Increased Co-operation Is Essential

IOSCO’s response to the G-20 Challenge to financial regulators

Originally published in the February 2009 issue

The G-20, at its recent Washington summit, recognised that while the regulation of financial markets is the responsibility of national regulators, the reality is that financial markets are global and therefore increased cooperation between regulators is essential. The G-20 also recognised the need for the strengthening of international standards and their consistent implementation, in order to avoid further market deterioration and to ensure the future viability of capital markets.

The Technical Committee of the International Organization of Securities Commissions (IOSCO), in response to the worsening financial crisis and the G-20’s recommended actions, met on 24 November 2008 to consider IOSCO’s response. The meeting resulted in the creation of three task forces to address the specific concerns of the G-20, in relation to market integrity and short selling, unregulated markets and products, and unregulated financial entities.

Christopher Cox, the then Chairman of IOSCO’s Technical Committee and then Chairman of the United States Securities and Exchange Commission, emphasised that “the regulation of trading abuses must be coordinated across major markets” and that “the three task forces the Technical Committee is forming….will help ensure that global capital markets address the current turmoil on a sound basis and in a well-coordinated way.”

The three Task Forces of the Technical Committee, whose work is currently underway, are focusing on the following issues:

Short Selling
In recent months, many jurisdictions have taken steps to restrict short sales in their markets in light of the ongoing financial market turmoil. These efforts have focused particularly on the securities of financial institutions whose performance may have an impact on financial stability. Some jurisdictions also have temporarily taken supplementary steps to address particular concerns in their markets, including restrictions on both naked and covered short selling.

Since the initial restrictions were imposed, these positions have changed, with several jurisdictions relaxing their ban on short-selling but maintaining the temporary disclosure regimes and retaining the option of re-imposing restrictions.

In light of the restrictions and their possible effects, securities regulators have an interest in attempting to develop and implement a common set of measures related to short selling, including specific ones related to their enforcement.

The Task Force on Short Selling is considering the effectiveness of the recent regulatory responses and whether to establish principles regarding short sales, including reporting, delivery, and pre-borrowing requirements, as a means of reducing manipulative short selling without stifling legitimate short selling activity.

In addition, it is examining how to minimize adverse impacts on legitimate securities lending, hedging and other types of transactions that are critical to capital formation and to reducing market volatility.

Unregulated Financial Markets and Products

In light of the impact that unregulated financial markets and products have had on global capital markets, the Task Force on Unregulated Financial Markets and Products is examining ways to introduce greater transparency and oversight to unregulated market segments, such as the over-the-counter OTC markets for derivatives and other structured financial products. The task force will identify the most pressing issues relating to transparency to the market and due diligence practices arising from unregulated financial markets and products including:

• The best methods of dealing with these issues, particularly in relation to the disintermediated debt market; and
• Where regulators should focus their efforts.

The task force intends, using two product areas as examples in its report, to illustrate what regulators can do to assist with restoring confidence in the integrity of these products and market segments, namely through:

• Analysing the regulatory issues that would need to be resolved to assist with renewing confidence in the integrity of these markets; and
• Considering how the principles identified by the G20 could be applied to the specific areas of securitisation and credit derivatives.

Unregulated Financial Entities
The ongoing financial market turmoil has once again drawn attention to the issues posed by the activities of unregulated financial entities, particularly hedge funds.

This Task Force on Unregulated Financial Entities is focusing primarily on hedge funds. Specifically, it is examining the issues posed by hedge funds to capital markets and lessons to be drawn from the crisis and the current level of regulation of hedge funds. It is also comparing the lessons drawn from the crisis and the existing principles and standards. The aim is to work towards the development of recommended regulatory approaches to mitigate risks associated with hedge funds’ trading activities and their traditional opacity.

The topics that the task force is focusing on are:

• Hedge funds’ role in the financial market crisis, both in build-up of leverage and subsequent deleveraging;
• Impact of hedge funds on the wider financial market;
• Market behaviours and transparency of investment strategies;
• Transparency/disclosure/reporting to the regulator, market, prime brokers, investors and unit holders at the entry point and on an on-going basis;
• Issues related to the role of offshore centres in the hedge funds industry; and
• Codes issued by the industry and how these might develop and be implemented.

The Task Forces aim to produce reports for consideration by the Technical Committee in mid-February, with a view to providing preliminary findings for inclusion in the report to the G-20 leaders ahead of the G-20 summit in April.

Industry Dialogue
The Technical Committee has an ongoing dialogue with financial markets stakeholders regarding the Technical Committee’s work and held a meeting on 16 January where a wide range of financial market participants engaged in frank and constructive discussions with representatives of the Technical Committee.

Hans Hoogervoorst, the vice-chairman of the Technical Committee and Chairman of the Netherlands AFM, felt that the meeting “provided the Technical Committee with clear industry views on our work and its direction. This will help inform the development and progress of our workstreams and contribute to the views that IOSCO will submit to the G-20 and its working groups ahead of the next G-20 summit.”

G-20 Participation
In recognition of its role in the development of international regulatory standards, IOSCO has also been invited to participate in two of the G-20 Working Groups – Enhancing Sound Regulation and Strengthening Transparency; and Financial Market Integrity and International Cooperation.

IOSCO’s participation in these Working Groups will ensure that the views of securities regulators are present at the policy formulation stage within the G-20.