Chapter 1 The International Regulatory Environment 20 questions 9 - - PDF document

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Chapter 1

The International Regulatory Environment

20 questions

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• 1. Models of Regulation

Introduction to models of regulation

• Objectives and benefits of regulation
• Law and regulation
• Rules-based and principles-based approach
• Models of self-regulation
• Extra-territorial reach of legislation
• Exchanges, multilateral trading facilities and systematic internalisers
• Off-market transaction

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• 1. Models of Regulation

(1.1) Objectives and benefits of regulation

• Objectives
• Confidence and trust
• Help prevent systemic risk
• Educate and protect investors
• Reduce financial crime
• Benefits
• Encourage investment
• Encourage economic development
• Encourage wealth creation

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• 1. Models of Regulation

(1.2) Law and regulation

• Law
• Framework for the financial service
• Specific coverage such as
• Financial crime
• Tax
• Consumer protection
• Regulation
• Rules
• Standards
• Market conventions
• Codes of practice

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• 1. Models of Regulation

(1.3) Rules-based and principle-based regulation

• Rules-based approach
• Specific and detailed
• Prescriptive
• Box-ticking
• Principles-based approach
• High-level rules and guidance
• Flexibility to support innovation
• Reliance on ethical standards

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• 1. Models of Regulation

(1.4) Models of self-regulation

• Forms of self-regulation
• Industry-based organisations
• Exchange-based frameworks
• Private association
• Key elements of an effective self-regulatory model
• Industry specialised knowledge
• Industry motivation
• Contractual relationship
• Transparency and accountability
• Flexible SRO compliance programmes
• Coordination and sharing information

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• 1. Models of Regulation

(1.5) Extra-territorial reach of legislation

• Summary
• Sarbanes-Oxley Act 2002 (SOX)
• US – Improve the financial reporting process
• Markets in Financial Instruments Directive 2007 (MiFID)
• EEA – Create a base level of investor protection for the financial services
• UK Bribery Act 2010
• UK – Criminalises the bribery of public officials in international transactions

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• 1. Models of Regulation

(1.5) Extra-territorial reach of legislation

• Summary (cont.)
• Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 (Dodd-Frank)
• US – Promotes the financial stability of the US financial services
• European Market Infrastructure Regulation 2012 (EMIR)
• EEA – Requires reporting and central clearing of OTC derivative contracts
• The Foreign Account Tax Compliance Act 2010 (FATCA)
• US – Combating tax evasion by US persons holding offshore investments

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• 1. Models of Regulation

(1.5) Extra-territorial reach of legislation

• Sarbanes-Oxley Act 2002 (SOX)
• Aim
• To protect investors by improving the accuracy and reliability of corporate

disclosures

• Section 404
• Annual reports on effectiveness of internal controls
• CEO and CFO responsible
• Auditors must confirm
• Public Company Accounting Oversight Board (PCAOB)
• Inspect large accounting firms annually
• Small accounting firms every three years
• Avoid conflicts of interest with auditors
• Restrictions on other services
• Auditors appointed by board not management
• Lead accounting firm replaced every five years
• Prohibition on accounting firms with senior executives who worked for the audited

firm in the previous year

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• 1. Models of Regulation

(1.5) Extra-territorial reach of legislation

• Sarbanes-Oxley Act 2002 (SOX) (cont.)
• Requirements of US listings
• Measures to prevent conflicts
• CEO and CFO to certify accuracy of annual and quarterly SEC reports
• Disclosure of
• Off-balance sheet transactions
• Material relationships
• Statement on whether code of ethics has been adopted
• Prohibition on personal loans to officers or directors
• Greater protection for whistleblowers
• Retaliation punishable with up to ten years
• Other crimes
• Defrauding securities investors – up to 25 years
• CEO knowingly signing a false financial statement – up to $5 million and 20 years
• Obstruction of justice by destroying documents – fines and up to 20 years

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• 1. Models of Regulation

(1.5) Extra-territorial reach of legislation Markets in Financial Instruments Directive 2007 (MiFID)

• Aims
• To extend the scope of passporting
• Remove major barriers to cross-border services
• Harmonised rules on investor protection
• General obligation
• Client’s best interests
• Other obligations
• Best possible result
• Information disclosure
• Suitability and appropriateness
• Inducements
• Fiduciary duties

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• 1. Models of Regulation

(1.5) Extra-territorial reach of legislation Markets in Financial Instruments Directive 2007 (MiFID) (cont.)

• FCA’s implementation of directives
• Considerations
• Protecting market innovation
• Protecting and enhancing international character
• Considering impact on competition
• Process
• Discussion paper
• Preliminary and informal
• Consultation paper
• Proposed rules and guidance
• Policy statement
• Decided policy
• Feedback

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• 1. Models of Regulation

(1.5) Extra-territorial reach of legislation UK Bribery Act 2010

• Background
• Organisation for Economic Co-operation and Development (OECD)
• Anti-Bribery Convention
• Combating bribery of foreign officials
• UK Bribery Act
• Key offences
• Offering or receiving a bribe
• Bribery of foreign public officials
• Failure to prevent bribery
• Scope
• Offences committed in the UK or
• Committed by a person with a close connection to UK

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• 1. Models of Regulation

(1.5) Extra-territorial reach of legislation Dodd-Frank Wall Street Reform and Consumer Protection Act (2010)

• Key elements
• Consolidation of regulatory agencies
• Review of regulation of markets
• Including increased transparency of derivatives markets
• Consumer protection agency
• Uniform standards for ‘vanilla products’
• Tools for financial crises
• Including a resolution regime
• Increasing international standards and co-operation
• Improved accounting
• Tightening of regulation around credit rating agencies

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• 1. Models of Regulation

(1.5) Extra-territorial reach of legislation European Market Infrastructure Regulation 2012 (EMIR)

• EMIR is regulation of OTC derivatives
• Provisions
• All OTC derivative trades to be reported to a trade repository (TR)
• All financial and non-financial counterparties to adequately mitigate the risk of the

contract

• Requirement to use a central counterparty where mandatory clearing is in effect

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• 1. Models of Regulation

(1.5) Extra-territorial reach of legislation The Foreign Account Tax and Compliance Act (FATCA)

• Purpose
• To combat tax evasion
• Provision
• US taxpayers holding financial assets in offshore accounts must report those assets to

the IRS

• Foreign financial institutions (FFI)
• Undertake due diligence on accountholders
• Report annually to the IRS if they hold accounts for US taxpayers
• Foreign entities owned substantially by US taxpayers
• Withhold certain payments

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• 1. Models of Regulation

(1.6) Exchanges, multilateral trading facilities and systematic internalisers Exchanges

• Typical responsibilities
• Regulating stock market
• Approving applications for listing
• Supervising and investigating members and listed companies
• Market surveillance and risk management
• Overseeing capital requirements of members
• UK recognised investment exchange (RIE)
• Fit and proper
• Financial resources
• Willing and able to share information
• Promote and maintain integrity and fair dealing
• Record, monitor and enforce compliance

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• 1. Models of Regulation

(1.6) Exchanges, multilateral trading facilities and systematic internalisers Exchanges (cont.)

• Possible disciplinary action
• Reprimand
• Financial penalties
• Suspension
• Expulsion

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• 1. Models of Regulation

(1.6) Exchanges, MTFs and systematic internalisers (cont.)

• Multilateral trading facility
• Alternative trading venue
• Operated by investment firms and market operators
• Directly regulated by national regulators
• Systematic internaliser
• Investment firms acting as market maker outside an exchange
• Matching customer orders in-house

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• 1. Models of Regulation

(1.6) Exchanges, MTFs and systematic internalisers (cont.) Transparency

• Pre-trade transparency
• Order-driven markets
• Best five price level on both buy and sell side
• Quote-driven markets
• Best bids and offers of market makers
• Post-trade transparency
• Publish price, volume and time of all shares

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• 1. Models of Regulation

(1.7) Off-market transactions Over-the-counter market

• Privately negotiated trades
• Perceived issues
• Transparency
• Lack of information on positions and exposures (opaque)
• Can prevent timely detection of risks
• Management of counterparty risk
• Bilateral
• Participants agree process between them, which can lead to under-

collateralisation

• Central counterparty
• A third party assesses the risk and calls collateral appropriately
• Operational risk
• Often manual intervention at most stages of processing trades
• Often bespoke and complex products

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• 1. Models of Regulation

(1.7) Off-market transactions Over-the-counter market (cont.)

• Proposed action by EU commission
• Increase transparency through reporting trades
• Reduce counterparty risk through use of central counterparties
• Reduce operational risk through use of straight-through processing

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• 2. International Approach to Regulation

Summary

• Jurisdiction of different regulators
• International regulatory organisations and standards setting
• Implementation of regulatory objectives and the approach to supervision
• IOSCOs principles relating to the regulator
• Regulatory enforcement powers
• Regulated activities and products
• Regulatory requirements on firms
• Regulation of cross-border services

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• 2. International Approach to Regulation

(2.2) International regulatory organisations Summary

• Bank for International Settlements (BIS)
• Basel Committee for Banking Supervision (BCBS)
• Financial Stability Board (FSB)
• International Organisation of Securities Commissions (IOSCO)
• European Supervisory Authorities
• European Securities Markets Authority (ESMA)
• European Banking Authority (EBA)
• European Insurance and Occupational Pensions Authority (EIOPA)
• European Systemic Risk Board

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• 2. International Approach to Regulation

(2.2) International regulatory organisations Bank for International Settlements (BIS)

• Central bank for central banks
• Fosters international fiscal and monetary co-operation
• Regulatory guidelines
• No legal force
• Voluntary implementation
• International Banking Federation

The Basel Committee on Banking Supervision (BCBS)

• The standard implementation group
• The policy development group
• The accounting task force
• The Basel consultative group

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• 2. International Approach to Regulation

(2.2) International regulatory organisations The Basel Committee on Banking Supervision (cont.)

• Basel Accords
• Basel II (2004)
• Recommendations on capital adequacy to cover financial and operational risk
• Basel III (2010)
• Recommendations on capital adequacy and liquidity
• Also considers the impact of leverage
• Measures
• Improve banking sector’s ability to absorb shocks
• Improve risk management and governance
• Strengthen banks’ transparency and disclosures
• Focus on:
• Micro-prudential regulation – bank level
• Macro-prudential regulation – system-wide risks

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• 2. International Approach to Regulation

(2.2) International regulatory organisations Financial stability board (FSB)

• Co-ordinates at an international level the national authorities and standard

setting bodies responsible for financial stability

• Supports the development and implementation of internationally accepted

economic, financial and statistical standards

• Mandate
• Assess vulnerabilities of financial services and identify action needed
• Monitor and advise on market developments and implications
• Advise and monitor best practice
• Set guidelines for and support regulatory colleges
• Manage contingency planning for cross-border crisis management
• Collaborate with IMF to conduct Early Warning Exercises
• Face-to-face plenary twice a year
• Hosted by BIS

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• 2. International Approach to Regulation

(2.2) International regulatory organisations International Organization of Securities Commissions (IOSCO)

• Membership open to securities commissions, government regulators and self-

regulatory body

• 38 principles of securities regulation
• Backed by G20 group and the Financial Stability Board
• Aims
• Protect investors
• Maintain fair, efficient
• Transparent markets and seek to address systemic risk
• Methods include information exchange and co-operation in enforcement

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• 2. International Approach to Regulation

(2.2) International regulatory organisations European Regulatory Bodies

• European Supervisory Authorities (ESA)
• Three regulatory authorities under ESA
• European Securities and Markets Authority (ESMA)
• European Banking Authority (EBA)
• European Insurance and Occupational Pensions Authority (EIOPA)
• In addition under the European Central Bank
• European Systemic Risk Board (ESRB)
• Improving co-operation between national supervisory authorities to raise standards

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• 2. International Approach to Regulation

(2.2) International regulatory organisations European Regulatory Bodies (cont.)

• European Supervisory Authorities (ESA)
• The role of ESA includes
• Single EU rule book
• Investigate and issue opinions on national authorities
• Enforce EU rules on firms and market participants
• Temporarily ban certain financial activities
• In times of crisis can issue decisions that are binding on national authorities
• Conduct peer reviews of national authorities
• Collect relevant information

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• 2. International Approach to Regulation

(2.3) Implementation of regulatory objectives Regulatory objectives

• Typical regulatory objectives include:
• Ensuring firms meet prudential requirements
• Establishing conduct of business rules
• Detailed regulation regarding packaged products
• Protection, dispute resolution and compensation
• Setting requirements and processes for investigation, supervision and enforcement

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• 2. International Approach to Regulation

(2.3) Implementation of regulatory objectives Regulatory approaches to supervision

• Risk-based
• Assesses the impact and probability of a risk crystallising
• Tools include:
• Diagnostic, monitoring, preventative and remedial
• Rules-based versus principle-based
• Specific and prescriptive versus high-level and outcomes focused
• Thematic-based
• Focus on a particular market, practice or product, e.g.
• Capital requirements
• Short-selling
• Often risk-based
• Relationship-based
• Where staff members of regulators are assigned to specific, high-impact firms
• Religion-based
• Complying with national regulators and a religion-based regulator

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• 2. International Approach to Regulation

(2.5) Regulator enforcement powers

• Inspection and Compliance programmes
• Preventative not necessarily based on suspicion
• Disclosure of information
• Use of technology
• On-site inspections and interviews
• Comprehensive enforcement powers
• Investigate, enforce, sanction, seek court orders, suspend trading and initiate criminal

proceedings

• International enforcement
• Co-operation with other regulators

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• 2. International Approach to Regulation

(2.6) Regulated activities and products

• Banking activities
• Accepting deposits
• Issuing e-money
• Investment Activities
• Dealing in investments
• Arranging deals in investments
• Managing investments
• Advising on investments
• Including basic advice on stakeholder products
• Operating a Multilateral Trading Facility
• Sending dematerialised instructions
• Safeguarding and administering investments
• Establishing, operating or winding up a collective investment scheme or stakeholder

pension scheme

• Assisting in the administration and performance of a contract of insurance

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• 2. International Approach to Regulation

(2.6) Regulated activities and products

• Insurance activities
• Effecting or carrying out contracts of insurance as principle
• Lloyd’s market activities
• Home Finance Activities
• Arranging home finance activities
• Advising on home finance activities
• Entering into home finance activities
• Administering home finance activities
• Agreeing to do most of the above activities

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• 2. International Approach to Regulation

(2.6) Regulated activities and products

• Specified Investments
• Shares/depositary receipts/warrants
• Debt instruments, including sukuk
• Units in collective investment schemes
• Options
• Futures
• Contracts for difference (CFDs)
• Lloyd’s syndicates
• Insurance contracts
• Funeral plans
• Pensions
• Regulated mortgages
• Home finance
• Deposits and electronic money
• Rights to investments, e.g. sale and repurchase agreements (repos)

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• 2. International Approach to Regulation

(2.7) Regulatory requirements on firms Linked to IOSCOs Principles for market intermediaries

• The regulator (or SRO) should set minimum entry standards
• Set for the firms and employees
• Authorisation should be granted, refused, withdrawn, suspended and limited based on

these standards

• Capital adequacy
• Sufficient initial and ongoing capital that reflect the risks taken
• Internal compliance function
• Ensures compliance with standards for internal organisation and operational conduct
• The aim of protecting the interests of clients and their assets
• For example, conduct of business and client asset rules

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• 2. International Approach to Regulation

(2.7) Regulatory requirements on firms Linked to IOSCOs Principles for market intermediaries (cont.)

• Internal compliance function
• Conditions for compliance function
• Compliance function must have authority, resources, expertise and access to

relevant information

• A compliance officer is appointed
• Relevant persons involved in the compliance function are independent
• Remuneration should not compromise objectivity

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• 2. International Approach to Regulation

(2.8) Regulation of cross-border business

• Reasons for cross-border regulation
• Extra-territorial reach of some legislation
• Interconnectedness of financial markets
• Cross-border nature of crimes such as fraud and money laundering
• Shares listed in more than one jurisdiction
• Memoranda of Understanding (MoU)
• Sets out relationship between regulators
• Identifies when assistance may be sought
• Identifies types of assistance and information that may be sought
• Commitments relating to confidentiality of information
• A description of permitted use of information

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• 2. International Approach to Regulation

(2.8) Regulation of cross-border business

• Supervisory colleges
• Multilateral working groups of relevant supervisors
• Home and host supervisors
• Responsibility needs to be clearly apportioned
• Home state rules are the rules in the jurisdiction where the firm is licensed
• Facilitates a single market
• Host state rules are the rules in the jurisdiction of the customer
• Clearer protection for consumers
• Potential problems with cross-border regulation
• Differing conduct of business rules
• The need for separate licenses
• The need for local operators
• Differing information requirements

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