1989 in response
to the 1987 market crash that shut down the SEHK for several days.
15. For further details, see Media Release, ASX, ASX Markets Supervision: New Structure to
Operate from I July (June 29, 2006), available at http://www.asx.com.au/supervision/pdf/
asxmsmediarelease 29jun_06.pdf.
Berkeley Business Law Journal
Vol. 4.2, 2007
Sao Paulo, and from Bratislava to Bermuda. Some, like Johannesburg, have
been around for a long time while others are brand new (or recently resurrected
from a long period of dormancy). Some, like Bermuda, are sophisticated, niche
market players that hardly fit the profile of exchanges found in emerging
economies. And others like Jakarta and Sao Paulo serve large, resource-based
economies, where there are considerable pools of domestic capital as well as a
significant level of political risk. China is a story unto itself; its domestic
markets are unlike any others in the world as are its regulatory approaches. For
different reasons in each case, there appears to be no rush towards embracing
traditional self-regulatory models, either for the exchanges or for other market
institutions. And this is so despite the occasional, well-intentioned, albeit
somewhat misguided, nudging in that direction by international development
agencies whose advisors may have their eyes firmly fixed on the past history of
certain developed markets.
In spite of the marked trend towards shifting regulatory authority away
from exchanges themselves (at least, in their commercial operations), some
market institutions continue to defend traditional self-regulatory powers for
exchanges. 16 The common advantages associated with self-regulating entities
are: (i) their ability to utilize industry expertise; (ii) the potential for higher
standards than may be imposed by law; (iii) potentially greater compliance with
mutually-agreed rules set by peers than with externally imposed requirements;7
and (iv) their greater flexibility and responsiveness to market forces.'
However, in light of the new realities of today's evolving exchanges, these
justifications for self-regulatory powers ring somewhat hollow.
If there is one generalization to be made on the optimal allocation of
regulatory authority for market institutions (exchanges, at least), it is that selfregulation is on the wane. Nevertheless, the governance structures and the
nature of the exchange to regulator relationship will continue to be
idiosyncratic for the major exchanges and considerably diverse for the others.
Despite market integration and the spillover effects of regulatory approaches
from dominant markets such as the United States, the factors at play in
determining the allocation of regulatory authority and the relationship exchange
to regulators are too varied and complex to produce one "right answer."
The discussion below will focus on a number of factors that have and can
determine the allocation of regulatory powers to market institutions.
16. For further details, see Pam Hughes & Ehsan Zargar, Exchange Demutualization, (May I,
2006),
available
at
http://www.blakes.com/english/publications/bsra/v143/PaperExchangeDemutualization -May2006.pdf.
17. Id.
Which Way for Market Institutions
III. MARKET HISTORY, BUSINESS CULTURE, LEGAL SYSTEM AND SELF
REGULATION
The market history, business culture and legal system are all influential
factors in determining the allocation of regulatory authority to market
institutions. A strong tradition of self-regulation, as it is now commonly
understood, is not a universal given. Where the tradition of market selfregulation is not firmly established in the business culture, there has not been
great debate over its limitations or its future prospects.
Self-regulatory market practices flourished in the United Kingdom, and by
extension, the Commonwealth and the United States. As a regulatory principle,
it has been largely unknown in Continental European countries 18 where legal
systems generally demonstrate a preference for "written law" on a take it or
leave it basis.' 9 There is either formal governmental regulation or there is no
regulation; the half-way house of self-regulation, whether by continuance of
traditional practices, tacit or overt delegation of authority, or "sharing" of
regulatory responsibility with a government regulatory body, is not part of the
modem Continental European legal culture.
As with any generalization, the true situation may be more nuanced but the
issue of the allocation of regulatory authority to market institutions does not
present itself forcefully in such jurisdictions and the choices tend to be starker.
This analysis would explain, at least in part, how until very recently, the highly
regulated pan-European financial markets (point the finger at Brussels)
coexisted with the largely unregulated Eurobond market. There may also be
constitutional and administrative law principles in these countries (and others
sharing their legal and political heritage) that work against the principles of
self-regulation as they have manifested themselves in the United Kingdom and
the United States.
The United States presents a fairly unique regulatory environment, in some
measure due to the historical influences of both English law (pre-War of
Independence) and European law-largely French (post-War of Independence).
"In many respects U.S. law represents a deliberate rejection of common law
principles, with preference being given to more affirmative ideas clearly
derived from civil law. These were not somehow reinvented in the United
States but were taken over directly from civilian sources in a massive process
18. Daniel W. Drezner, Who Rules? The Regulation of Globalization, Aug. 2002, at 17, 18,
available at http://www.danieldrezner.com/research/whorules.pdf.
19. Cally Jordan, The Conundrum of Corporate Governance, 30 BROOK. J. INT'L L. 983, 1009
(2005), available at http://www.brooklaw.edu/students/joumals/bjil/bjil3Oiii-jordan.pdf.
20. Similar to the Eurobond market, the over-the-counter derivative markets are also largely
unregulated. These markets are largely unregulated because their participants are sophisticated
institutional investors capable of protecting their own interests without the need for statutory
intervention.
Berkeley Business Law Journal
Vol. 4.2, 2007
of change in adherence to legal information in the nineteenth century." 2 1 Glenn
calls this "constructive combination of elements of both civil and common
law," the "particular genius of US law." 22 Genius as it may be, the competing
principles drawn from both 181h century England and 191h century Europe, may
account for the tensions in the United States between a long tradition of selfof
regulation of exchanges on the one hand, and a highly prescriptive regime
23
other.
the
on
rules
written
formal,
on
emphasis
with
securities regulation
Concepts of "public interest" (discussed below) and the importance of a
"prudential" approach to financial regulation play into this discussion as well.
Prudential regulation finds its justification in the public interest and systemic
risk. While normally associated with banking supervision, a non-disclosurebased or prudential approach to regulation is also found, to a greater or lesser
degree depending on the jurisdiction, in the capital markets. By definition, such
an approach is prescriptive and usually errs on the side of formal regulation
backed by governmental authority (although not always).
Other contextual factors likely serve to determine the effectiveness and
persistence of self-regulatory principles. A few of the obvious ones are the
existence of a relatively small number of market participants, bound together
by a community of interest; a jurisdiction with a small population and high
visibility of market functions and participants; the normative force of
"reputational" consequences; the level of development of the market (whether
everyone knows and agrees to the rules); the extent to which the market is
international (with participants who may not necessarily know and agree to the
rules); in addition to being self-regulatory, whether there are means for the
rules to be self-enforcing.
IV.
THE CONCEPT OF THE PUBLIC INTEREST
The nature of regulation applicable to market infrastructure institutions is
intimately connected to the concept of the public interest. Notably, what is
considered in the public interest and how best to promote it varies considerably
from place to place. Furthermore, notions of public interest may be highly
culturally or politically specific, and notoriously difficult to define with
precision.
As public interest often serves as the justification for formal governmental
21. H. PATRICK GLENN, LEGAL TRADITIONS OF THE WORLD 248 (Oxford University Press 2d ed.
2004) (2000).
22 Id.at251.
23. See Jeremy Grant, Watchdogs and Companies Fight Regulatory Creep, FIN. TIMES, Oct. 31,
2006, at 21. This work notes that the current, very interesting debate over "regulatory creep" is
indicative of the differences in regulatory approach between the U.S. and the UK: "This explains why
Ed Balls, the UK's economic secretary to the Treasury is working on draft legislation that would give
the FSA veto power over a US-owned UK exchange if it were to produce rules that did not fit current
British regulatory templates." Id.
Which Way for Market Institutions
regulatory intervention, it might be surmised that the broader the understanding
of the concept of public interest, the narrower the scope for self-regulation, and
the greater the scope for potential government regulatory intervention.
Arguably, the concept of public interest in the United States is a narrower and
more circumscribed one than, say, in Singapore.
Similar to German and Canadian law, 24 both Hong Kong and Singapore, in
the recent demutualization of their exchanges, have explicitly posited a public
interest function in the authorizing legislation. 25 There is not necessarily a
linear relationship between a broad concept of public interest and a lesser
allocation of regulatory powers to market institutions, but the concept of public
interest is definitely a factor in determining such allocation.
The extent to which the public interest dominates a decision on the
allocation of regulatory power also depends on the kind of market institution
involved. It is generally understood that market institutions are, either explicitly
or implicitly, endowed with a public interest. However, not all market
institutions invoke the same intensity of public interest. A clearing and
settlement system, for example, essential though it may be to an exchange's
operation, does not necessarily raise public interest concerns to the same extent
as the operation of the exchange itself.
V. THE MARKET INSTITUTION AS CORPORATION
A good deal has been written about the implications for governance
structures and allocation of regulatory powers, which demutualization and
potential self-listing of exchanges may entail. Interestingly, very little attention
has been paid to the implications of use of the corporate form itself by an
26
exchange.
24.
NI 21-101 states that the rules and policies of an exchange must not be contrary to the "public
interest" and must be designed to prevent fraudulent practices and promote "just and equitable"
principles of trade. Additionally, NI 21-101 introduces rules that prohibit an exchange from using its
position to limit competition from other exchanges or ATSs or unreasonably deny access to its services.
25. Andreas M. Fleckner, Stock Exchanges at the Crossroads, 74 FORDHAM L. REV. 2541 (2006);
see also John W. Carson, Conflicts of Interests in Self-Regulation: Can Demutualized Exchanges
Successfully Manage Them?, World Bank Policy Research (Working Paper No. 3183, 2003), available
at http://econpapers.repec.org/paper/wbkwbrwps/3183.htm; Technical Committee of the IOSCO,
Responses to the IOSCO Consultation Report Entitled Regulatory Issues Arising from Exchange
Evolution, June 2006, at 20-25 (Deutsche B6rse notes the requirements of German law with respect to
the public interest function of exchanges), available at: http://www.iosco.org/library/pubdocs/pdf/
IOSCOPD221.pdf,; IOSCO Consultation Report, supra note 8, at 33 (the French Association of
Investment Firms discusses the public interest implications of exchanges and they note it is a "situation
that demands appropriate governance arrangements and close regulatory scrutiny").
26. Euronext, Inc., Registration Statement (Form S-4) (Sept. 21, 2006). The proposed merger of
NYSE and Euronext has very recently focused attention on the significance of the use of the corporate
form. Each of the NYSE and Euronext has proposed the creation of non-corporate entities. In the case of
Euronext, a Dutch foundation, and NYSE, a Delaware trust, shares of the ultimate holding company
would be transferred in the event of untoward regulatory actions that might otherwise catch the holding
company and result in "regulatory creep."
Berkeley Business Law Journal
Vol. 4.2, 2007
In demutualizing, formerly self-regulated member organizations become
subject to the strictures of national corporate law as well as various financial
sector regulators. Different concepts of public interest may be at work here,
depending on the jurisdiction involved. This will impact directly governance
structure and the degree of external regulation imposed. Purely commercial
corporations elicit different public interest considerations than financial
institutions; in some jurisdictions, there is very little evidence of a "public
interest" element in corporate law.
In the United States, corporate law statutes have become highly "enabling"
as opposed to regulatory. Few formalities under corporate law are associated
with their operation and management enjoys great latitude for action-selfinterested or otherwise-under the aegis of the business judgment rule. There is
little regard accorded to "public interest" aspects of the operation of business
corporations. Public interest concerns are the domain of securities regulation;
the controversial 2002 Sarbanes-Oxley legislation, applicable to publicly traded
corporations in the United States, is exceptional in that it is essentially federal
corporate law that touches upon public interest concerns but enacted under the
guise of securities regulation.
However, in the United States, the corporate form does mean that a listed
market institution will trip numerous triggers designed to increase transparency
and reduce conflicts of interest: insider trading regulations, extensive disclosure
and other issuer regulation. The debate surrounding demutualization of the
NYSE noted that demutualization could address the opaqueness of the member
association form and perceived internal governance abuses. That said, adoption
of the corporate form extends the reach of external regulation that will be
applicable to the exchange, casting light on the dark comers of the selfregulated entity.
Compared to the United States, corporations law in continental Europe is
prescriptive and quite regulatory. There are still minimum capital requirements
for commercial corporations as well as more structured and mandatory internal
corporate governance mechanisms. Corporate law demonstrates a greater
degree of public interest (workers councils or workers representation in dual
board structures, for example). There is little of the balancing of external
regulation against self-regulatory functions. Regulators regulate.
The concept of the independent, privately-funded, self-regulated
organization is quite alien in continental Europe. Regulators may not be as
close to the market but many believe there is vigorous regulatory oversight. For
an exchange to adopt corporate form is seen as a fairly non-contentious move,
with little internal resistance from self-interested parties chary of losing
autonomy. It also means that the exchange becomes subject to the real
strictures of corporate law. Euronext, for example, is a Dutch limited liability
company with a two-tier board structure that arguably provides a superior form
Which Way for Market Institutions
of internal governance. In addition, it is subject to the regulatory oversight of
the Dutch Ministry of Finance, the French Autorit6 des marches, various
interagency memoranda of understanding, and EU Directives (to name a few
sources of external regulatory pressure and oversight).
Share ownership restrictions, implemented to deter self-interested behavior
on the part of a dominant shareholder, have also been proposed as a governance
mechanism for demutualized exchanges. Such restrictions already exist in some
European commercial corporate laws and some Commonwealth banking laws.
The more cynical might see such restrictions as a form of protectionism,
deterring foreign control of a national symbol. As well, there is the usual
panoply of United States corporate governance mechanisms, the conflict
committees and other board committees, independent directors, etc., that may
have found expression elsewhere.
The substantial differences in national corporate laws will result in
persistent differences in internal and external governance of demutualized
exchanges and the extent of government regulatory intervention. There are
other intriguing implications for exchange structures. Because United States
corporate law is enabling and non-regulatory in nature, in the process of
demutualization the NYSE found itself creating compensatory internal
governance measures. Some of these compensatory mechanisms, such as the
dual board structure and a chief regulatory officer reporting to a regulatory
committee rather than the CEO,27 were directly or indirectly inspired by
European corporate law. In a further twist, the NYSE and Euronext, in their
proposed merger, are looking to non-corporate law vehicles, a Delaware trust
and a Dutch foundation, to avoid setting off certain regulatory triggers.
VI. THE POLITICAL PROCESS
Financial markets and their regulation are intimately intertwined with the
political systems in which they operate. 28 As legislation and regulation are
products, or perhaps only by-products of the political systems in place, they
reflect the prevailing political ideologies. Inherent differences in political
systems will perpetuate persistent differences in the structure of market
infrastructure institutions and the regulatory balancing act in which they
engage.
As noted above, some political systems either do not embrace the concept
27.
Roberta
Karmel,
Government
Regulatory
Intervention
in
the
Governance
of Market
Infrastructure Institutions (forthcoming) [hereinafter Government Intervention].
28. Raghuram G. Rajan & Luigi Zingales, The Great Reversals: The Politics of Financial
Development in the Twentieth Century (NBER Working Paper No. 8178, 2001), available at
http://www.nber.org/papers/w8178; see also Mark Roe, Presentation at CIFRA TI Finance Seminars:
Legal
Origins
and
Modem
Stock
Markets
(Sept.
27,
2003),
available
at
http://www.abs.uva.nl/fmseminars/object.cfn/objectid=D 10650EF-6771-419B-B I 1B521 FB639F898;
Mark Roe, Delaware's Politics, 118 HARv. L. REV. 2491 (2005).
Berkeley Business Law Journal
Vol. 4.2, 2007
of self-regulatory organizations or face constitutional hurdles to their
recognition. In federal states such as Germany, Canada, and the United States,
jurisdictional rivalries may provoke regulatory competition and the potential
for regulatory arbitrage (witness the savings and loans crisis
of the 1980s in the
29
itself).
Sarbanes-Oxley
of
enactment
the
or
States,
United
In some cases, self-regulation may act as a substitute where political factors
impede government regulation; Canada's political inability to create a federal
securities regulator has meant that a number of other entities, some endowed
with self-regulatory authority, have stepped into the breach (TSX, Market
Regulation Services Inc., Investment Dealers Association of Canada and
Canadian Securities Administrators).
The political system will determine not only the type of regulatory
approach but also whether the implementation of government regulation is
feasible at all. Some federal jurisdictions, Germany for example, recognize or
30
permit shared competencies in an effort to defuse jurisdictional rivalries.
Others, such as the United Kingdom, encourage a close, cooperative
relationship between regulators and exchanges.
In the United States, does self-regulation play a compensatory role in the
face of legislative impasse resulting from the political system? In a
parliamentary democracy, a majority government may implement radical
change virtually at the drop of a hat; for example, witness Gordon Brown's
separation of regulatory from supervisory power at the Bank of England and
the creation of the FSA. The legislative process in the United States, on the
other hand, is one of exquisite complexity. It is contentious and incremental in
most cases, due to the powerful influences of lobby groups and the checks and
balances of the political system itself. It has not been uncommon for sensible
financial sector legislative initiatives-for example, repeal of the McFadden
Act and the Glass-Steagall Act-to take thirty years to crawl through to
implementation. The inability of the United States to legislate on financial
sector matters at the federal level, except in response to crisis and public
outrage with its potential for very personal and unpleasant fallout for
legislators, has the untoward consequence that legislated agendas do not
necessarily represent a balanced or optimal allocation of regulatory authority.
Instead, expediency and ad hoc-ery rule. It is true that the delegated rulemaking authority exercised by the SEC compensates for the impasse at the
legislative level. However, to judge by recent controversies such as shareholder
nomination of and voting for directors, the SEC too is constrained by political
factors.
Compared to the situation in the United States, both the United Kingdom
29. See Mark J. Roe, Delaware's Competition, 117 HARV. L. REV. 588 (2003).
30. See Fleckner, supra note 25.
Which Way for Market Institutions
and Hong Kong have moved away from self-regulation as the prevailing
concept in securities markets with astonishing swiftness. As noted above, in the
case of Hong Kong, a precipitating factor in the change in the balance between
self-regulation of the exchange and statutory powers in the regulator was the
Asian financial crisis. The political system in Hong Kong permits the
administration to act swiftly and decisively when it wishes, unfettered by messy
issues of congressional or parliamentary procedure. Despite its reputation for
laissez-faire liberalism in its approach to markets, the Hong Kong
administration can intervene rapidly in markets so as to put its thumb on the
scale. The Hong Kong government's intervention in the stock market during
the Asian financial crisis illustrated this point graphically, but the ongoing
growth of Hong Kong as the market of choice for mainland Chinese issuers has
sustained the pressures in favor of government regulators.
As Howard Davies noted in his speech, "in London's securities markets
most regulation began as self-regulation .. .[p]olicing those rules [by selfregulatory organizations] was patchy, and of course the powers at their disposal
were not very strong, but they did their best." 31 In the 1980s, the United
Kingdom established "a rather unusual halfway house system, with a statutory
body-the Securities & Investments Board-sitting on top of a number of selfin place by Michael Howard, though
regulators ... [t]his architecture was put 32
days."
these
it
about
talk
often
not
does
he
This self-regulatory system in the United Kingdom, however, did not
respond well to rapidly changing market conditions and for several reasons.
The complex structure "almost guaranteed tensions between the statutory
oversight body and the frontline regulators." 33 New entrants into the United
Kingdom markets broke down the community of interest in a well-defined
marketplace. The clubby world of London's financial district, the "City," and
self-regulation proved inadequate "to cope with a situation in which market
34
practices as a whole need[ed] to be improved to regain public confidence."
And so the "government decided-with some reluctance-that the day of selfregulation in retail financial markets was largely over." 35 A popular majority
government and a strong-handed Chancellor hustled self-regulation out the
door with little ado, a feat that would be unimaginable in the United States.
VII. INTERNATIONALIZATION OF MARKETS
Internationalization of markets has had complex consequences for the
balance between self-regulation of market institutions and government
31.
32.
33.
34.
35.
Davies, supra note 10, at 1.
Id.at 1-2.
Id.at 3.
Id.at 4.
Id.
Berkeley Business Law Journal
Vol. 4.2, 2007
regulation. The Hong Kong administration acted quickly as the Hong Kong
markets caught the virus of the Asian financial crisis spreading from Thailand
and Indonesia in 1997. The United Kingdom government jettisoned selfregulation in response to the entry of new market players who did not play by
"club" rules and in an effort to raise standards across an entire industry which
was no longer homogenous. Elsewhere, shareholder restrictions imposed in the
wake of demutualization of national exchanges have been criticized as a
"poison pill" tactic, designed to deter international takeovers of the newly listed
national exchanges.
The much touted issue of international competitiveness is a double-edged
sword for the self-regulatory powers of market institutions, its consequences
dependent on business culture, the degree of acceptance or resistance to
governmental intervention in markets and the political system (see above).
Industry self-regulation can be nimble and responsive to changing conditions
brought about by external pressures and participants. Self-regulation may also
work well in certain kinds of international markets where there is no
supranational governmental authority to intervene (for example, the
Euromarket).
On the other hand, faced with competitive international pressures,
government authorities may be tempted to preserve and promote markets and
their institutions within their national borders. 36 This has occurred more so
recently, as has been demonstrated by the United Kingdom government's
reaction to potential implications of regulatory "spillover" from the United
States.37 A government may intervene to insulate its markets from
governmental regulation emanating from a foreign source.
The internationalization of the market institutions themselvesconsolidation of different national exchanges, cross-border mergers and
alliances-raises intriguing unresolved questions. A form of self-regulation
may facilitate these alliances where there is no supranational framework to
provide guidance or regulatory authority. Large, cross-border institutions will
be small in number and highly visible; they will be sui generis to a large degree
and their prominence may enhance the effectiveness of the "reputational"
element of self-regulation. Yet, domestic or supranational, as in the case of the
36.
In spite of NI 21-101, which prohibits exchanges from unreasonably denying access to its
services, TSX's proposed rules for permitted counterparties for equity derivative transactions exclude
certain foreign financial institutions; that is, foreign banks listed under Schedule II of the Bank Act,
1991 S.C. (Can.), available at http://laws.justice.gc.ca/en/showdoc/cs/B- 1.01 ///en?page= .
37. See George Osborne, The Way to Prevent American Regulatory Creep, FIN. TIMES (London),
Oct. 12, 2006, at 13; Jeremy Grant, Ex-SEC Chief Hits Out at 'Turf Protection,' FIN. TIMES (London),
Sept. 15, 2006, at 9; see also Elliot Posner, The New TransatlanticRegulatory Relations in Financial
Services (Sept. 2006) (prepared for presentation at the 1st Annual GARNET Conference, "Global
Financial and Monetary Governance, the EU and Emerging Market Economies"), available at
http://www.garnet-eu.org/index.php?id=29&dir-/JERP%205.2.4:%20Globa%20Economic%20Govema
nce%20and%20Market%20Regulation&mountpoint-4.
Which Way for Market Institutions
EU, governmental regulation may be required to provide the legal foundations
for these internationalized market institutions.
A further difficulty may be the juxtaposition and interaction of different
regulatory approaches resulting from internationalization of the markets and
their institutions, such as introducing self-regulatory concepts to systems where
they are more or less unknown. 38 United States regulatory initiatives, in
particular, have inspired waves of "spill-over" or "me too" regulation which
may produce less than optimal results elsewhere. 39 This phenomenon has been
pronounced in transition and emerging markets which are desperately in search
of regulatory models, but even the EU has not been immune from rather
thoughtless copycat impulses.40
Among the major markets, internationalization has heightened awareness of
conflicts between regulatory approaches arising from different legal and
political systems. 4 1 For example, divergent views between two major market
of
regulators, the United Kingdom and the United States, as to the merits 42
"principles-based" regulation and "rules based" regulation, surfaced recently.
With the consolidation of transatlantic exchanges a reality, there is a greater
imperative for close cooperation among regulators in different jurisdictions.
Here there may be new importance given to the old role of self-regulatory
market organizations, like the International Capital Market Association
(ICMA). In its comments on the IOSCO Consultation Report, ICMA highlights
38 Roel C. Campos, SEC Commissioner, The Current Role of Capital Market Regulation, Speech
Delivered at CVM's 30th Anniversary: Assessing the Present, Conceiving the Future (Sept. 5, 2006),
available at http://www.sec.gov/news/speech/2006/spchO9O506rcc.htm.
39. The phrase "me too reforms" has been attributed to Gerard Hertig, On-Going Board Reforms:
One Size-Fits-All and Regulatory Capture, 21 OXFORD REV. ECON. POL. 269, available at
http://papers.ssm.com/sol3/papers.cfm?abstractid=676417, and Luca Enriques & Matteo Gatti, EC
Reforms of Corporate Governance and Capital Markets Law: Do They Tackle Insiders' Opportunism?
(Feb. 2006) (prepared for the 2006 Policy Dialogue on Corporate Governance in India), available at
http://papers.ssm.com/sol3/papers.cfm?abstractid=886345.
40. On the effectiveness of legal transplants in transition economies, see Katharina Pistor et al.,
1999), available at
Economic Development, Legality and the Transplant Effect (Nov.
http://ssm.com/abstract-183269. See also Jordan, supra note 19. Also note that in the EU, legislation
and other initiatives emanating from the U.S. are closely monitored in the area of corporate governance
and capital markets. Some initiatives are successfully adapted, even improved upon (for example, the
recent EU Prospectus Directive) while others flounder (for example, the demise of the mandatory audit
committee proposal for European companies).
41. Institute of Chartered Accountants in England and Wales (ICAEW), Dialogue in Corporate
= 1
22337. The ICAEW, a
Governance (July 2005), available at http://www.icaew.co.uk/index.cfm?route
self-regulatory organization, has launched an ambitious initiative, the Dialogue in Corporate
Governance, "to challenge commonly held assumptions, identify fundamental questions, set challenges
for future research and generate practical proposals . . . [as] difficulties arise in striving to achieve a
single, global approach to corporate governance. There are too many deep-rooted cultural and structural
differences for a single approach to work equally well in all countries and for all companies regardless
of their stage of development and business." See also a series of research papers prepared by the
ICAEW, including Pressure Points-Contrasting US and UK Securities Markets: How They Impact
Business and Accounting (Nov. 2005), available at
International Policy, Investment,
www.icaew.co.uk/index.cfm?route= 145128.
42. See Schedule Ill of the Bank Act, supra note 36.
Berkeley Business Law Journal
Vol. 4.2, 2007
its role as liaison among national and supranational regulators and as a gapfiller.43 Rather than being the primary mode of regulation of market
infrastructure institutions, self-regulation may be assuming an important, but
subsidiary, role in the oiling of the market machinery.
The IOSCO principles merit one last observation in this context. In the
absence of a supranational regulator, internationalization of markets has
prompted IOSCO to develop international standards and principles, giving
guidance to market institutions. The various IOSCO principles, having been
heavily influenced by 1990s regulatory models from the United States, may
overweigh the importance of self-regulatory principles. In other words, the
markets may have outpaced them.
VIII. CONCLUSION
At present, it is not easy to isolate an optimal allocation of regulatory
authority for market institutions. There are too many variables at play in a
complex, rapidly changing environment. Market participants, institutions and
regulators themselves demonstrate sharply divided views on the implications of
the dramatic changes affecting the structure and governance of exchanges and
other market institutions. Some market institutions continue to insist on the
virtues of self-regulation and the powerful incentive of their "brand" to produce
appropriate regulatory outcomes, even as such authority is slipping away. On
the other hand, commentators have little trouble pointing to the scandals and
even market participants find the "brand"
failures of self-regulation 44 and
45
convincing.
than
less
argument
In some cases, such as Hong Kong and London, self-regulatory concepts,
once a primary source of regulation, have been quickly shoved to the margin.
In others, such as Toronto, in the absence of a strong federal capital markets
regulator, a pragmatic approach to the separation of regulatory and commercial
TSX
aspects of exchange function has been adopted. With few regrets, the
46
itself quickly shuffled off market regulatory authority to another entity.
43.
IOSCO, REGULATORY ISSUES ARISING FROM EXCHANGE EVOLUTION:
RESPONSES TO THE
REPORT (June 2006), available at http://www.iosco.org/library/pubdocs/pdf/
CONSULTATION
IOSCOPD221 .pdf.
44. Karmel, supra note 5, at 28 n.82 (Karmel notes the Report Pursuant to §21(a) of the Securities
Exchange Act of 1934 regarding the NASD and the Nasdaq Market, Exchange Act Release No. 37542
(Aug. 8, 1996); see also Press Release, Securities Exchange Commission, SEC Charges the New York
12,
2005), available at
Specialists (Apr.
to Police
with Failing
Stock Exchange
http://www.sec.gov/news/press/2005-53.htm.
45. IOSCO, supra note 43, at 42-45, R4.2(a).
46. The market regulatory authority of the TSX has been transferred to Market Regulation Services
at
Inc.,
available
Services,
Regulation
Market
History
of
Inc.
See
However,
the
http://www.rs.ca/en/about/history.asp?printVersion=no&loc I=about&loc2=history.
corporate governance of an issuer is regulated by the securities regulators pursuant to National
Corporate Governance Practices,
Disclosure of
58-101,
Instrument
http://www.tsx.com/en/pdf/NI58- 101_DisclosureOfCGPracticesAprl 5-05.pdf.
available
at
Which Way for Market Institutions
Where you find consolidated regulation of financial institutions, the
presence of the unitary regulator tends to oust self-regulation and, incidentally,
may produce a more prudential approach to capital markets regulation. The
potential for heavy-handed regulatory intervention by such a regulator, a
spectre haunting the markets, may be offset by the regulatory approach itself
(for example, "principles-based" as opposed to "rules-based"). The United
Kingdom government certainly makes this assertion fairly convincingly,
touting its "light touch" regulation as one competitive advantage of the London
47
markets.
The United States market on the other hand has witnessed a gradual shift in
influence from self-regulatory bodies to greater government oversight and
direct intervention. Roberta Karmel capably argues that this is a time of tension
and compromise between self-regulation and government intervention in the
United States.48 Attempts are being made to maintain the faqade of selfregulation (for example, a market-neutral SRO with governmental members, a
third party SRO supplying regulatory services, or constituency representation
dominating SRO boards), while in reality, shifting to another form of
regulation. Overlapping oversight and shared responsibilities are now
characteristic of United States market regulation, which is a function, Karmel
maintains, of market evolution, technology, and international pressures. It may
also be a manifestation of longstanding tensions attributable 49to the historic
undercurrents in the United States legal system discussed above.
Australia, with its long tradition of self-regulatory market institutions
inherited from the United Kingdom (but without the same United Kingdom
political dynamic at work) demonstrates similar tension and compromise in its
overlapping oversight approach. The political complexity of a federal system is
one likely factor contributing to this situation; unlike in the United Kingdom (a
unitary state), sharp changes in course pose a more difficult proposition in
Australia. Australia has also been an innovator, not the first but definitely in the
vanguard of change, when it comes to market institutions.50 It is learning by
experience. The pressures of market evolution, technology, and
internationalization, which Karmel identifies in the United States, are also
having full play in Australia.
47. Press Release, City of London, London Stock Exchange: City Welcomes Treasury
Commitment
to
"Light
Touch"
Regulation
(Sept.
13,
2006),
available
at
http://www.cityoflondon.gov.uk/Corporation/media centre/files2006/London+Stock+Exchange+City+w
elcomes+Treasury+commitment+to+light+touch+regulation.htm; see also Norma Cohen, IOSCO to
Push
for
Regulatory
Consistency,
FIN.
TIMES,
Nov.
15,
http://www.fl.com/cms/s/7f4cd74a-744d- II db-8dd7-0000779e2340.html.
2006,
available
at
48. Government Intervention, supra note 27.
49. Karmel, supra note 5, at 29.
50. Government Intervention, supra note 27, at 21; Australian Securities Exchange, ASX Overview
& Structure, available at http://www.asx.com.au/about/asx/asx-overview.htm (the ASX demutualized in
1988 and was one of the first exchanges to do so).
Berkeley Business Law Journal
Vol. 4.2, 2007
So, which way for market institutions? It depends. Self-regulation will
persist in the United States, although perhaps not in as vigorous and
unchallenged a form as in the past. The industry, which prefers to mind its own
shop, is sophisticated, politically savvy, and well-financed. Congressional
action is unlikely, except in response to a perceived crisis which would reach
the level of general public awareness. The SEC appears determined to change
the legacy of the implementation of Sarbanes-Oxley-the perception of a
51
heavy-handed regulatory intervention.
Nevertheless, in the wake of Sarbanes-Oxley, there have also been calls for
the United States to look abroad to find new regulatory approaches, in
particular to the United Kingdom, which, as noted above, has more or less
abandoned a self-regulatory approach to exchange regulation, at least
ostensibly. This call to look abroad for regulatory solutions is atypical (the
United States prefers homegrown solutions) 52 and for that reason is also
intriguing. There have been numerous suggestions in the past that the United
States demonstrates greater deference to non-U.S. regulatory approaches, 53 and
while the NYSE itself has done some creative borrowing from abroad,54 no
audacious soul had so far suggested overtly importing foreign regulatory
solutions. Despite the blue ribbon credentials of the source of this suggestion,55
it is unlikely to provoke a regulatory about-face on the part of the SEC. 56 Legal
and regulatory systems are notoriously path-dependent, and none more so than
51. See Press Release, Securities Exchange Commission, SEC Votes to Propose Interpretive
Guidance for Management to Improve Sarbanes-Oxley 404 Implementation (Dec. 13, 2006), available
at http://www.sec.govlnews/press/2006/2006-206.htm. The SEC announced modifications to the
application of Sarbanes-Oxley, among other things, in an attempt to meet mounting criticism of the
regulatory burdens imposed.
52. There are interesting historical reasons behind this reluctance to learn from experience
elsewhere. These date back to the end of the 19th century when the United States entered a period of
"nation-building" after a terrible and divisive civil war. U.S. legislators and regulators looked to create
indigenous solutions and institutions, to the despair to this day of comparativists. Even where regulatory
solutions were obviously modeled on foreign sources (e.g., the Uniform Commercial Code (UCC)), no
acknowledgement is made. Karl Llewellyn, a U.S. academic trained in Germany and principal
draftsperson of the UCC, is said to have commented that to acknowledge a foreign source was the "kiss
of death" for proposed US legislation. See Marietta Auer, "Good Faith " and its German Sources: A
Structural Frameworkfor the "Good Faith" Debate in General Contract Law & Under the Uniform
Commercial Code, 14 n.36 (2001) available at http://www.law.harvard.edu/academics/graduate/
publications/papers/auer.pdf.
53. Edward F. Greene et al., Hegemony or Deference: U.S. Disclosure Requirements in the
InternationalCapital Markets, 50 Bus. LAW. 413 (1995).
54. See, e.g., NYSE Rules on Corporate Governance.
55. The Committee on Capital Market Reform (the "Paulson Committee") mobilized the great and
the good of the US securities practicing bar and academic community. It was only one of three
committees struck more or less simultaneously to consider the competitive threat to the U.S. capital
markets. The Commission on the Regulation of U.S. Capital Markets in the 21st Century reported, at the
behest of the U.S. Chamber of Commerce in March 2007. See U.S. Chamber of Commerce,
Commission on the Regulation of U.S. Capital Markets in the 21st Century - Report and
Recommendations, http://www.uschamber.compublications/reports/O703capmarketscomm.
56. See Robert Bruce, Oceans Apart on the Rights and Wrongs of Control, FIN. TIMES (LONDON),
Jan. 18, 2007, available at http://www.ft.com/cms/s/2ad35f58-a699-1 I db-937f-0000779e2340.html.
Which Way for Market Institutions
that of the United States.
As for the United Kingdom, despite appearances to the contrary, selfregulation has not completely bit the dust. As noted by Sir Howard Davies, the
situation is more complex than it may appear on the surface. Despite the
massive shift of regulatory authority to the FSA, some strong forms of self57
regulation persist, even at the LSE. The NOMAD system for the AIM market,
for example, substitutes the judgment and integrity of a seasoned market
professional for direct regulatory oversight and accountability. The AIM
lately 58 although there are some indications of
market has been booming 59
paradise.
troubles brewing in
Concepts of self-regulation continue to pop up in some unlikely corners of
the world: small or emerging markets are attempting to modemize their
regulatory structures and claim a place in the international arena. These markets
often have a considerable advantage over developed markets in terms of their
ability, at a formal level at least, to effectuate legislative and regulatory change.
What the minister of finance wants, the minister of finance gets.
Rather perversely, however, the attempts at modernization may be
undermined by recourse to outdated or inappropriate regulatory concepts,
including self-regulation. Both IOSCO and international financial institutions,
such as The World Bank, share some responsibility in this regard. The IOSCO
Objectives and Principles of Securities Regulation, despite their extensive
interpretative glosses and tweaking at the edges, is essentially backwardlooking, based on United States regulation and institutions in the heyday of the
soul-searching of the post-Enron era.
1990s as they existed prior to the great
60
Self-regulation features prominently.
Even where it may not be intuitively obvious, many governments in small
or emerging economies have felt compelled to ape the old self-regulatory
models of the 1990s (even where they may have dramatically changed in their
place of origin, such as the United Kingdom). One motivation for this has been
"signaling" to international markets and investors that the government is
adopting international best practice. Somewhat slavish adoption of IOSCO
principles, including the emulation of concepts of self-regulation, has been
further reinforced by the Financial Sector Assessment Program (FSAP) of the
57. A Nomad is a Nominated Advisor. All Nomads must be approved by the LSE and a Nomad is
generally responsible for ensuring that a company adheres to AIM's rules and regulations. For more
see
information,
http://www.londonstockexchange.com/engb/products/companyservices/ourmarkets/aim-new/About+Al
M/choosingadvisersl .htm.
58. Note the increase in listings in 2006, ostensibly at the expense of NYSE and NASDAQ. For
more information, see Norma Cohen et al., Top SEC Official Calls Aim a "Casino," FIN. TIMES, Mar. 9,
2007, available at http://www.ft.com/cms/s/fa3488b8-cde4- II db-839d-O00b5df1 0621 .html.
59. Id.
60. IOSCO, OBJECTIVES AND PRINCIPLES OF SECURITIES REGULATION (May 2003), available at
http://www.iosco.org/library/pubdocs/pdf/IOSCOPD 154.pdf.
Berkeley Business Law Journal
Vol. 4.2, 2007
International Monetary Fund (IMF) and The World Bank.6' With various
international principles in hand, teams of experts led by IMF and World Bank
staff have roamed the world, assessing financial systems and making
recommendations for improvement. Countries take these assessments seriously;
recommendations tend to find expression in loan "conditionalities" imposed by
the IMF and the62 World Bank, and thus have an immediate and tangible
economic impact.
There is no doubt that much good has come of the FSAP experience, which
has resulted in a great wave of useful and pertinent technical assistance being
provided to regulators. However, along with the good have come some
outdated concepts as well.
To close on a more cheerful note, there are indications that the role of selfregulation may be evolving in response to the times. As the ICMA has pointed
out, self-regulation can be a useful gap-filler, particularly in times of rapid
change and for the international markets where there may not be an obvious
regulator to which to look. Since the international markets are primarily
composed of sophisticated players and serve as the testing grounds for
innovation in financial products, this development is a welcome and
appropriate one. So though self-regulation appears here to stay; it just might not
be staying where it used to be.
61. The Financial Sector Assessment Program (FSAP) originated in 1999 as a joint initiative of the
International Monetary Fund (IMF) and The World Bank in the wake of the Asian Financial crisis of
1997, The IMF had been criticized for having been taken by surprise by the suddenness and severity of
the Asian financial crisis, and the FSAP was designed to identify strengths and vulnerabilities of country
financial systems to determine how risk was being managed and help prioritize policy responses.
Detailed assessments of the observance of numerous financial sector standards and codes, which give
rise to Reports on Observance of Standards and Codes (ROSCs) as a by-product, are a key component of
the FSAP. FSAPs are conducted on a voluntary basis at the request of the individual country
government. Teams of IMF and World Bank staff and outside experts spend several weeks in a country
conducting the assessments of the banking, insurance, capital markets and other sectors. The FSAP
findings feed into IMF surveillance efforts, particularly with respect to macroeconomic stability and the
capacity of the financial sector to absorb macroeconomic shocks. They are also used as the basis for
determining ongoing technical assistance in the financial sector and may also be the source of exigencies
required of government by the international financial institutions as a condition of lending. Dozens of
countries have participated in the FSAP exercise, both in the developed and developing world. The first
participant was that good international citizen, Canada. Notably absent among the volunteers has been
the United States.
62. Id.