Equity Markets, Deregulation, International Organization of Securities Commissions - Case Study Example

Equity Markets Name Course Name Professor’s Name University Name Date Equity Markets Businesses have a set of requirements or factors necessary for their success. Among the most significant contributors to the running of any business, concern is the availability of capital. At inception, the founders come up with the resources necessary to get the organization going by pooling their monies or borrowing from friends and family. As the business grows, it requires additional funding and management at this stage may go for a bank loan or take on a strategic investor. With time, the firm may thrive so much so that it cannot just rely on loans but needs to raise a lot of funds. The retained earnings of the organization may prove a crucial source of capital but with time, the funding requirements may grow so large that management decides to trade some of the company’s shares or equity so as to obtain additional funds. One way of doing this is through listing on a stock exchange. A stock exchange is a form an organized market where stock brokers, buyers, and sellers interact while buying and selling one or more types of securities such as shares, bonds, derivatives, among others (Elliott and Carvajal, 2007). Deregulation Every organized financial market has rules and regulations that govern how the various players or actors act and ensures that the particular market runs in an orderly manner. In a typical securities market, there are rules regarding the procedures for a firm that wants to trade its shares, procedures for becoming a stockbroker, rules on foreign participation, among other regulations (Auzairy, Ahmad, and Ho, 2011). The word deregulation is a term that has been in regular use for the past 25 years in the financial world. In a nutshell, it encompasses the steps that governments take towards removing or lifting legal or informal restrictions Auzairy et al., (2011). One of the significant areas of deregulation is the relaxing of the rules that require the segmentation of market activities such that each player sticks to their particular area of operations such as banking, insurance, and securities. According to Auzairy et al., (2011), it is not uncommon to find a banking institution having a stock brokerage arm. A customer would walk into a banking hall, get the cash they require and buy shares of a quoted company of choice before they leave. IOSCO Every country that has an organized securities exchange usually has a regulatory body charged with overseeing the smooth running of the markets. At the international level, there is an organ, the International Organization of Securities Commissions (IOSCO) that regulates the world’s securities and futures markets Auzairy et al., (2011). The authors note that the organization draws membership from over 100 countries worldwide, representing about 95 percent of the world’s securities markets. As an apex body, IOSCO is less of an enforcement agency than it is an advisory agency. Its primary service to member organizations is assisting them to maintain and promote high standards and best practice in the markets that they regulate. The body also provides a framework for the national organizations to cooperate among themselves and with other international institutions in their efforts to benchmark and learn from each other. IOSCO, in assisting members promote regulatory governance has a raft of recommendations for each regulatory agency that delve into some aspects of each market. The principles relate to regulators, issuers of capital, market intermediaries, collective investment schemes, and information providers. Over the years, some have raised the concern that ongoing deregulation measures could be going against the Principles recommended by IOSCO on the regulation of markets, and this creates tremendous challenges for all those concerned. The first set of IOSCO Objectives touches on the regulators and their roles. First, the regulatory agency should be independent and autonomous in its operations and accountable for all its actions. Independence would guarantee that the body functions devoid of any allegiance to anyone, preventing the possibility of manipulation while discharging its mandate. The reality though is that in many instances, the institutions that are supposed to supervise the markets are state- controlled with no specific provisions in the law to guarantee their operational freedom Auzairy et al., (2011). Therefore, there are many cases where a market regulator operates at the whim of state operatives or under undue influences from some of the players in the market. Deregulation shifts power to individuals and organizations who operate in the market such as stock brokers and each tries to preserve their interests even though they may overstep the rules in the process. Market regulatory bodies carry out the important role of monitoring, mitigating and managing risk in their areas of operation. As such, these organs should on a continuous basis watch the market and all the activities taking place to ensure that the actions do not deviate from the expectation and that the environment minimizes the risk (Suarez and Kolodny, 2011). Many observers and market experts say that the most difficult part of the mandate of any market regulator is successfully identifying and minimizing risk. This challenge, according to Suarez and Kolodny, (2011) is exacerbated by the fact that it is not possible for commissions in charge of markets to look into each and every single entity or transaction, something that creates a loophole for unscrupulous individuals. In the aftermath of the global financial crisis of 2008, many fingers pointed to excessive risk-taking by some of the players in the market especially given the free reign environment that came with deregulation for the systemic collapse of the world’s leading financial institutions Auzairy et al., (2011). The authors go further to say that the single most challenging task for any regulator dealing with whatever form of securities is ensuring that they keep the market risk to a minimum and to keep the players from taking on excess risk than they can handle. For a regulator to perform and discharge their mandate as expected, the organ has to have the sanction and authority to carry out the laid down objectives. Further, the said body must have the resources and capabilities that would enable it to sufficiently and adequately do its work. Deregulation brought about an era where markets have organs whose task is to regulate and ensure that they function properly but in many instances the institutions lack the requisite authority, and the power to discharge their duties effectively Auzairy et al., (2011). Market regulators are public entities and as such rely on government funding. They compete with other government agencies for funding and in many instances, the state may not see them as a priority area because spending on social affairs such as health and education always gets preferential treatment. Conflict of Interest One of the major problems that have come with the advent of deregulation is conflict of interest. The market has different players, and some rules govern how each of them behaves. Conflict of interest would arise where a party is willing to bend the rules so as to benefit themselves or another party in a manner that is contrary to the prescribed procedure (Auzairy et al., 2011). According to Bolton, Freixas, and Shapiro, (2007), the conflict is present when brokers receive payment for order flows as well as rebates for directing orders to certain trading venues or platforms. In a publication by the Securities and Exchanges Commission (SEC), the US market regulator raised concern over the cases of the exchanges that offer the highest prices also offering the highest rebates, noting that the trend was worrying for investors. The SEC also made reference to a Senate committee hearing in which the members issued a warning to brokers for receiving payments in ways that contravene the law. A broker is supposed to seek the best deal for his client and not look for the biggest commission that they can get. There are two broad forms in which conflict of interest manifests itself. In the first instance, a retail broker earns commissions for rerouting their order flow to a wholesale broker. This happens when the retail dealer passes on his business to the wholesaler in exchange for some fee, and in many cases is not in the client’s best interest (Bolton et al., 2007 ). In the second instance, brokers direct their trades to the exchange paying the highest interest rate, often to the client’s detriment. According to Bolton et al., (2007 ) exchanges offer varying rates of rebates, and some unscrupulous dealers may choose to direct client funds to particular exchanges so that they can earn the highest commission possible even though the customer would have preferred a different exchange. Flow payments, according to the SEC is compensation, cash or otherwise that a broker receives for directing trades to a particular trading venue such as a given broker- dealer. The SEC identifies these payments as underhanded and possible causes of conflict of interest. They also lead to a mismatch of information and consequently a distortion of the market. Technology has changed the way that people conduct business, including stock trading. Trading today is automated and in many cases automated. Market order and stop order are two concepts that have become popular in the market today. In a deregulated market, trade occurs via the demand and supply economics. A market order is thus a situation where there is an order to buy or sell a given block of shares or a particular security on the spot or immediately and at the best price, with no possible price caps. It is common with speculators keen on making a quick buck by taking advantage of volatility in the prices as well as asymmetry of information across various channels. A stop order is a contingent order in which the decision to execute a sale or purchase is triggered when the price of a security reaches a predetermined level, known as the stop price (Securities and Exchanges Commission, 2016). Flow orders, as well as market and stop orders, represent instances when market players take advantage of the information asymmetry that exists in the market to benefit more than they would have under normal circumstances. They represent abuse of incentive and conflict of interest and present a headache for regulators. IOSCO requires regulators to monitor trading for the two vices but with deregulation, it becomes so hard to do that. In any deregulated market there may be cases of breach of the rules by market agents once in a while. IOSCO principles require that the regulatory agency has authority to enforce its directives and guidelines. This would require that the concerned agency should have the power to punish or prosecute any individual or entity that does not play by the rules (Auzairy et al., 2011). The authors, however, note that the reality in many instances is that most regulators do not have the mandate to investigate and bring out action against errant parties. While most market players act according to the book, few try to cut corners and part of it is because they realize that the enforcement system contains several loopholes, and they thus take advantage. It is critical that governments grant market regulators the power to enforce their rules and pronouncements because failure to do so does not inspire confidence in the market, especially where there are cases of breach of rules. IOSCO calls for full disclosure of information by market players to the public and discourages the use of insider information. As an example, a company intending to list its shares should make a full disclosure of prior financial data as well as other material information such as the company’s risk profile (Auzairy et al., 2011). The authors, however, note that not all entities reveal their risk information because that would hurt their firm’s prospects. Deregulation has brought about an era of massive competition in the market, and a company would not risk falling behind rivals and thus, may choose to withhold some information that may hurt its prospects. IOSCO principles also have a provision for the conduct of accountants. Accountants should be independent in all their undertakings and should strive to uphold the highest professional standards in their engagements. Other bodies such as credit agencies and market analysts should also hold themselves to high standards as well as be subject to oversight by regulators. Deregulation has seen a tremendous increase in the number of practitioners carrying out diverse roles in the marketplace, and this poses a serious challenge to the bodies charged with oversight because they do not have enough resources and capabilities to monitor the activities of each one of them (Auzairy et al., 2011). Trade in equities forms plays a very critical role in any economy. It enables firms to raise capital to expand and offers investors an avenue to invest their money and earn returns. The trade has experienced rapid expansion, especially in the past two decades as a result of measures to deregulate the market. A typical market comprises various agents or parties, each carrying out a distinctive role. However, deregulation has brought out a phenomenon whereby one player carries out more than just one role, and that brings added risk. Regulators have the task of ensuring the smooth and efficient running of the markets and enforcing the rules for all parties. IOSCO, being an umbrella body of regulators provides a host of guidelines that local regulators should apply to their respective markets. Deregulation, however, presents a challenge when it comes to implementing these principles. References Auzairy, N., Ahmad, R. and Ho, C. (2011). Stock Market Deregulation, Macroeconomic Variables and Stock Market Performances. International Journal of Trade, Economics and Finance, pp.495-500. Bolton, P., Freixas, X. and Shapiro, J. (2007). Conflicts of interest, information provision, and competition in the financial services industry. Journal of Financial Economics, 85(2), pp.297-330. Elliott, J. and Carvajal, A. (2007). Strengths and Weaknesses in Securities Market Regulation: A Global Analysis. IMF Working Papers, 07(259), p.1. Securities and Exchanges Commission, (2016). Certain Issues Affecting Customers in the Current Equity Market Structure. New York. Suarez, S. and Kolodny, R. (2011). Paving the Road to "Too Big to Fail": Business Interests and the Politics of Financial Deregulation in the United States. Politics & Society, 39(1), pp.74-102. Read More