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Development of equity markets

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Overview of key building blocks for the development of ... National exchanges: NYSE, Amex ... Amex. Nasdaq. NYSE. FSD. 2002. Case: The U.S. Equity Market - III ... – PowerPoint PPT presentation

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Title: Development of equity markets


1
Development ofequity markets
  • Jeppe Ladekarl
  • Financial Sector Department
  • The World Bank

2
Structure of presentation
  • Overview of key building blocks for the
    development of an equity market
  • What characterizes a good market
  • Case the US equity market
  • Should equity market development be a public
    policy priority?
  • What are the common (mainly regulatory) problems
    we see in emerging equity markets?

3
The building blocks of the market
  • Issuers
  • Investors
  • Intermediaries
  • Soft infrastructure (legal, regulation
    supervision, accounting, taxation)
  • Hard infrastructure (trading, clearing
    settlement, securities depository)
  • Instruments

4
Overview of the key components
Issuers User of capital
Investors Suppliers of capital
Intermediaries - provides liquidity - access to
investors
Market infrastructure - trading systems -
information systems - brokers - clearing and
settlement - registration
Regulation and supervision. - The Central Bank,-
The Government- Self Regulatory Organizations
5
Market cap of NYSE 11.7 trillion
Source SP Emerging Markets Database
6
Desirable Market Characteristics
  • Transparent
  • Timely and accurate information about prices and
    volume, as well as trends in supply and demand
    should be available
  • Efficient
  • Internally efficient low direct and indirect
    transaction cost (commissions, taxes, market
    impact costs)
  • Externally efficient market prices adjust
    quickly to new information (prices are fair).
    Farma efficiency
  • Liquid
  • Market liquidity is not easily defined. Three
    factors are usually considered tightness, depth
    and resiliency.

7
A note on market liquidity
  • Tightness is how far transaction prices diverge
    from mid-market prices. (bid-ask spreads).
  • Market depth usually refers to the volume of
    trades possible without affecting market prices.
    (Amount of orders on the order book market
    impact fluctuation in quotes or bid-ask spread
    resulting from a trade).
  • Market resiliency is the speed with which
    imbalances in the market are absorbed. (The speed
    of the restoration of normal market conditions
    (such as bid-ask spread and order volume) after
    trades).

8
Case The U.S. Equity Market - I
  • Market venues
  • National exchanges NYSE, Amex
  • Regional exchanges Boston, Chicago, Cincinnati,
    Philadelphia, and Pacific Stock Exchanges
  • Over-the-counter markets (NASDAQ, )
  • Brokered institution OTC market (NYSE
    Intermarket, Nasdaq intermarket,)
  • Direct institutional trading (ECNs, )

9
Case The U.S. Equity Market - II
NYSE Nasdaq Amex
Number of issues 3543 4363 802
Total market cap. (USD) 11.7 trillion 2.9 trillion 103.1 billion
Avg. daily share volume 1.2 billion 1.8 billion 54.1 million
Revenues (USD) 815.3 million 832.7 million 270.4 million
10
Case The U.S. Equity Market - III
  • The regulatory issue in the US as identified by
    the SEC
  • Undermining of market quality by the formation
    of disparate liquidity pools within a fragmented
    structure

11
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12
Case The U.S. Equity Market - IV
  • Possible remedies
  • Greater disclosure by market centers of trade
    execution and order routing
  • Restrictions on internalization and payment for
    order flows
  • Exposure of market orders to price competition
  • Change intermarket trading priorities (prevent
    trading ahead of displayed limit orders, time
    priority to the first order that improves the
    national best bid or offer (NBBO)
  • Creation of a central limit order book
  • Modification of the Intermarket Trading System
    (ITS)

13
Is there a future for equity markets in small
economies?
  • Increasing price correlation between US and other
    markets. Are the benefits of international
    diversification shirking?
  • Listing of national champions increasingly
    occurring in international centers (direct
    listing, ADR, GDR)
  • Network externalities favor larger markets.
    Liquidity disappears in smaller markets?
  • Does new technology have an impact?
  • Price formation occurs where news is
    disseminated. Is the local monopoly to news
    services evaporating?

14
What should the policy response be?
  • Use of legal monopolies and/or local listing
    requirements? (infant industry argument and
    market fragmentation)
  • Demutualize the exchange in preparation for
    competition?
  • Support introduction of technology intensive
    competitors (ACNs, ECNs)?
  • Import regulatory functions?
  • Introduce regulation light regimes?
  • Regional corporation?

15
Regulation
  • Objectives of regulation
  • Ensure fair, efficient and transparent markets
  • Minimize systemic risk
  • Ensure investor protection
  • With regulation the devil is in the detail

16
The IOSCO Principles
  • Objectives and Principles of Securities
    Regulation from 1998 (http//www.iosco.org/library
    _docs-public.html)
  • Subjects covered by the 30 principles
  • The regulator
  • Self Regulatory Organizations
  • Enforcement
  • Corporation
  • Issuers
  • Collective investment schemes
  • Market Intermediaries
  • Secondary market

17
Principles Relating to the Regulator
  • The responsibilities of the regulator should be
    clear and objectively stated
  • The regulator should be operationally independent
    and accountable in the exercise of its functions
    and powers
  • The regulator should have adequate powers, proper
    resources and the capacity to perform its
    functions and exercise its powers.
  • The regulator should adopt clear and consistent
    regulatory processes.
  • The staff of the regulator should observe the
    highest professional standards including
    appropriate standards of confidentiality.

18
Common problems
  • Unclear mandate
  • Responsibilities divided between different
    agencies (loopholes and overlaps
  • No independence (the ministry dominates)
  • Lack of human, monetary and IT resources
  • Lack of consistency in application of policy
  • Corruption?

19
Principles for Self-Regulation
  • The regulatory regime should make appropriate use
    of Self-Regulatory Organizations (SROs) that
    exercise some direct oversight responsibility for
    their respective areas of competence, to the
    extent appropriate to the size and complexity of
    the markets.
  • SROs should be subject to the oversight of the
    regulator and should observe standards of
    fairness and confidentiality when exercising
    powers and delegated responsibilities.

20
Common problems
  • No use of SROs or SRAs
  • Over reliance on SROs (more powerful and capable
    than the regulator)
  • No oversight of the SRO
  • No clear definition of SRO responsibilities
  • Regulatory capture of the SRO by market
    participants
  • A governance/ownership structure of the SRO,
    which creates conflict of interest and adverse
    incentives
  • Unclear design of SRO functions after
    demutualization

21
Principles for the Enforcement of Securities
Regulation
  • The regulator should have comprehensive
    inspection, investigation and surveillance
    powers.
  • The regulator should have comprehensive
    enforcement powers.
  • The regulatory system should ensure an effective
    and credible use of inspection, investigation,
    surveillance and enforcement powers and
    implementation of an effective compliance program.

22
Common Problems - I
  • Unclear division of labor in enforcement and
    investigation between e.g. regulator, police, and
    prosecutors
  • Lack of investigative powers (supeena documents
    and information from industry as well as others,
    right to interrogate, access to premises)
  • Lack of enforcement powers (administrative,
    criminal, and civil tools)

23
Common Problems - II
  • Lack of desire, skills and practical tools to
    make use of existing investigative and
    enforcement powers
  • Inconsistent application of powers
  • Wrong focus no use of risk based supervision
    focus more on formal compliance, filing
    requirements etc. check box approach

24
Principles for Cooperation in Regulation
  • The regulator should have authority to share both
    public and non-public information with domestic
    and foreign counterparts.
  • Regulators should establish information sharing
    mechanisms that set out when and how they will
    share both public and non-public information with
    their domestic and foreign counterparts.
  • The regulatory system should allow for assistance
    to be provided to foreign regulators who need to
    make inquiries in the discharge of their
    functions and exercise of their powers.

25
Common Problems
  • Overlap and underlap in regulation and
    supervision
  • No domestic MoUs (banking and securities
    regulator, accounting board, corporate
    registration)
  • No international MoUs
  • Only high level and not day to day
    corporation
  • Problems with exchange of information due to
    secrecy laws

26
Principles for Issuers
  • There should be full, timely and accurate
    disclosure of financial results and other
    information that is material to investors
    decisions.
  • Holders of securities in a company should be
    treated in a fair and equitable manner.
  • Accounting and auditing standards should be of a
    high and internationally acceptable quality.

27
Common problems
  • Inadequate ongoing and initial disclosure of
    information from listed companies
  • Where information is given the administrative
    burdens overwhelm the regulator (lack of
    prioritization and inadequate access to use of IT
    edgar type filing)
  • Lack of minority shareholder protection
  • Weak corporate governance (and no corporate
    governance code)
  • Low accounting and auditing standards. No
    enforcement of standards in place

28
Principles for Collective Investment Schemes
  • The regulatory system should set standards for
    the eligibility and the regulation of those who
    wish to market or operate a collective investment
    scheme.
  • The regulatory system should provide for rules
    governing the legal form and structure of
    collective investment schemes and the segregation
    and protection of client assets.
  • Regulation should require disclosure, as set
    forth under the principles for issuers, which is
    necessary to evaluate the suitability of a
    collective investment scheme for a particular
    investor and the value of the investors interest
    in the scheme.
  • Regulation should ensure that there is a proper
    and disclosed basis for asset valuation and the
    pricing and the redemption of units in a
    collective investment scheme.

29
Common Problems
  • Weak eligibility criteria fit and proper
  • CISs used as dumping ground for banks
  • Weak asset management capability
  • Lack of asset segregation
  • Role of (independent) custodians unclear
  • Asset valuation in illiquid markets
  • High direct and indirect costs
  • Lack of disclosure of costs

30
Principles for Market Intermediaries
  • Regulation should provide for minimum entry
    standards for market intermediaries.
  • There should be initial and ongoing capital and
    other prudential requirements for market
    intermediaries that reflect the risks that the
    intermediaries undertake.
  • Market intermediaries should be required to
    comply with standards for internal organization
    and operational conduct that aim to protect the
    interests of clients, ensure proper management of
    risk, and under which management of the
    intermediary accepts primary responsibility for
    these matters.
  • There should be procedures for dealing with the
    failure of a market intermediary in order to
    minimize damage and loss to investors and to
    contain systemic risk.

31
Common Problems
  • Very low minimum entry standards. fit and
    proper
  • Unregulated brokers active in the market
  • Capital not adequate for the business exposure
  • Know you client rules not implemented
  • best execution not ensured. Client order
    handling rules mechanic.
  • Segregation of assets unclear
  • Conduct of business rules, if in place, not
    enforced
  • Lack of funding tools for market intermediaries

32
Principles for the Secondary Market - I
  • The establishment of trading systems including
    securities exchanges should be subject to
    regulatory authorization and oversight.
  • There should be ongoing regulatory supervision of
    exchanges and trading systems which should aim to
    ensure that the integrity of trading is
    maintained through fair and equitable rules that
    strike an appropriate balance between the demands
    of different market participants.
  • Regulation should promote transparency of trading.

33
Principles for the Secondary Market - II
  • Regulation should be designed to detect and deter
    manipulation and other unfair trading practices.
  • Regulation should aim to ensure the proper
    management of large exposures, default risk and
    market disruption.
  • Systems for clearing and settlement of securities
    transactions should be subject to regulatory
    oversight, and designed to ensure that they are
    fair, effective and efficient and that they
    reduce systemic risk.

34
Common problems - I
  • No definitions of exchange (ATS, ECNs,
    Interdealer brokers)
  • Weak regulatory oversight of the exchange and its
    SRO functions
  • Opaque trading environment pre- and post trade
    information only available to select market
    participants
  • Minimum commissions
  • once size fits all approach to market regulation

35
Common problems - II
  • Unclear definitions of market manipulation.
  • Market abuse no deterrence or preventive
    measures
  • Tainted script in the market
  • Dematerialization / immobilization of script not
    in place. No central securities depository.
  • No Electronic Fund Transfer System (I.e. no DVP)
  • T ?. Use of account period settlement system.
  • No central clearing counterparty
  • Inadequate risk management of open positions

36
Sequencing ?
  • Start top down with a securities law
  • Provide market structure owned by the government
    but run as a company
  • Ensure concentration of liquidity (monopoly or at
    least reporting and trade consolidation)
  • Build and rely on a paperless depository system
  • Start with a few stocks relying on local investor
    interest for liquidity
  • Use a non-continues auction market

37
Thank you !
  • Questions/comments/suggestions to
  • Jeppe Ladekarl
  • jladekarl_at_worldbank.org
  • (202) 473-4718
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