CFA Institute on Self -Regulation in Financial Markets
CFA Institute
Self-Regulation in the Financial Markets: Exchange Issues, Market Structure, and
Investor Protections
Thursday, June 12, 2014
Key Topics & Takeaways
- Mary Schapiro noted that removing SRO status of exchanges is not realistic because both the SEC and CFTC are still underfunded and would lack the resources to take on the SROs’ regulatory duties
- Richard Ketchum discussed how even if exchanges did not have SRO status they would still remain responsible for integrity of their market, so therefore would have a regulatory responsibility.
- David Blass discussed the benefits that SRO’s provide, which include: (1) more resources; (2) inside information and expertise; and (3) closer relationship with members.
- Panelists stressed that the benefits of SROs outweighed the conflict of interests.
Meeting Participants
- Anna Martinez, CFA, President, CFA Institute
- Jim Allen, CFA, Head of Capital Markets Policy-Americas, CFA Institute
- Mary Schapiro, Vice Chairman of the Advisory Board, Promontory Financial Group
- Chris Brummer, Professor of Law, Georgetown University Law Center
- Amarilis Sardenberg, Chair of the Board, BM&FBOVESPA
- Susan Wolburgh Jenah, President and CEO, IIROC
- Roberta Karmel, Centennial Professor of Law, Brooklyn Law School
- Richard G. Ketchum, Chairman and CEO, FINRA
- Andrew N. Vollmer, University of Virginia Law School
- David W. Blass, Chief Council, SEC
- Lynnette Kelly, Executive Director, MSRB
- Daniel J. Roth, President and CEO, NFA
- Cheryl Evans, Senior Investigator, CFA Institute
Opening Remarks
Jim Allen opened the conference by stating that Self-Regulating Organizations are always on the mind of the CFA Institute and that they support SROs because of the professionalism and agility in regulatory response they bring to the market. He stated that self-regulation is the de facto standard in 38 countries, and is beginning in Latin America as well. He said to create a trustworthy and forward-thinking industry, SROs must provide stability, transparent markets, sensitivity to investors, objectivity, experience, and an understanding that SROs are not always the solution.
Mary Shapiro, Vice Chairman of the Advisory Board at Promontory Financial Group stated that a professional, independent, well funded, and technologically able SRO can be a positive institution for the markets. Shapiro stressed that Congress does not adequately fund primary regulators, and this absence of political will to improve funding will perpetuate SROs. She concluded stating that she does not believe SROs are a necessary evil or second choice, but rather an opportunity for deep domain expertise, technology capability, and shared funding. She then highlighted the importance of governmental oversight and public interest, and stated it is the government’s responsibility to hold SROs accountable to ensure the public interest is put above all others.
Panel 1 – Global Overview: Role of Self-Regulation in Increasingly Interconnected and Complex Markets
Witnesses
Susan Wolburgh Jenah, President and CEO of Investment Industry Regulatory Organization of Canada (IIROC), explained that SROs regulate investment firms through their authority over the market, enforcement of business conduct, registration requirements, and real-time market surveillance. She added that IIROC, a recognized SRO, does this while maintaining transparency, accountability, independence, and being subject to oversight by a primary regulator.
Amarilis Sardenberg, Chair of the Board of BM&FBOVESPA Market Supervision, explained that in Brazil there are three types of markets: the government bond market, the private bond market, and the securities market of stocks and derivatives. She added that the central banks are the primary regulator of government bonds, but not for the private bonds and securities. She noted that private over the counter markets and exchanges have a mandatory SRO. Sardenberg concluded that the staff and the board of her organization are completely independent from the exchange, even though their budgets are combined.
Discussion
Challenges of SROs
On the topic of challenges surrounding SROs, Allen asked what the difficulties are and how they affect the public and the market.
Chris Brummer, Professor of Law at Georgetown University Law Center, responded that globalization leads to democratization of capital and has caused dispersion that changed how markets are regulated as well as the coordination between SROs and regulators. He noted that the markets are no longer run by the New York Stock Exchange (NYSE), but rather through other means that he referred to as “soft-law”. Brummer asserted that the major challenge of SROs is the supervision, stating that “rule making does not equal supervision”. He surmised that putting pressure on SROs through development and globalization will lead to increased supervision.
Wolburgh stated that she believed the challenges stem from unprecedented market evolution, but that these can be overcome through specialization of function within SROs along with expertise surveillance with the primary regulators, ultimately creating transparency. She then highlighted the importance of data in policy development. She said data needs to be used to inform high frequency trader (HFT) activity to weigh the advantages and disadvantages.
Sardenberg agreed with Wolburgh, and stated that coordination and communication between regulators is an important issue. She discussed how Brazil is transitioning from a national to international market. She highlighted the importance of investing in IT training, and investing in knowledgeable experts.
Technological Issues: Hackers
Allen questioned the speakers on their knowledge of hackers within the realm of SROs, and ways in which their firms and institutions are fighting against this threat.
Wolburgh stated that this is a top priority and it is important to ensure the industry is sensitized to hackers. She asserted her role is to ensure all firms understand how they could be a victim, and to promote ways for cost effective protections. She noted IIROC hires professionals annually to try and attack thier system to find any possible loopholes.
Harmonization Issues: Divergence
Allen questioned the speakers on how to achieve harmonization of regulations and accounting practices.
Brummer stated that the dangers of divergence are slightly overplayed insofar as there has been enormous progress made in coordination. He further discussed, however, how countries can be in agreement at a broad level, but then disagree on specifics. He then said that many of the acute challenges will involve moving from the questions of rulemaking to supervision of cross border financial activities.
Wolburgh stated that the issues come from the fact that regulatory structure does not always keep up with these changes, so old regulations are serving an ever changing business environment. She noted that competition incentivizes change and innovation, but can create a lack of consistent standards.
Sardenberg then discussed the emerging market in Brazil and said that divergence stems for a lack of acceptance of U.S. rules in Brazil and that regulators and participants are resistant to changes which seek harmonization.
Industry Capture
Wolburgh said there is a large spectrum of different SRO models, and that recognized SROs require recognized enforcement authority. She stated that the general public believes SROs are the industry regulating itself alone, but she explained that IIROC has professional staff to make their rules with the industry being just one player.
Sardenberg stated that mandatory SROs were established by the national securities commission in Brazil, and their main purpose is to be effective, and transparent. She emphasized that the shareholders of the exchange support the SRO and although the budget is submitted and provided by the securities commission, it is independent.
Panel 2 – Exchange SROs: Meeting the Needs of Investors and the Financial Marketplace
Witnesses
Mary Shapiro began the discussion with the historical context of SROs. She stated that historically, they were member owned facilities dating back to 1817. However, she noted they were not codified into federal law until 1934. Schapiro highlighted that Congress has consistently shown strong support for SROs, and attributed this support to their cost effectiveness, efficiency, flexibility to impose higher standards, more prescriptive rules, and deep expertise. When exchanges became for-profit, Shapiro said, their motives to maximize profits and compete with non-SRO trading became a conflict of interest. However, she asserted that the benefits outweigh these conflicts.
Roberta Karmel, Centennial Professor of Law, at Brooklyn Law School asserted that she viewed the history of SROs more cynically. She said that fixed commissions held together the framework of exchanges as SROs and that self-regulation had always been based on price fixing. She stated that in the National Association of Securities Dealers’ system (NASD), trading with each other and regulation of that exchange was often in the interest of the members. She asserted that the ever-changing nature of the markets raises questions about the future of self regulation but that ultimately, self regulation is good because “the industry is close to it, and the rules are closer to reality.”
Richard G. Ketchum, Chairman and CEO of the Financial Industry Regulator Authority (FINRA), responded that, “SROs have less to do with self-regulation and more to do with accessible regulation.” He explained the role of FINRA as two-fold: it combines the two largest entities, NASD and the New York Stock Exchange (NYSE), and takes responsibility from a market surveillance standpoint. Regarding the responsibilities of exchanges as SROs, he clarified that exchanges cannot give total oversight responsibility to FINRA but instead can contract them out for this monitoring. Ketchum added that exchanges can delegate some functions but not all.
Discussion
Efficiency of Current System
The moderator, Andrew N. Vollmer, University of Virginia School of Law, asked the panel if the current system of SROs is working well, and well enough to not make changes.
Schapiro noted that government oversight and transparency are essential, and that engaging stakeholders and properly funding technology also enable the system work effectively.
Karmel agreed with Schapiro but noted that until the Securities and Exchange Commission (SEC) becomes self-funded or joins forces with the Commodity Futures Trading Commission (CFTC), there is no choice but to stick with the current system. She further added that FINRA does a good job but unless something unifies the markets to address fragmentation and changes in trading, exchanges should not be SROs.
Vollmer asserted that the terminology of SROs may cause confusion and asked if SROs can be a force multiplier for government regulators.
Ketchum stated that the value of SROs comes from their leverage of funding as well as their level of knowledge, focus, and access.
Vollmer asked if the benefits of original SROs had been lost, and namely if they had more expertise, could innovate better than the government, and were closer to and had a better appreciation for the industry.
Ketchum stated that they have, in part, lost the benefits of the original SROs, but for good reason. He noted that the costs and risks were too great when SROs did not step up and thus required government interference. He also highlighted that the value of the members has been retained even if they lost some of their control. He asserted that FINRA is thoughtful in the knowledge it provides.
Karmel stated that a lot has been lost due to the industry’s destruction of the exchange model of trading and their preference for fragmentation. She also said the industry does not feel a connection to securities anymore and have lost the sense of obligation to the system that existed in old SROs.
Role of Exchanges
Vollmer asked if there were other responsibilities exchanges had as regulatory organizations or if there was an advantage to FINRA controlling them.
Schapiro noted that exchanges will always have a public responsibility even if they are controlled by FINRA.
Ketchum explained that exchanges are very active in the rule-making process and create their own fundamental rules. He also highlighted that exchanges always remain responsible for the integrity of their markets.
Karmel asserted that it would be better if exchanges were more competitive and cared about the products they list. She noted that exchanges should have stricter price listing requirements.
Streamlining CFTC & SEC
Vollmer asked if it would be beneficial to combine both the CFTC and SEC.
Schapiro, having held leadership positions on both the CFTC and SEC, stated that the two agencies are very competitive entities and it would be difficult to come together. However, she asserted that she had “argued both sides of the merger” and that the need for them to be combined was highlighted by Dodd-Frank.
Karmel was also in support of a combination of the two however she believed that ultimately politics gets in the way of any sort of merger.
Panel 3 – U.S. System of Self-Regulation Through SROs
Witnesses
Daniel Roth, President and CEO of the National Futures Association (NFA), said that the basic role of the NFA as an SRO is to be the “front line regulator” to monitor the market and take disciplinary action. He noted that rules adopted by the NFA are subject to CFTC approval and that there is daily communication between the two bodies.
Lynette Kelly, Executive Director of the Municipal Securities Rulemaking Board (MSRB), explained that the MSRB is not a membership organization and noted that while it writes rules to regulate the market, other agencies are the ones to enforce these rules. Kelly highlighted that the MSRB was set up to protect investors and that the Dodd-Frank Act also required the agency to protect municipal issues. Protection of investors is something that has never been done in the U.S., Kelly mentioned, saying that is has presented challenges as the diversity of issuers is “extreme.”
David Blass, Chief Counsel of the Division of Trading and Markets at the SEC, stated that his division oversees the rule filing process of SROs if they want to make a change; explaining that the staff assesses submissions on behalf of the Commission to determine potential impacts. Blass noted that the SEC also seeks public input on rule changes and has an “open mind” when reviewing comments.
Discussion
Protecting Muni Issuers
Cheryl Evans, CFA Institute and moderator of the panel, asked what the new mandate of protecting issuers has meant for the MSRB.
Kelly replied that dealing with the new mandate has been difficult because many municipal issuers do not want to be protected. She explained that the MSRB has sought to meet this new requirement by making sure that the professionals who issuers deal with are well qualified, transparent, and held to high standards.
SRO Key Traits
Evans then asked what qualities of an SRO are most significant.
Roth replied that enforcement responsibilities are a “huge part” of being a SRO and highlighted that mandatory membership and the ability to expel members, thus potentially putting them out of business, is a key to a strong enforcement regime.
Kelly stated that the ability to collect market data along with innovation to “get ahead of the curve” in regulation are important qualities of effective self regulation.
Blass noted that he values the “front line capabilities” of SROs and the expertise they bring to monitoring the markets.
Data and Policy Making
Evans then asked how surveillance information and market data are used to make policy decisions.
Blass said that the SEC is “data centric” in their policy initiatives and cited use of the Market Information Data Analytics System (MIDAS) to gather timely information to make rulemaking decisions and respond to market events. He added that the SEC has more capabilities than ever before to analyze big data and that they use this information to monitor for improper sales practices.
Kelly explained that the MSRB voluntarily adopted a cost-benefit policy to engage in economic analyses “grounded in hard data” for their rulemakings.
Roth noted that a challenge of collecting large amounts of information is being able to “connect the dots” and look for “combinations of data elements that raise flags.” He also stressed that computer systems should be “a tool and not a crutch” as human judgment is still important when analyzing data.
Managing Conflicts of Interest
Evans asked how SROs manage any conflicts of interest inherent in their structure.
Roth explained that conflicts have proven to be managed effectively over time through proper oversight and governance practices, adding that having diverse interests on the board of directors helps create a system of checks and balances.
Kelly agreed that “good governance is key” and the fact that the MSRB staff is independent “adds another layer” of checks and balances.
Blass noted that the SEC has sanction authority if a SRO is not fulfilling its responsibilities or is seen as being subject to “undue industry influence.”
Data Sharing
Evans asked how data is shared among different regulatory agencies and how duplicative efforts are reduced.
Roth noted that the CFTC has access to all NFA data and that the NFA communicates with other regulators such as FINRA if they see problems with firms who are active in other markets.
Kelly noted that the MSRB has formal information sharing agreements with FINRA, the bank regulators, and the Internal Revenue Service (IRS). She added that the MSRB requests subpoenas if other agencies want their data. Kelly said “it is ridiculous to have redundant systems and not share information.”
Prescriptive vs. Principals Based Rules
Evans asked if future regulations will be more prescriptive and specific in nature or principals based.
Blass and Roth agreed that both approaches have benefits in different circumstances and that one approach will not likely win out over the other in the future.
For more information on this event, please click here.
CFA Institute
Self-Regulation in the Financial Markets: Exchange Issues, Market Structure, and
Investor Protections
Thursday, June 12, 2014
Key Topics & Takeaways
- Mary Schapiro noted that removing SRO status of exchanges is not realistic because both the SEC and CFTC are still underfunded and would lack the resources to take on the SROs’ regulatory duties
- Richard Ketchum discussed how even if exchanges did not have SRO status they would still remain responsible for integrity of their market, so therefore would have a regulatory responsibility.
- David Blass discussed the benefits that SRO’s provide, which include: (1) more resources; (2) inside information and expertise; and (3) closer relationship with members.
- Panelists stressed that the benefits of SROs outweighed the conflict of interests.
Meeting Participants
- Anna Martinez, CFA, President, CFA Institute
- Jim Allen, CFA, Head of Capital Markets Policy-Americas, CFA Institute
- Mary Schapiro, Vice Chairman of the Advisory Board, Promontory Financial Group
- Chris Brummer, Professor of Law, Georgetown University Law Center
- Amarilis Sardenberg, Chair of the Board, BM&FBOVESPA
- Susan Wolburgh Jenah, President and CEO, IIROC
- Roberta Karmel, Centennial Professor of Law, Brooklyn Law School
- Richard G. Ketchum, Chairman and CEO, FINRA
- Andrew N. Vollmer, University of Virginia Law School
- David W. Blass, Chief Council, SEC
- Lynnette Kelly, Executive Director, MSRB
- Daniel J. Roth, President and CEO, NFA
- Cheryl Evans, Senior Investigator, CFA Institute
Opening Remarks
Jim Allen opened the conference by stating that Self-Regulating Organizations are always on the mind of the CFA Institute and that they support SROs because of the professionalism and agility in regulatory response they bring to the market. He stated that self-regulation is the de facto standard in 38 countries, and is beginning in Latin America as well. He said to create a trustworthy and forward-thinking industry, SROs must provide stability, transparent markets, sensitivity to investors, objectivity, experience, and an understanding that SROs are not always the solution.
Mary Shapiro, Vice Chairman of the Advisory Board at Promontory Financial Group stated that a professional, independent, well funded, and technologically able SRO can be a positive institution for the markets. Shapiro stressed that Congress does not adequately fund primary regulators, and this absence of political will to improve funding will perpetuate SROs. She concluded stating that she does not believe SROs are a necessary evil or second choice, but rather an opportunity for deep domain expertise, technology capability, and shared funding. She then highlighted the importance of governmental oversight and public interest, and stated it is the government’s responsibility to hold SROs accountable to ensure the public interest is put above all others.
Panel 1 – Global Overview: Role of Self-Regulation in Increasingly Interconnected and Complex Markets
Witnesses
Susan Wolburgh Jenah, President and CEO of Investment Industry Regulatory Organization of Canada (IIROC), explained that SROs regulate investment firms through their authority over the market, enforcement of business conduct, registration requirements, and real-time market surveillance. She added that IIROC, a recognized SRO, does this while maintaining transparency, accountability, independence, and being subject to oversight by a primary regulator.
Amarilis Sardenberg, Chair of the Board of BM&FBOVESPA Market Supervision, explained that in Brazil there are three types of markets: the government bond market, the private bond market, and the securities market of stocks and derivatives. She added that the central banks are the primary regulator of government bonds, but not for the private bonds and securities. She noted that private over the counter markets and exchanges have a mandatory SRO. Sardenberg concluded that the staff and the board of her organization are completely independent from the exchange, even though their budgets are combined.
Discussion
Challenges of SROs
On the topic of challenges surrounding SROs, Allen asked what the difficulties are and how they affect the public and the market.
Chris Brummer, Professor of Law at Georgetown University Law Center, responded that globalization leads to democratization of capital and has caused dispersion that changed how markets are regulated as well as the coordination between SROs and regulators. He noted that the markets are no longer run by the New York Stock Exchange (NYSE), but rather through other means that he referred to as “soft-law”. Brummer asserted that the major challenge of SROs is the supervision, stating that “rule making does not equal supervision”. He surmised that putting pressure on SROs through development and globalization will lead to increased supervision.
Wolburgh stated that she believed the challenges stem from unprecedented market evolution, but that these can be overcome through specialization of function within SROs along with expertise surveillance with the primary regulators, ultimately creating transparency. She then highlighted the importance of data in policy development. She said data needs to be used to inform high frequency trader (HFT) activity to weigh the advantages and disadvantages.
Sardenberg agreed with Wolburgh, and stated that coordination and communication between regulators is an important issue. She discussed how Brazil is transitioning from a national to international market. She highlighted the importance of investing in IT training, and investing in knowledgeable experts.
Technological Issues: Hackers
Allen questioned the speakers on their knowledge of hackers within the realm of SROs, and ways in which their firms and institutions are fighting against this threat.
Wolburgh stated that this is a top priority and it is important to ensure the industry is sensitized to hackers. She asserted her role is to ensure all firms understand how they could be a victim, and to promote ways for cost effective protections. She noted IIROC hires professionals annually to try and attack thier system to find any possible loopholes.
Harmonization Issues: Divergence
Allen questioned the speakers on how to achieve harmonization of regulations and accounting practices.
Brummer stated that the dangers of divergence are slightly overplayed insofar as there has been enormous progress made in coordination. He further discussed, however, how countries can be in agreement at a broad level, but then disagree on specifics. He then said that many of the acute challenges will involve moving from the questions of rulemaking to supervision of cross border financial activities.
Wolburgh stated that the issues come from the fact that regulatory structure does not always keep up with these changes, so old regulations are serving an ever changing business environment. She noted that competition incentivizes change and innovation, but can create a lack of consistent standards.
Sardenberg then discussed the emerging market in Brazil and said that divergence stems for a lack of acceptance of U.S. rules in Brazil and that regulators and participants are resistant to changes which seek harmonization.
Industry Capture
Wolburgh said there is a large spectrum of different SRO models, and that recognized SROs require recognized enforcement authority. She stated that the general public believes SROs are the industry regulating itself alone, but she explained that IIROC has professional staff to make their rules with the industry being just one player.
Sardenberg stated that mandatory SROs were established by the national securities commission in Brazil, and their main purpose is to be effective, and transparent. She emphasized that the shareholders of the exchange support the SRO and although the budget is submitted and provided by the securities commission, it is independent.
Panel 2 – Exchange SROs: Meeting the Needs of Investors and the Financial Marketplace
Witnesses
Mary Shapiro began the discussion with the historical context of SROs. She stated that historically, they were member owned facilities dating back to 1817. However, she noted they were not codified into federal law until 1934. Schapiro highlighted that Congress has consistently shown strong support for SROs, and attributed this support to their cost effectiveness, efficiency, flexibility to impose higher standards, more prescriptive rules, and deep expertise. When exchanges became for-profit, Shapiro said, their motives to maximize profits and compete with non-SRO trading became a conflict of interest. However, she asserted that the benefits outweigh these conflicts.
Roberta Karmel, Centennial Professor of Law, at Brooklyn Law School asserted that she viewed the history of SROs more cynically. She said that fixed commissions held together the framework of exchanges as SROs and that self-regulation had always been based on price fixing. She stated that in the National Association of Securities Dealers’ system (NASD), trading with each other and regulation of that exchange was often in the interest of the members. She asserted that the ever-changing nature of the markets raises questions about the future of self regulation but that ultimately, self regulation is good because “the industry is close to it, and the rules are closer to reality.”
Richard G. Ketchum, Chairman and CEO of the Financial Industry Regulator Authority (FINRA), responded that, “SROs have less to do with self-regulation and more to do with accessible regulation.” He explained the role of FINRA as two-fold: it combines the two largest entities, NASD and the New York Stock Exchange (NYSE), and takes responsibility from a market surveillance standpoint. Regarding the responsibilities of exchanges as SROs, he clarified that exchanges cannot give total oversight responsibility to FINRA but instead can contract them out for this monitoring. Ketchum added that exchanges can delegate some functions but not all.
Discussion
Efficiency of Current System
The moderator, Andrew N. Vollmer, University of Virginia School of Law, asked the panel if the current system of SROs is working well, and well enough to not make changes.
Schapiro noted that government oversight and transparency are essential, and that engaging stakeholders and properly funding technology also enable the system work effectively.
Karmel agreed with Schapiro but noted that until the Securities and Exchange Commission (SEC) becomes self-funded or joins forces with the Commodity Futures Trading Commission (CFTC), there is no choice but to stick with the current system. She further added that FINRA does a good job but unless something unifies the markets to address fragmentation and changes in trading, exchanges should not be SROs.
Vollmer asserted that the terminology of SROs may cause confusion and asked if SROs can be a force multiplier for government regulators.
Ketchum stated that the value of SROs comes from their leverage of funding as well as their level of knowledge, focus, and access.
Vollmer asked if the benefits of original SROs had been lost, and namely if they had more expertise, could innovate better than the government, and were closer to and had a better appreciation for the industry.
Ketchum stated that they have, in part, lost the benefits of the original SROs, but for good reason. He noted that the costs and risks were too great when SROs did not step up and thus required government interference. He also highlighted that the value of the members has been retained even if they lost some of their control. He asserted that FINRA is thoughtful in the knowledge it provides.
Karmel stated that a lot has been lost due to the industry’s destruction of the exchange model of trading and their preference for fragmentation. She also said the industry does not feel a connection to securities anymore and have lost the sense of obligation to the system that existed in old SROs.
Role of Exchanges
Vollmer asked if there were other responsibilities exchanges had as regulatory organizations or if there was an advantage to FINRA controlling them.
Schapiro noted that exchanges will always have a public responsibility even if they are controlled by FINRA.
Ketchum explained that exchanges are very active in the rule-making process and create their own fundamental rules. He also highlighted that exchanges always remain responsible for the integrity of their markets.
Karmel asserted that it would be better if exchanges were more competitive and cared about the products they list. She noted that exchanges should have stricter price listing requirements.
Streamlining CFTC & SEC
Vollmer asked if it would be beneficial to combine both the CFTC and SEC.
Schapiro, having held leadership positions on both the CFTC and SEC, stated that the two agencies are very competitive entities and it would be difficult to come together. However, she asserted that she had “argued both sides of the merger” and that the need for them to be combined was highlighted by Dodd-Frank.
Karmel was also in support of a combination of the two however she believed that ultimately politics gets in the way of any sort of merger.
Panel 3 – U.S. System of Self-Regulation Through SROs
Witnesses
Daniel Roth, President and CEO of the National Futures Association (NFA), said that the basic role of the NFA as an SRO is to be the “front line regulator” to monitor the market and take disciplinary action. He noted that rules adopted by the NFA are subject to CFTC approval and that there is daily communication between the two bodies.
Lynette Kelly, Executive Director of the Municipal Securities Rulemaking Board (MSRB), explained that the MSRB is not a membership organization and noted that while it writes rules to regulate the market, other agencies are the ones to enforce these rules. Kelly highlighted that the MSRB was set up to protect investors and that the Dodd-Frank Act also required the agency to protect municipal issues. Protection of investors is something that has never been done in the U.S., Kelly mentioned, saying that is has presented challenges as the diversity of issuers is “extreme.”
David Blass, Chief Counsel of the Division of Trading and Markets at the SEC, stated that his division oversees the rule filing process of SROs if they want to make a change; explaining that the staff assesses submissions on behalf of the Commission to determine potential impacts. Blass noted that the SEC also seeks public input on rule changes and has an “open mind” when reviewing comments.
Discussion
Protecting Muni Issuers
Cheryl Evans, CFA Institute and moderator of the panel, asked what the new mandate of protecting issuers has meant for the MSRB.
Kelly replied that dealing with the new mandate has been difficult because many municipal issuers do not want to be protected. She explained that the MSRB has sought to meet this new requirement by making sure that the professionals who issuers deal with are well qualified, transparent, and held to high standards.
SRO Key Traits
Evans then asked what qualities of an SRO are most significant.
Roth replied that enforcement responsibilities are a “huge part” of being a SRO and highlighted that mandatory membership and the ability to expel members, thus potentially putting them out of business, is a key to a strong enforcement regime.
Kelly stated that the ability to collect market data along with innovation to “get ahead of the curve” in regulation are important qualities of effective self regulation.
Blass noted that he values the “front line capabilities” of SROs and the expertise they bring to monitoring the markets.
Data and Policy Making
Evans then asked how surveillance information and market data are used to make policy decisions.
Blass said that the SEC is “data centric” in their policy initiatives and cited use of the Market Information Data Analytics System (MIDAS) to gather timely information to make rulemaking decisions and respond to market events. He added that the SEC has more capabilities than ever before to analyze big data and that they use this information to monitor for improper sales practices.
Kelly explained that the MSRB voluntarily adopted a cost-benefit policy to engage in economic analyses “grounded in hard data” for their rulemakings.
Roth noted that a challenge of collecting large amounts of information is being able to “connect the dots” and look for “combinations of data elements that raise flags.” He also stressed that computer systems should be “a tool and not a crutch” as human judgment is still important when analyzing data.
Managing Conflicts of Interest
Evans asked how SROs manage any conflicts of interest inherent in their structure.
Roth explained that conflicts have proven to be managed effectively over time through proper oversight and governance practices, adding that having diverse interests on the board of directors helps create a system of checks and balances.
Kelly agreed that “good governance is key” and the fact that the MSRB staff is independent “adds another layer” of checks and balances.
Blass noted that the SEC has sanction authority if a SRO is not fulfilling its responsibilities or is seen as being subject to “undue industry influence.”
Data Sharing
Evans asked how data is shared among different regulatory agencies and how duplicative efforts are reduced.
Roth noted that the CFTC has access to all NFA data and that the NFA communicates with other regulators such as FINRA if they see problems with firms who are active in other markets.
Kelly noted that the MSRB has formal information sharing agreements with FINRA, the bank regulators, and the Internal Revenue Service (IRS). She added that the MSRB requests subpoenas if other agencies want their data. Kelly said “it is ridiculous to have redundant systems and not share information.”
Prescriptive vs. Principals Based Rules
Evans asked if future regulations will be more prescriptive and specific in nature or principals based.
Blass and Roth agreed that both approaches have benefits in different circumstances and that one approach will not likely win out over the other in the future.
For more information on this event, please click here.