Financial Market Law and Regulation

Theory and practice of financial market regulation

Carmine Di Noia

Financial markets

Definition/sMarkets – Intermediaries – Financial InstrumentsBanking, Securities, Insurance (further functional

and timing differentiation) Monetary (short term)/capital (medium-long term) Primary/Secondary Retail/Wholesale Internal/International Regulated/Unregulated

Financial Intermediaries:

Banks, securities int., insurance firmsBanks: real time claim with sure nominal

valueCommercial Banks/Investment banksDealing (Own account/on behalf of),

Portfolio management, advisory servicesLife Insurance

1. Why do we regulate(/supervise)?

Same reasons of public intervention in the economy:

StabilityEfficiencyEquity

2. Why do we regulate(/supervise)? Macroeconomic Stability (Monetary Policy, LLR,

Payment Systems, Settlement and Clearing, Wholesale Mkts)

Microeconomic Stability (Prudential Supervision, entry/exit controls, registers, capital requirements, limits to activities, controls on off-balance operations, protection schemes…)

Market Transparency and Investor Protection (disclosure requirements, proper behaviour, homogeneous treatment, conflict of interest)

Efficiency: Safeguarding and Promoting Competition

3. Theory of financial intermediation and regulation

Traditional or classicNew viewAsymmetric infoNew theory

Traditional theories

Banks: only inter-mediariesEconomic stability/positive slope of

interest rate curveReasons for banks: timing transformation,

risk sharing, transaction cost reduction, investment divisibility, payment services

Deposits: lower return than market

Traditional regulation

Banks: only inter-mediaries = Banks important! Only intermediaries in the economy: must be regulated!

Nazionalization, antitrust, asset and liabilities limitations, (functional, geographical, reserve requirements)

Cons: inefficient, no economies of scale and scope, no innovation

New view

Gurley and Shaw, Tobin Financial Innovation Speciality of Banks due to regulation,

NOT nature! End of banks due to competition by

other intermediaries? Deregulation

Asymmetric info theories

Asset asymmetries: scope economies for monitoring (Diamond)

Liability asymmetries: optimal deposit (Diamond-Dybvig)

Risk-based regulation (Basle, AD risk based)

New theories

No difference between banks and other intermediaries

“Less bank” (deposit and loans, more services (asset management, underwriting, advice)

Inter-mediaries among entities in surplus and deficit on one side and financial markets on the other

Regulation by objective (twin/four peaks) Separation central banking/banking supervision Federal dimension

4. How do we regulate at national level

INSTITUTIONAL (by subject)REGULATION BY OBJECTIVE SINGLE REGULATORFUNCTIONAL - by activity

Financial supervision in selected countries, 2012

Country Banking Securities Insurance/Pension fund

Austria FSA FSA FSA

Belgium CB/FSA CB/FSA CB/FSA

Denmark FSA FSA FSA

Finland FSA FSA FSA

France PA/IP PA/IP PA/IP

Germany FSA FSA FSA

Greece CB S CB/G

Ireland CB CB CB/PF

Italy CB/S S/CB I-CB/PF

Luxembourg FSA FSA FSA/I

Netherlands CB/S CB/S CB/S

Portugal CB/S S/CB I

Spain CB/S S/CB G

Sweden FSA FSA FSA

UK (end 2012) CB/IP CB/IP CB/IP/FP

EU EBA ESMA EIOPA

United States B/CB B/CB/S/S I/CB

Japan FSA FSA FSA

CB (Central bank), PA (Prudential Authority on banks, securities and insurance, different from CB), B (Prudential Agency for banks), IP (Investor protection Authority for banks, securities and insurance), S (Securities Authority), I (Insurance Authority), PF (Pension Fund Authority), FSA (Single prudential and investor protection regulator), G (Government department)

“Optimal” Model? Different for industrial, emerging and developing

countries. Path-dependence: any reform starts from a status

quo, and this is often “hybrid”, characterized by the adoption of regulatory regimes that mix different elements of the models above.

In Europe, today, the debate focuses on: a) centralizing powers and responsibilities versus maintaining a mainly domestic view, b) choosing a regulatory model (currently in the single countries).

Domestic regulation/supervision still good?

One currency (but not UK), one monetary policy.....different FM rules? Consolidated regulation

How to deal with financial groups and conglomerates? Need some consolidated supervision (more than lead regulator)

Incentives for policy makers and regulators to compete in regulatory or supervisory laxity in order to attract more firms and funds locally. At the same time, it is not clear who will pay the costs of insolvency. And it is not clear how a solvency (or even a liquidity) crisis will be managed.

Hence…More Harmonization in FMR is needed as FM integration goes on (M&A among exchanges, internet, X-border mergers among intermediaries, dual and X-border offerings and listings), in order to promote further integration

However… Not necessarily harmonization means full

centralization. The Euro area (but UK?) may be too large for one (or more) central regulator (s)

Too many different national rules exist (commercial codes, company laws, insolvency procedures, corporate governance)

Fiscal policies still not harmonized In many cases, national enforcement might still

be desirable Too early for full centralization….too late for

complete decentralization

Then...September 12 package.....

Exclusive power of ECB on prudential supervision of banks of Euro area

Opt in by EU non euro countries Supervisory Board within ECB Still some parts of a Federal model Securities and Insurance untouched Use of art. 127(6) TFEU

The sources of the EU financial legal framework

Lisbon treaty Directives, Regulations, Communications, .... Commission/Council/Parliament or other Minimum/Maximum Harmonization Implementation Level 1 or 2

Figure 1. The Lamfalussy Structure

Council

Parliament

Commission

EBC1 ESC1

EIOPC1

CEBS2 CESR3

CEIOPS3

Commission

L1LegislationL2

Implementing details

L3 Guidelines

L4 Enforcement

¹ Finance ministries ² Supervisors and Central Banks ³ Supervisors

EBC = European Banking CommitteeESC = European Securities CommitteeEIOPC = European Insurance and Occupational Pensions CommitteeCEBS = Committee of European Banking Supervisors CESR = Committee of European Securities RegulatorsCEIOPS = Committee of European Insurance and Occupational Pensions Supervisors 19