Speeches: Securities Markets and Exchanges


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Securities Markets and Exchanges - Global Perspectives

Chairman, Executive Committee IOSCO
& New Zealand Securities Commission

World Federation of Exchanges Annual Conference
12-15 October, 2008, Milan

Introduction

Good afternoon distinguished guests, ladies and gentlemen.

I am honoured to be invited to speak to you today. My prepared remarks have somewhat been overtaken by recent events and so I hope you will forgive me if I divert from the formal topic to touch on the global regulatory framework and the challenges ahead.

I am speaking today in my capacity as Chair of the Executive Committee of IOSCO, the international organisation of securities regulators, which has been meeting just last week in Marrakech.

I'd like to take a moment to celebrate our good fortune to be here in this wonderful city of Milan. Milan is home to a rich and wonderful range of architecture, art and music and literature. The city has a great tradition of patronage of the arts which we are all looking forward to enjoying this evening.

I know that we are all truly grateful to the wonderful welcome and hospitality of the Borsa Italiana and I would like to thank Chairman Capuano and his team and Thom Krantz and the World Federation of Exchanges organization for hosting such a fine conference.

Current Financial Crisis and the Underpinning regulation

In the latest developments of the current financial crisis we have seen the underlying foundations of the entire financial system at severe risk. We have seen that it has taken an extreme series of Government bail outs and bank acquisitions all around the world, to rescue it.

I would like to suggest to you that it is important to consider the regulatory landscape or backdrop on which all this activity is now proceeding. To reflect on what we have actually achieved, the current urgent activity is to my mind only possible because of the significant underpinning that the modern global regulatory framework provides. The 21st Century solutions are only possible because regulators and others have put in place the necessary preconditions to enable the solutions to be credibly proposed. The existence of a global consensus of regulatory standards such as the Basel framework, the IASB standards and the IOSCO principles are to my mind a necessary precondition to policy makers having confidence that the institutions they are supporting are well regulated and will respond in an appropriate way. The development of globally agreed standards, for disclosure, transparency and consistent financial reporting standards are all part of the global landscape which makes the current proposed solutions to the crisis possible.

It is in fact impossible to imagine the interventions in the market currently being contemplated if in fact such global regulatory underpinnings were not accepted and in place.

Globalisation

The crisis has certainly shown us that what there is no question about now is that the worlds' markets are truly global. From a US beginning, the turbulence quickly reverberated around the world.

The metaphor of a butterfly flapping its wings in the jungles of Brazil, causing a tsunami on the other side of the world has now been overtaken by that of the householder taking out a mortgage in suburban Chicago and bringing a tsunami washing over the financial institutions over the other side of the world.

Who would have ever thought that the rather pedestrian phenomena of suburban household mortgages combined with profligate lending practices and poorly valued securitization would lead to the brink of the collapse of the entire financial system.

As the Financial Times commented in its editorial this weekend "The crises might have started out in the United States but economic crises do not respect national borders".

Gobalisation means there is a need for global solutions. Never has global cooperation been more needed at every level. In relation to the securities markets, IOSCO is a key organisation to facilitate this cooperative solution.

Many of you will be aware of IOSCO and its work as the recognized global standards setter for securities regulation. With its 109 regulator members IOSCO actively promotes its 30 broad Principles for securities regulation for full implementation in the regulatory framework of every member jurisdiction. IOSCO has developed the facility, through its Multilateral Memorandum of Understanding (IOSCO MMOU) to which regulator members can sign up to share information and co-operate to engage in effective enforcement across borders. This ability of course is another important element of any mutual recognition arrangement. IOSCO is pivotal in bringing together securities regulators from around the world, and its Principles and MMOU are fundamental building blocks to the achievement of cooperation.

Individual Responses

During this crisis, we have seen attempts at coordination but there have been a number of interventions taken unilaterally by national policy makers, driven by national imperatives which have had unforeseen implications for policy makers and regulators in other jurisdictions.

An example is the response, jurisdiction by jurisdiction on short selling. Despite some attempts at coordination we have seen various different approaches, from complete bans, to bans only on naked short selling, to bans on short selling of certain stocks. The implications for interlocked markets of the disparity in approach can be quite serious. Some commentators have suggested that these different approaches have increased rather than settled volatility in markets.

While there appears to be an international consensus that naked short selling is not legitimate there needs to be more work done to assess the broader implications of short selling more widely. IOSCO plans to update some previous work done in this area.

Again I repeat how important it will be that remedies to problems arising in the future will need coordination and a cooperative approach, in today's global markets.

Strong performance of Regulated Exchanges

Exchanges must take some heart from the tremendous success of your industry in recent times. As a recent McKinsey report noted "Exchanges have been world-beaters for the past decade. In capital productivity, they have performed better than the rest of the financial sector and much better than traditional industries. Their profitability has proved extraordinarily attractive to investors; total returns to shareholders have outpaced those of even red-hot sectors, such as materials and energy".

The gains in incumbent exchanges are all the more impressive in coming at a time when forces - liberalized market entry, advanced technologies and savvy entrepreneurs - have combined to challenge the position of exchanges. Exchanges continue to provide liquidity in otherwise difficult times despite the challenges from unregulated markets. This has been evermore important in the current difficult times.

From a regulatory perspective, competitive and efficient exchanges make an extremely important contribution to the finance industry and through it to the economy as a whole. Competitive and efficient exchanges enhance liquidity in our financial markets. If there is any single lesson from the current turmoil on financial markets, it is that liquidity is key. Efficient and competitive exchanges facilitate efficient and reliable price discovery. A key causal factor in the current turmoil has been unreliable valuations of assets that were not traded on established exchanges and for which the prime discovery was clearly lacking, with the benefit of hindsight. Efficient and competitive markets enable clearing and settlement of trading to take place, an issue in some of the dealings in OTC products which have been at the heart of the current financial crisis.

And while speaking of clearing and settlements I cannot overemphasise the importance to securities regulators and exchanges of investing in efficient clearing and settlement arrangements. I have mentioned the growth in trading volumes that we hare seen, which one would reasonably expect to cause stress to the infrastructure upon which the trade takes place. I would now like to imagine how much worse the turmoil could have been if people were not able to execute their trades because of inadequate clearing and settlement systems. Put another way, are we satisfied that we have invested enough in the machinery underpinning our trading platform, to ensure that trades can continue to be efficiently cleared and settled?

The Future- Unregulated Markets

On the matter of unregulated markets, the crisis has highlighted a number of issues around this part of the market. During the financial crisis, as it has been difficult to ascertain the true risk of a number of players and products, hedge funds and credit default swaps (CDS) spring to mind, to the broader financial market both regulated and unregulated until the problems actually happened. There is concern in industry and governments that the reality is that the unregulated part of the market has been instrumental in driving much of the volatility in global markets and that this part of the market is opaque and un-transparent. There is increasingly an appetite for regulators and policy makers to consider these issues. It is my view that IOSCO is the appropriate venue for this consideration. It is an organisation with global reach, and has a structure which provides for technical expertise, trust and understanding and which is increasingly well connected with industry. It is vitally important that this endeavour be globally coordinated! Over the past few months we have seen unprecedented global co ordination in the central banking world as the realisation is clear that it is only with all dealing with the crisis in a like fashion that the issues will be solved.

Mutual Recognition

At your annual conference last year I discussed the theme of cooperation between regulators, and in particular the mechanism of mutual recognition, as a solution in addressing the challenges faced with globalization of markets whilst needing to maintain national and regional regulatory authorities. To my mind this is an idea whose time has definitely arrived.

To work effectively, mutual recognition requires coordinated responses and consistent approaches to regulating cross-border transactions. As a first step for achieving mutual recognition, one must agree on a common basis of principles on which to assess the effectiveness of foreign regulations and the work of the foreign regulator. The IOSCO Principles which many of you are familiar with provide such a basis.

I am no less convinced about the mutual recognition solution than I was a year ago. As I look at what has taken place over the last year, I can point to a number of significant developments which illustrate that mutual recognition is a system which is quickly gaining international acceptance and recognition as an effective approach to regulation in the world of cross border trade. These have included for instance in my own part of the world, the coming into force of the regime between New Zealand and Australia to introduce mutual recognition of securities offerings. The US Securities and Exchange Commission (US SEC) is in discussion to further the implementation of mutual recognition with a number of countries notably Australia, Canada and the EU. And there have been a number of other developments. Just today the ASEAN nations have announced a new approach to mutual recognition of securities offerings in that region.

Mutual Recognition and Exchanges

As we have discussed over the last few days the landscape in which Exchanges now operate has and continues to change rapidly. Incumbent exchanges have responded to competitive elements in combining or seeking to combine with others at a surprising speed when we recall that this was an industry almost without merger and acquisition activity until a few years ago. But we might well ask ourselves if striving for cost savings and revenue synergies through this merger and acquisition activity will continue to be adequate in the future. A range of forces are making exchanges and their investors vulnerable to more challenging time ahead. A March 2008 McKinsey report forecasts that further consolidation is inevitable, and it recommends three tactics for exchanges: Firstly that they should continue to examine opportunities to make acquisitions. But to preserve profitability as conditions change they should also seek to improve their value propositions, and thirdly to find new sources of growth outside the core business. There are of course different models for exchanges around the world and not all will lend themselves to growth through merger and acquisition activity. They need to look to other solutions and strategies in order to improve their value propositions.

I suggest that mutual recognition might be a fourth mechanism that could support exchanges in keeping up with competition. Recognition arrangements could open up cooperation around exchanges from the regulatory perspective where some of the current growth and consolidation developments and strategies by exchanges that I outlined above are not possible. This might provide an interesting opportunity particularly in jurisdictions which are not demutualised, which are government owned or where there is a market cap on foreign ownership, all of which preclude the consolidation activity we are seeing in a commercially competitive environment. If exchanges cannot continue to grow and remain competitive in the commercial environment due to structural limitations would it not be wise for their Governments to explore other ways to support healthy regulated exchanges which in turn play an important role in promoting and sustaining deep and liquid capital markets, an important contributor to economic growth.

If we take a look for a moment at the exciting example of the Australian and US mutual recognition regime, we might start to understand how this would work. On 25th August a mutual recognition agreement was signed by the US SEC and the Australian Securities and Investments Commission (ASIC) which provides a framework for the US SEC, the Australian Government and ASIC to consider regulator exemptions that would permit US and eligible Australian stock exchanges and broker dealers to operate in both jurisdictions, without the need for these entities (in certain aspects) to be separately regulated in both countries.

Once implemented, these exemptions could permit U.S. stock exchanges and broker-dealers regulated by the SEC, subject to conditions imposed by the Australian authorities, to offer their services to Australian wholesale investors and financial firms without being subject to most ASIC regulation. And vice versa.

Mutual recognition agreements may well limit the unilateral actions I spoke of earlier as they require consultation between participants.

Concluding Comments - The Future

In concluding, it is my strong view that whatever reforms take place in 2009 for a new financial regulatory framework there needs to be a global approach to ensure that the coverage is total and does not provide for arbitrage between regulatory frameworks around the world.

The debate about how far the regulatory pendulum should swing is still to be had, and will be informed by the learnings out of this crisis but it appears that currently, un-or under-regulated parts of the global financial market will come under policy makers and the regulators scrutiny. Unregulated derivatives, hedge funds, mortgage brokers and credit rating agencies will face the limelight of regulatory scrutiny. As economists such as Robert Liten of the Bookings Institute has suggested "there is a collective anger over our whole financial system and its obvious we are going to get a regulatory backlash".

A backlash infers an impetuous response. To my mind rather than a backlash this crisis provides us the opportunity to think carefully about the regulatory landscape and to provide a risk framework for the global financial markets which is resilient and capable of dealing with the 21st Century. IOSCO will be a major participant in this work.

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