Which Way for Market Institutions: the Fundamental Question of Self

Which Way for Market Institutions:

The Fundamental Question of Self-Regulation

Cally Jordant & Pamela Hughestt'

ABSTRACT: It is a fundamental question: how should financial market institutions be regulated? Is self-regulation alive and well, at least in some parts of the world,for some marketfunctions? Or, despite a last gasp here and there, is self-regulation shuffling towards extinction? In particular,the wave of demutualizations and consolidations of exchanges has prompted questions as to traditional roles, governance models, and the nature of regulation of exchanges. Demutualizationof exchanges has been a catalystfor these debates, but the debates are not new. Although numerous studies have discussed the advantagesand disadvantagesof a self-regulatory structurefor exchanges and other market institutions, few have considered the interaction of factors that have determined the traditional allocations of regulatory powers: market history, business culture, legal system, the concept of public interest, the corporateform, the political system, forces of internationalization.How have these factors affected the allocation of regulatory power? Will the self- regulatory model of market institution, where it has been dominant, be pushed to the margins by the interplay of these various factor, as in the United Kingdom? Do unitary regulators oust self-regulatory principles? Is self- regulation in the United States merely a faqade? Are small and emerging markets adopting outdated self-regulatory models at the behest of the internationalfinancial institutions? Do self-regulatory organizations have a new role to play as liaison between national and supranationalregulators? It may be too soon to definitively answer the questions posed by this paper, but for the moment, self-regulation is here to stay; it just might not be staying where it used to.

t Formerly Senior Counsel, The World Bank (Washington, DC); Associate Professor, University of Melbourne (Melbourne, Australia). tt Partner, Blake, Cassels & Graydon LLP (Toronto, Canada). 1. The authors would like to thank Amanda J. Simpson of Blake, Cassels & Graydon LLP (Toronto, Canada), in particular, for her able and continuing assistance in the preparation of this paper. In addition, for their able assistance, the authors would like to thank Ryan Zalis of Blake, Cassels & Graydon LLP (Toronto, Canada) and Ehsan Zargar of Paul, Weiss, Rifkind, Wharton & Garrison LLP (New York, USA). The usual disclaimers apply. This work was originally prepared as a background paper for a project on "The Governance of Infrastructure Institutions in the Financial Markets," undertaken by the Oxford Finance Group, led by Ruben Lee. The project report will be published in 2007. The views in this paper are the views of the authors and do not represent the views of The World Bank or its Board of Directors. Berkeley Business Law Journal Vol. 4.2, 2007

TABLE OF CONTENTS I. Introduction ...... 207 II. Focus On Exchanges ...... 209 III. Market History, Business Culture, Legal System and Self Regulation ..... 213 IV. The Concept of the Public Interest ...... 214 V. The M arket Institution as Corporation ...... 215 VI. The Political Process ...... 217 VII. Internationalization of M arkets ...... 219 VIII. Conclusion ...... 222 Which Way for Market Institutions

Which Way for Market Institutions:

The Fundamental Question of Self-Regulation

I. INTRODUCTION

It is a fundamental question: how should financial markets be regulated? Is self-regulation alive and well, at least in some parts of the world, for some market functions? 2 Or, despite a last gasp here and there, is self-regulation shuffling towards extinction, heading the way of the dodo? Is there a discemable optimal allocation of regulatory powers to emerging market institutions? The wave of demutualization of exchanges and the recent merger of the New York Stock Exchange and Euronext have triggered the fundamental question. Exchanges are the interface between capital seekers and capital providers and between buyers and sellers of financial products of all kinds. Of the existing market infrastructure institutions, exchanges are the most visible (and vocal). Other market infrastructure institutions, essential as they may be to the market, are masked from view to the general public. Clearing and settlement systems are out of sight, relegated to the "back office." The community of professional market intermediaries, a clannish group wherever they are found, operates behind the high walls of professional associations.' In

2. To judge by the smile on Mary Schapiro's face the week of November 29, 2006, the answer might appear to be a resounding yes. Tuesday's announcement that the NASD and the New York Stock Exchange will combine regulatory functions not only fulfills a long-term Wall Street goal but also stands as testament to the perseverance and integrity of one woman: NASD chairwoman Mary Schapiro, who will become CEO of the merged operation ... The combination of the two private regulators culminates more than a decade of work by Ms. Schapiro. Schapiro to Lead Merged US Watchdog, FIN. TIMES, Nov. 29, 2006, at 30; see also Randall Smith & Kara Scannell, NASD, NYSE Agree to Merge Some Oversight-Supporters Foresee Streamlining in Market Regulation as Foes Fear Less Protection for Individuals, WALL ST. J., Nov. 29, 2006, at C 1, C4: The new 'self-regulatory' organization, or SRO, will be responsible for all broker examination, enforcement, arbitration and mediation functions. It will handle 'market regulation by contract' for Nasdaq, the Amex, ISE, Chicago Climate Exchange and the OTC Bulletin Board. NYSE Regulation will continue to oversee the NYSE market. A 23-person board of governors will oversee the new SRO's activities, with II seats held by public governors. Large firms, consisting of 500 or more brokers, and small firms (150 brokers or fewer) will each be guaranteed three seats on the board. Medium size firms will be guaranteed one seat. 3. On November 15, 2006, seven investment banks in Europe announced that they would form a new company to create a pan-European equities trading platform to enhance the current market-trading infrastructure in Europe. The seven investment banks are: Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley, and UBS. However, Euronext may be partially shielded from this new source of competition, as BNP Paribas and Societ6 G~n~rale did not participate in the formation of this new company. The formation of this new equities trading platform has become possible as a result of changes to be introduced by European member states once the directives of Markets in Financial Instruments Directive are implemented. For further details, see Norma Cohen, Ivar Berkeley Business Law Journal Vol. 4.2, 2007 addition, implicitly or explicitly, exchanges are imbued with a "public interest," given the relationship between their activities and the related issues of economic growth, systemic financial stability and investor protection. And, as capital markets have grown in importance, the prominence of exchanges has extended beyond their strictly market function; modem-day exchanges may also play a political role as national symbols, thus eliciting regulatory responses which are not based entirely on market considerations. So although the great upheavals of recent years have raised numerous issues which radiate beyond the perimeters of the exchanges, the debates have remained firmly focused on the exchanges themselves. 4 In particular, the wave of demutualizations and consolidations of exchanges has prompted questions as to traditional roles, governance models and the nature of exchange regulation. Demutualization of exchanges has been a catalyst for these debates, but the issues being raised preceded demutualization. 5 As Professor Roberta Karmel points out, the prevalent self-regulatory model of exchange governance in the United States has been susceptible to abuses and scandal for decades. There have been notable failures in the areas of self-regulators policing their 6 members, anti-trust violations, and conflicts of interest. This is a time of flux and transition for market institutions, more so for some than for others. Over the last several years, what are currently the two major stock exchanges in the United States have undergone some profound structural changes in their organization and governance, with more to come. There have been consolidations, demutualizations, diversification of financial instruments traded, and new service lines, all amidst a blizzard of technological change. And, in the United States, the stock exchanges are only one part of a complex of market institutions trading a dazzling variety of financial instruments.7

Simensen, Gillian Tett & Gerrit Wiesmann, Banks to Clash with European Exchanges, FIN. TIMES, Nov. 15, 2006, at I. The implications of this new trading system for traditional exchanges may be far- reaching, as the banks account for about half of all trading in European equities, with trading tariffs far below those of the London Stock Exchange, Euronext, and Deutsche Borse. 4. A closely-related debate, regarding the regulation of Alternative Trading Systems ("ATSs"), ensued approximately 15 years ago. ATSs are privately-operated, computerized systems that perform many of the functions of an exchange by centralizing and matching buy and sell orders and providing post-trade information. At that time, ATSs were considered a significant source of competition to exchanges. Among other countries, Australia, Canada, and the United States have developed specific rules to regulate the activities of ATSs in their respective capital markets. For further details, see Ruben Lee, What is an Exchange? A Discussion Paper (1992) (unpublished discussion paper, on file with Nuffield College, Oxford University). See also TRANSPARENCY ON SECONDARY MARKETS, A SYNTHESIS OF THE IOSCO DEBATE, 1992 IOSCO TECHNICAL COMMITTEE WORKING PARTY ON THE REGULATION OF SECONDARY MARKETS, available at http://www.iosco.org/library/ index.cfm?section=pubdocs&year- 1992. 5. Roberta S. Karmel, What Should Market Infrastructure Institutions Regulate?, in OXFORD FINANCE GROUP, THE GOVERNANCE OF INFRASTRUCTURE INSTITUTIONS IN FINANCIAL MARKETS (forthcoming 2007) (manuscript on file with author, at 29). 6. Id. at 12, 22. 7. The creation of such new financial instruments has threatened the prominence of equity Which Way for Market Institutions

of regulatory powers to At present, there is no obvious optimal allocation 8 market institutions. There are too many variables and not that many players. Commentators have contented themselves with pointing to the diversity of models and responses to the allocation of regulatory powers by market institutions as well as by regulators. As the International Organization of Securities Commissions (IOSCO) Consultation Report - Regulatory Issues Arising from Exchange Evolution concludes, "steps taken have tended to be on an assessment of the particular customized and pragmatic, based9 circumstances in a jurisdiction. Though it may be too soon to definitively answer the question posed by this paper, will this change? Is there one optimal allocation of regulatory powers to market institutions? Are there discernible or dominant trends? What are the factors that have determined the traditional allocations and how are they changing? Will the self-regulatory model of market institutions, where it has been dominant, be pushed to the margins by a new interplay of these factors? There is no doubt that there have been remarkably swift shifts in the allocation of regulatory powers in the last few years. The United Kingdom, once the heart of a self-regulatory approach to market institutions, presents one case in point. In a recent speech, Howard Davies, former Chairman of the Financial Services Authority (FSA) in London, asked, "What's left for self- regulation?" His "rapid answer" to this question could have been "not much," he admitted. "We could then all have a relaxed lunch and go home. But the 0 answer is a little more complex."' The following discussion will attempt to tease out some tentative answers to these questions and identify the factors at work in determining various outcomes.

II. Focus ON EXCHANGES

As noted above, demutualization and consolidation of exchanges has put the focus of the debate about governance and regulatory powers of market exchanges. For example, increased trading in derivative products linked to performance of individual equities, basket of equities, equity indices, and baskets of indices has diverted trading away from equities themselves and to derivatives exchanges to a limited extent, but mainly to over-the-counter markets. 8. The International Council of Securities Associations has commented on the relatively small number of self-regulatory organizations in the world. See, e.g., Working Group on the Governance of Market Infrastructures of the International Council of Securities Associations, Principles for the Governance of Market Infrastructures, Oct. 2006, available at http://www.icsa.bz/pdf/ ICSAPrinciplesGovemanceMarketlnfrastructure.pdf. 9. Technical Committee of the International Organization of Securities Commissions, Consultation Report, Regulatory Issues Arising from Exchange Evolution, March 2006, available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD212.pdf, at 28. 10. Howard Davies, Director, London School of Economics, Address at Hong Kong Theatre (Mar. 26, 2004), What's Left for Self-Regulation?, available at http://www.lse.ac.uk/collections/ meetthedirector/pdf/whatsLeftForSelfRegulation04Feb27.pdf. Berkeley Business Law Journal Vol. 4.2, 2007 institutions squarely on exchanges." Despite the wave of demutualization and consolidation, exchanges and their regulation remain highly diverse, if not idiosyncratic. Even where similar structural reorganizations have occurred in different exchanges, the underlying factors prompting such moves, and potentially the ongoing operations of the exchanges, are often dissimilar. Exchanges differ considerably amongst themselves. Markets are not monolithic. There is a definite hierarchy with a few major exchanges at the top (NYSE, LSE, NASDAQ, Deutsche B6rse (DB), Euronext, the Tokyo Stock Exchange (TSE), and now, NYSE Euronext). These exchanges share in the headlines but differ greatly among themselves. The LSE is the most internationalized. The NYSE is the largest in the biggest domestic market. DB is the largest in Europe. NASDAQ is the major alternative to the NYSE in the United States market. The TSE is the largest in Asia, yet still primarily a domestic market. Euronext, after several marriages of convenience, has surged to prominence due to its negotiations with the NYSE. These exchanges can afford tailor-made regulatory regimes to suit the complex business and regulatory environments in which they operate. Certainly, recent indications are that LSE sees its own particular principles-based regulatory model as having a competitive advantage over the NYSE. 2 There is no convergence to an optimal model going on here. In the second tier are smaller exchanges, some regional, others national, and some specialized, including the various commodities and futures exchanges in the United States, the TSX in Canada, the OMX in the Nordic/Baltic region, the ASX in Australia, the SEHK in Hong Kong, and the KSX in Korea. Again, although roughly similar in size (that is to say, smaller than the big guys), each is very different in its own way. Nevertheless, these exchanges appear to "punch above their weight." They have significance and play a role greater than their size might otherwise warrant, especially over the last decade or two. These second-tier exchanges have been innovators, open to technology, quick to change, and adept at seizing opportunities. Of course, not all experiments have been successful as the demise of the Neue Markt13, a victim of the

11. Canada and the United States have developed specific rules to regulate the activities of ATSs in their respective capital markets. In the United States, ATSs are governed by Regulation ATS. In Canada, Canadian securities regulators have introduced National Instrument 21-101-Marketplace Operation ("NI 21-101"), which applies to ATSs due to its definition of "marketplaces." The definition of marketplaces include exchanges, an entity that maintains a market for bringing together buyers and sellers of securities and a dealer that executes a trade of an exchange-traded security outside of a marketplace. 12. Clara Furse, Sox is Not to Blame-London is Just Better as a Market, FIN. TIMES, Sept. 17, 2006, at 15 ("London's principles-based regime ... continues to prove itself as a model that facilitates pro-competitive innovation in a tough but sensible regulatory environment."), available at http://search.ft.com/searchArticle?queryText=london+is+just+better+as+a+market&y=6&javascriptEna = bled-true&id=060917003996&x 18. 13. The Neue Markt was a new market, as its name suggests. Although innovative and well- supported by the major German stock exchange, it nevertheless failed. Which Way for Market Institutions technology bubble of the 1990s, will attest. But these exchanges have been learning from each other as well as innovating for themselves, creating models responsive to their particular circumstances. Exchanges such as the ASX, TSX and SEHK have a long history of self- regulation; however, in different ways and in response to different pressures, each has moved sharply away from a self-regulatory model. The TSX, buoyed by a strong Canadian economy and the national primacy, which resulted from the sudden consolidation of most Canadian equity markets, happily shed much of its regulatory role to focus on product innovation and its primary role as a marketplace. Additional factors in Canada's very pragmatic and open approach to the allocation of regulatory authority have been the competitive pressures from its large southern neighbor and ironically, the lack of a federal securities regulator. Hong Kong's SEHK relinquished most of its regulatory authority more reluctantly, only after years of skirmishes with a relatively new regulator. 14 The resistance to realignment of regulatory authority in Hong Kong, however, could not withstand the combined pressures of the Asian financial crisis of 1997 (which gave government regulators the upper hand), the dramatic shift in regulatory authority in the United Kingdom from the LSE to the FSA in 2000 (the United Kingdom market had long provided inspiration and technical expertise for Hong Kong) and the upsurge in mainland Chinese listings (which prompted heightened regulatory concerns). The longstanding potential for conflicts of interest, endemic in small financial communities such as Hong Kong or Singapore, was not sufficient, in and of itself, to prompt a major realignment of regulatory authority. Australia's ASX, one of the first exchanges to demutualize, has trodden a more tortuous path in trying to delineate the boundaries of regulatory authority between exchange and government regulator. Now, many years after the demutualization of 1988, the mechanisms designed to separate commercial and regulatory affairs within the exchange structure, as well as the relationship of exchange to regulator, are still being rebalanced. As this process of shedding self-regulatory authority by the exchange may still be evolving,' 5 it is hard not to consider the tentativeness of the situation in Australia, in part at least, as a manifestation of the prevailing political ideology with its general bias against government intervention. And then there are the rest, the small players and the emerging transitional or frontier markets, ranging from Johannesburg to Shanghai, from Jakarta to

14. The Securities and Futures Commission (SFC) in Hong Kong was created in 1989 in response to the 1987 market crash that shut down the SEHK for several days. 15. For further details, see Media Release, ASX, ASX Markets Supervision: New Structure to Operate from I July (June 29, 2006), available at http://www.asx.com.au/supervision/pdf/ asxmsmediarelease 29jun_06.pdf. Berkeley Business Law Journal Vol. 4.2, 2007

Sao Paulo, and from Bratislava to Bermuda. Some, like Johannesburg, have been around for a long time while others are brand new (or recently resurrected from a long period of dormancy). Some, like Bermuda, are sophisticated, niche market players that hardly fit the profile of exchanges found in emerging economies. And others like Jakarta and Sao Paulo serve large, resource-based economies, where there are considerable pools of domestic capital as well as a significant level of political risk. China is a story unto itself; its domestic markets are unlike any others in the world as are its regulatory approaches. For different reasons in each case, there appears to be no rush towards embracing traditional self-regulatory models, either for the exchanges or for other market institutions. And this is so despite the occasional, well-intentioned, albeit somewhat misguided, nudging in that direction by international development agencies whose advisors may have their eyes firmly fixed on the past history of certain developed markets. In spite of the marked trend towards shifting regulatory authority away from exchanges themselves (at least, in their commercial operations), some market institutions continue to defend traditional self-regulatory powers for exchanges. 16 The common advantages associated with self-regulating entities are: (i) their ability to utilize industry expertise; (ii) the potential for higher standards than may be imposed by law; (iii) potentially greater compliance with mutually-agreed rules set by peers than with externally imposed requirements; 7 and (iv) their greater flexibility and responsiveness to market forces.' However, in light of the new realities of today's evolving exchanges, these justifications for self-regulatory powers ring somewhat hollow. If there is one generalization to be made on the optimal allocation of regulatory authority for market institutions (exchanges, at least), it is that self- regulation is on the wane. Nevertheless, the governance structures and the nature of the exchange to regulator relationship will continue to be idiosyncratic for the major exchanges and considerably diverse for the others. Despite market integration and the spillover effects of regulatory approaches from dominant markets such as the United States, the factors at play in determining the allocation of regulatory authority and the relationship exchange to regulators are too varied and complex to produce one "right answer." The discussion below will focus on a number of factors that have and can determine the allocation of regulatory powers to market institutions.

16. For further details, see Pam Hughes & Ehsan Zargar, Exchange Demutualization, (May I, 2006), available at http://www.blakes.com/english/publications/bsra/v143/Paper- ExchangeDemutualization -May2006.pdf. 17. Id. Which Way for Market Institutions

III. MARKET HISTORY, BUSINESS CULTURE, LEGAL SYSTEM AND SELF REGULATION

The market history, business culture and legal system are all influential factors in determining the allocation of regulatory authority to market institutions. A strong tradition of self-regulation, as it is now commonly understood, is not a universal given. Where the tradition of market self- regulation is not firmly established in the business culture, there has not been great debate over its limitations or its future prospects. Self-regulatory market practices flourished in the United Kingdom, and by extension, the Commonwealth and the United States. As a regulatory principle, it has been largely unknown in Continental European countries 18 where legal systems generally demonstrate a preference for "written law" on a take it or leave it basis.' 9 There is either formal governmental regulation or there is no regulation; the half-way house of self-regulation, whether by continuance of traditional practices, tacit or overt delegation of authority, or "sharing" of regulatory responsibility with a government regulatory body, is not part of the modem Continental European legal culture. As with any generalization, the true situation may be more nuanced but the issue of the allocation of regulatory authority to market institutions does not present itself forcefully in such jurisdictions and the choices tend to be starker. This analysis would explain, at least in part, how until very recently, the highly regulated pan-European financial markets (point the finger at Brussels) coexisted with the largely unregulated Eurobond market. There may also be constitutional and administrative law principles in these countries (and others sharing their legal and political heritage) that work against the principles of self-regulation as they have manifested themselves in the United Kingdom and the United States. The United States presents a fairly unique regulatory environment, in some measure due to the historical influences of both English law (pre-War of Independence) and European law-largely French (post-War of Independence). "In many respects U.S. law represents a deliberate rejection of common law principles, with preference being given to more affirmative ideas clearly derived from civil law. These were not somehow reinvented in the United States but were taken over directly from civilian sources in a massive process

18. Daniel W. Drezner, Who Rules? The Regulation of Globalization, Aug. 2002, at 17, 18, available at http://www.danieldrezner.com/research/whorules.pdf. 19. Cally Jordan, The Conundrum of Corporate Governance, 30 BROOK. J. INT'L L. 983, 1009 (2005), available at http://www.brooklaw.edu/students/joumals/bjil/bjil3Oiii-jordan.pdf. 20. Similar to the Eurobond market, the over-the-counter derivative markets are also largely unregulated. These markets are largely unregulated because their participants are sophisticated institutional investors capable of protecting their own interests without the need for statutory intervention. Berkeley Business Law Journal Vol. 4.2, 2007

of change in adherence to legal information in the nineteenth century." 2 1 Glenn calls this "constructive combination of elements of both civil and common law," the "particular genius of US law." 22 Genius as it may be, the competing principles drawn from both 181h century England and 191h century Europe, may account for the tensions in the United States between a long tradition of self- and a highly prescriptive regime of regulation of exchanges on the one hand, 23 securities regulation with emphasis on formal, written rules on the other. Concepts of "public interest" (discussed below) and the importance of a "prudential" approach to financial regulation play into this discussion as well. Prudential regulation finds its justification in the public interest and systemic risk. While normally associated with banking supervision, a non-disclosure- based or prudential approach to regulation is also found, to a greater or lesser degree depending on the jurisdiction, in the capital markets. By definition, such an approach is prescriptive and usually errs on the side of formal regulation backed by governmental authority (although not always). Other contextual factors likely serve to determine the effectiveness and persistence of self-regulatory principles. A few of the obvious ones are the existence of a relatively small number of market participants, bound together by a community of interest; a jurisdiction with a small population and high visibility of market functions and participants; the normative force of "reputational" consequences; the level of development of the market (whether everyone knows and agrees to the rules); the extent to which the market is international (with participants who may not necessarily know and agree to the rules); in addition to being self-regulatory, whether there are means for the rules to be self-enforcing.

IV. THE CONCEPT OF THE PUBLIC INTEREST

The nature of regulation applicable to market infrastructure institutions is intimately connected to the concept of the public interest. Notably, what is considered in the public interest and how best to promote it varies considerably from place to place. Furthermore, notions of public interest may be highly culturally or politically specific, and notoriously difficult to define with precision. As public interest often serves as the justification for formal governmental

21. H. PATRICK GLENN, LEGAL TRADITIONS OF THE WORLD 248 (Oxford University Press 2d ed. 2004) (2000). 22 Id.at251. 23. See Jeremy Grant, Watchdogs and Companies Fight Regulatory Creep, FIN. TIMES, Oct. 31, 2006, at 21. This work notes that the current, very interesting debate over "regulatory creep" is indicative of the differences in regulatory approach between the U.S. and the UK: "This explains why Ed Balls, the UK's economic secretary to the Treasury is working on draft legislation that would give the FSA veto power over a US-owned UK exchange if it were to produce rules that did not fit current British regulatory templates." Id. Which Way for Market Institutions

regulatory intervention, it might be surmised that the broader the understanding of the concept of public interest, the narrower the scope for self-regulation, and the greater the scope for potential government regulatory intervention. Arguably, the concept of public interest in the United States is a narrower and more circumscribed one than, say, in Singapore. Similar to German and Canadian law, 24 both Hong Kong and Singapore, in the recent demutualization of their exchanges, have explicitly posited a public interest function in the authorizing legislation. 25 There is not necessarily a linear relationship between a broad concept of public interest and a lesser allocation of regulatory powers to market institutions, but the concept of public interest is definitely a factor in determining such allocation. The extent to which the public interest dominates a decision on the allocation of regulatory power also depends on the kind of market institution involved. It is generally understood that market institutions are, either explicitly or implicitly, endowed with a public interest. However, not all market institutions invoke the same intensity of public interest. A clearing and settlement system, for example, essential though it may be to an exchange's operation, does not necessarily raise public interest concerns to the same extent as the operation of the exchange itself.

V. THE MARKET INSTITUTION AS CORPORATION

A good deal has been written about the implications for governance structures and allocation of regulatory powers, which demutualization and potential self-listing of exchanges may entail. Interestingly, very little attention has been paid to the implications of use of the corporate form itself by an 26 exchange.

24. NI 21-101 states that the rules and policies of an exchange must not be contrary to the "public interest" and must be designed to prevent fraudulent practices and promote "just and equitable" principles of trade. Additionally, NI 21-101 introduces rules that prohibit an exchange from using its position to limit competition from other exchanges or ATSs or unreasonably deny access to its services. 25. Andreas M. Fleckner, Stock Exchanges at the Crossroads, 74 FORDHAM L. REV. 2541 (2006); see also John W. Carson, Conflicts of Interests in Self-Regulation: Can Demutualized Exchanges Successfully Manage Them?, World Bank Policy Research (Working Paper No. 3183, 2003), available at http://econpapers.repec.org/paper/wbkwbrwps/3183.htm; Technical Committee of the IOSCO, Responses to the IOSCO Consultation Report Entitled Regulatory Issues Arising from Exchange Evolution, June 2006, at 20-25 (Deutsche B6rse notes the requirements of German law with respect to the public interest function of exchanges), available at: http://www.iosco.org/library/pubdocs/pdf/ IOSCOPD221.pdf,; IOSCO Consultation Report, supra note 8, at 33 (the French Association of Investment Firms discusses the public interest implications of exchanges and they note it is a "situation that demands appropriate governance arrangements and close regulatory scrutiny"). 26. Euronext, Inc., Registration Statement (Form S-4) (Sept. 21, 2006). The proposed merger of NYSE and Euronext has very recently focused attention on the significance of the use of the corporate form. Each of the NYSE and Euronext has proposed the creation of non-corporate entities. In the case of Euronext, a Dutch foundation, and NYSE, a Delaware trust, shares of the ultimate holding company would be transferred in the event of untoward regulatory actions that might otherwise catch the holding company and result in "regulatory creep." Berkeley Business Law Journal Vol. 4.2, 2007

In demutualizing, formerly self-regulated member organizations become subject to the strictures of national corporate law as well as various financial sector regulators. Different concepts of public interest may be at work here, depending on the jurisdiction involved. This will impact directly governance structure and the degree of external regulation imposed. Purely commercial corporations elicit different public interest considerations than financial institutions; in some jurisdictions, there is very little evidence of a "public interest" element in corporate law. In the United States, corporate law statutes have become highly "enabling" as opposed to regulatory. Few formalities under corporate law are associated with their operation and management enjoys great latitude for action-self- interested or otherwise-under the aegis of the business judgment rule. There is little regard accorded to "public interest" aspects of the operation of business corporations. Public interest concerns are the domain of securities regulation; the controversial 2002 Sarbanes-Oxley legislation, applicable to publicly traded corporations in the United States, is exceptional in that it is essentially federal corporate law that touches upon public interest concerns but enacted under the guise of securities regulation. However, in the United States, the corporate form does mean that a listed market institution will trip numerous triggers designed to increase transparency and reduce conflicts of interest: insider trading regulations, extensive disclosure and other issuer regulation. The debate surrounding demutualization of the NYSE noted that demutualization could address the opaqueness of the member association form and perceived internal governance abuses. That said, adoption of the corporate form extends the reach of external regulation that will be applicable to the exchange, casting light on the dark comers of the self- regulated entity. Compared to the United States, corporations law in continental Europe is prescriptive and quite regulatory. There are still minimum capital requirements for commercial corporations as well as more structured and mandatory internal corporate governance mechanisms. Corporate law demonstrates a greater degree of public interest (workers councils or workers representation in dual board structures, for example). There is little of the balancing of external regulation against self-regulatory functions. Regulators regulate. The concept of the independent, privately-funded, self-regulated organization is quite alien in continental Europe. Regulators may not be as close to the market but many believe there is vigorous regulatory oversight. For an exchange to adopt corporate form is seen as a fairly non-contentious move, with little internal resistance from self-interested parties chary of losing autonomy. It also means that the exchange becomes subject to the real strictures of corporate law. Euronext, for example, is a Dutch limited liability company with a two-tier board structure that arguably provides a superior form Which Way for Market Institutions of internal governance. In addition, it is subject to the regulatory oversight of the Dutch Ministry of Finance, the French Autorit6 des marches, various interagency memoranda of understanding, and EU Directives (to name a few sources of external regulatory pressure and oversight). Share ownership restrictions, implemented to deter self-interested behavior on the part of a dominant shareholder, have also been proposed as a governance mechanism for demutualized exchanges. Such restrictions already exist in some European commercial corporate laws and some Commonwealth banking laws. The more cynical might see such restrictions as a form of protectionism, deterring foreign control of a national symbol. As well, there is the usual panoply of United States corporate governance mechanisms, the conflict committees and other board committees, independent directors, etc., that may have found expression elsewhere. The substantial differences in national corporate laws will result in persistent differences in internal and external governance of demutualized exchanges and the extent of government regulatory intervention. There are other intriguing implications for exchange structures. Because United States corporate law is enabling and non-regulatory in nature, in the process of demutualization the NYSE found itself creating compensatory internal governance measures. Some of these compensatory mechanisms, such as the dual board structure and a chief regulatory officer reporting to a regulatory committee rather than the CEO,27 were directly or indirectly inspired by European corporate law. In a further twist, the NYSE and Euronext, in their proposed merger, are looking to non-corporate law vehicles, a Delaware trust and a Dutch foundation, to avoid setting off certain regulatory triggers.

VI. THE POLITICAL PROCESS

Financial markets and their regulation are intimately intertwined with the political systems in which they operate. 28 As legislation and regulation are products, or perhaps only by-products of the political systems in place, they reflect the prevailing political ideologies. Inherent differences in political systems will perpetuate persistent differences in the structure of market infrastructure institutions and the regulatory balancing act in which they engage. As noted above, some political systems either do not embrace the concept

27. Roberta Karmel, Government Regulatory Intervention in the Governance of Market Infrastructure Institutions (forthcoming) [hereinafter Government Intervention]. 28. Raghuram G. Rajan & Luigi Zingales, The Great Reversals: The Politics of Financial Development in the Twentieth Century (NBER Working Paper No. 8178, 2001), available at http://www.nber.org/papers/w8178; see also Mark Roe, Presentation at CIFRA TI Finance Seminars: Legal Origins and Modem Stock Markets (Sept. 27, 2003), available at http://www.abs.uva.nl/fmseminars/object.cfn/objectid=D 10650EF-6771-419B-B I 1 B521 FB639F898; Mark Roe, Delaware's Politics, 118 HARv. L. REV. 2491 (2005). Berkeley Business Law Journal Vol. 4.2, 2007 of self-regulatory organizations or face constitutional hurdles to their recognition. In federal states such as Germany, Canada, and the United States, jurisdictional rivalries may provoke regulatory competition and the potential for regulatory arbitrage (witness the savings and loans crisis of the 1980s in the 29 United States, or the enactment of Sarbanes-Oxley itself). In some cases, self-regulation may act as a substitute where political factors impede government regulation; Canada's political inability to create a federal securities regulator has meant that a number of other entities, some endowed with self-regulatory authority, have stepped into the breach (TSX, Market Regulation Services Inc., Investment Dealers Association of Canada and Canadian Securities Administrators). The political system will determine not only the type of regulatory approach but also whether the implementation of government regulation is feasible at all. Some federal jurisdictions, Germany for example, recognize or 30 permit shared competencies in an effort to defuse jurisdictional rivalries. Others, such as the United Kingdom, encourage a close, cooperative relationship between regulators and exchanges. In the United States, does self-regulation play a compensatory role in the face of legislative impasse resulting from the political system? In a parliamentary democracy, a majority government may implement radical change virtually at the drop of a hat; for example, witness Gordon Brown's separation of regulatory from supervisory power at the Bank of England and the creation of the FSA. The legislative process in the United States, on the other hand, is one of exquisite complexity. It is contentious and incremental in most cases, due to the powerful influences of lobby groups and the checks and balances of the political system itself. It has not been uncommon for sensible financial sector legislative initiatives-for example, repeal of the McFadden Act and the Glass-Steagall Act-to take thirty years to crawl through to implementation. The inability of the United States to legislate on financial sector matters at the federal level, except in response to crisis and public outrage with its potential for very personal and unpleasant fallout for legislators, has the untoward consequence that legislated agendas do not necessarily represent a balanced or optimal allocation of regulatory authority. Instead, expediency and ad hoc-ery rule. It is true that the delegated rule- making authority exercised by the SEC compensates for the impasse at the legislative level. However, to judge by recent controversies such as shareholder nomination of and voting for directors, the SEC too is constrained by political factors. Compared to the situation in the United States, both the United Kingdom

29. See Mark J. Roe, Delaware's Competition, 117 HARV. L. REV. 588 (2003). 30. See Fleckner, supra note 25. Which Way for Market Institutions and Hong Kong have moved away from self-regulation as the prevailing concept in securities markets with astonishing swiftness. As noted above, in the case of Hong Kong, a precipitating factor in the change in the balance between self-regulation of the exchange and statutory powers in the regulator was the Asian financial crisis. The political system in Hong Kong permits the administration to act swiftly and decisively when it wishes, unfettered by messy issues of congressional or parliamentary procedure. Despite its reputation for laissez-faire liberalism in its approach to markets, the Hong Kong administration can intervene rapidly in markets so as to put its thumb on the scale. The Hong Kong government's intervention in the stock market during the Asian financial crisis illustrated this point graphically, but the ongoing growth of Hong Kong as the market of choice for mainland Chinese issuers has sustained the pressures in favor of government regulators. As Howard Davies noted in his speech, "in London's securities markets most regulation began as self-regulation .. .[p]olicing those rules [by self- regulatory organizations] was patchy, and of course the powers at their disposal were not very strong, but they did their best." 31 In the 1980s, the United Kingdom established "a rather unusual halfway house system, with a statutory body-the Securities & Investments Board-sitting on top of a number of self- regulators ... [t]his architecture was put in place by Michael Howard, though 32 he does not often talk about it these days." This self-regulatory system in the United Kingdom, however, did not respond well to rapidly changing market conditions and for several reasons. The complex structure "almost guaranteed tensions between the statutory oversight body and the frontline regulators." 33 New entrants into the United Kingdom markets broke down the community of interest in a well-defined marketplace. The clubby world of London's financial district, the "City," and market self-regulation proved inadequate "to cope with a situation in which 34 practices as a whole need[ed] to be improved to regain public confidence." And so the "government decided-with some reluctance-that the day of self- regulation in retail financial markets was largely over."35 A popular majority government and a strong-handed Chancellor hustled self-regulation out the door with little ado, a feat that would be unimaginable in the United States.

VII. INTERNATIONALIZATION OF MARKETS

Internationalization of markets has had complex consequences for the balance between self-regulation of market institutions and government

31. Davies, supra note 10, at 1. 32. Id.at 1-2. 33. Id.at 3. 34. Id.at 4. 35. Id. Berkeley Business Law Journal Vol. 4.2, 2007

regulation. The Hong Kong administration acted quickly as the Hong Kong markets caught the virus of the Asian financial crisis spreading from Thailand and Indonesia in 1997. The United Kingdom government jettisoned self- regulation in response to the entry of new market players who did not play by "club" rules and in an effort to raise standards across an entire industry which was no longer homogenous. Elsewhere, shareholder restrictions imposed in the wake of demutualization of national exchanges have been criticized as a "poison pill" tactic, designed to deter international takeovers of the newly listed national exchanges. The much touted issue of international competitiveness is a double-edged sword for the self-regulatory powers of market institutions, its consequences dependent on business culture, the degree of acceptance or resistance to governmental intervention in markets and the political system (see above). Industry self-regulation can be nimble and responsive to changing conditions brought about by external pressures and participants. Self-regulation may also work well in certain kinds of international markets where there is no supranational governmental authority to intervene (for example, the Euromarket). On the other hand, faced with competitive international pressures, government authorities may be tempted to preserve and promote markets and their institutions within their national borders.36 This has occurred more so recently, as has been demonstrated by the United Kingdom government's reaction to potential implications of regulatory "spillover" from the United States.37 A government may intervene to insulate its markets from governmental regulation emanating from a foreign source. The internationalization of the market institutions themselves- consolidation of different national exchanges, cross-border mergers and alliances-raises intriguing unresolved questions. A form of self-regulation may facilitate these alliances where there is no supranational framework to provide guidance or regulatory authority. Large, cross-border institutions will be small in number and highly visible; they will be sui generis to a large degree and their prominence may enhance the effectiveness of the "reputational" element of self-regulation. Yet, domestic or supranational, as in the case of the

36. In spite of NI 21-101, which prohibits exchanges from unreasonably denying access to its services, TSX's proposed rules for permitted counterparties for equity derivative transactions exclude certain foreign financial institutions; that is, foreign banks listed under Schedule II of the Bank Act, 1991 S.C. (Can.), available at http://laws.justice.gc.ca/en/showdoc/cs/B- 1.01 ///en?page= . 37. See George Osborne, The Way to Prevent American Regulatory Creep, FIN. TIMES (London), Oct. 12, 2006, at 13; Jeremy Grant, Ex-SEC Chief Hits Out at 'Turf Protection,' FIN. TIMES (London), Sept. 15, 2006, at 9; see also Elliot Posner, The New TransatlanticRegulatory Relations in Financial Services (Sept. 2006) (prepared for presentation at the 1st Annual GARNET Conference, "Global Financial and Monetary Governance, the EU and Emerging Market Economies"), available at http://www.garnet-eu.org/index.php?id=29&dir-/JERP%205.2.4:%20Globa%20Economic%20Govema nce%20and%20Market%20Regulation&mountpoint-4. Which Way for Market Institutions

EU, governmental regulation may be required to provide the legal foundations for these internationalized market institutions. A further difficulty may be the juxtaposition and interaction of different regulatory approaches resulting from internationalization of the markets and their institutions, such as introducing self-regulatory concepts to systems where they are more or less unknown. 38 United States regulatory initiatives, in particular, have inspired waves of "spill-over" or "me too" regulation which may produce less than optimal results elsewhere. 39 This phenomenon has been pronounced in transition and emerging markets which are desperately in search of regulatory models, but even the EU has not been immune from rather thoughtless copycat impulses.40 Among the major markets, internationalization has heightened awareness of conflicts between regulatory approaches arising from different legal and political systems. 4 1 For example, divergent views between two major market regulators, the United Kingdom and the United States, as to the merits of "principles-based" regulation and "rules based" regulation, surfaced recently. 42 With the consolidation of transatlantic exchanges a reality, there is a greater imperative for close cooperation among regulators in different jurisdictions. Here there may be new importance given to the old role of self-regulatory market organizations, like the International Capital Market Association (ICMA). In its comments on the IOSCO Consultation Report, ICMA highlights

38 Roel C. Campos, SEC Commissioner, The Current Role of Capital Market Regulation, Speech Delivered at CVM's 30th Anniversary: Assessing the Present, Conceiving the Future (Sept. 5, 2006), available at http://www.sec.gov/news/speech/2006/spchO9O506rcc.htm. 39. The phrase "me too reforms" has been attributed to Gerard Hertig, On-Going Board Reforms: One Size-Fits-All and Regulatory Capture, 21 OXFORD REV. ECON. POL. 269, available at http://papers.ssm.com/sol3/papers.cfm?abstractid=676417, and Luca Enriques & Matteo Gatti, EC Reforms of Corporate Governance and Capital Markets Law: Do They Tackle Insiders' Opportunism? (Feb. 2006) (prepared for the 2006 Policy Dialogue on Corporate Governance in India), available at http://papers.ssm.com/sol3/papers.cfm?abstractid=886345. 40. On the effectiveness of legal transplants in transition economies, see Katharina Pistor et al., Economic Development, Legality and the Transplant Effect (Nov. 1999), available at http://ssm.com/abstract-183269. See also Jordan, supra note 19. Also note that in the EU, legislation and other initiatives emanating from the U.S. are closely monitored in the area of corporate governance and capital markets. Some initiatives are successfully adapted, even improved upon (for example, the recent EU Prospectus Directive) while others flounder (for example, the demise of the mandatory audit committee proposal for European companies). 41. Institute of Chartered Accountants in England and Wales (ICAEW), Dialogue in Corporate = 1 Governance (July 2005), available at http://www.icaew.co.uk/index.cfm?route 22337. The ICAEW, a self-regulatory organization, has launched an ambitious initiative, the Dialogue in Corporate Governance, "to challenge commonly held assumptions, identify fundamental questions, set challenges for future research and generate practical proposals . . . [as] difficulties arise in striving to achieve a single, global approach to corporate governance. There are too many deep-rooted cultural and structural differences for a single approach to work equally well in all countries and for all companies regardless of their stage of development and business." See also a series of research papers prepared by the ICAEW, including Pressure Points-Contrasting US and UK Securities Markets: How They Impact International Policy, Investment, Business and Accounting (Nov. 2005), available at www.icaew.co.uk/index.cfm?route= 145128. 42. See Schedule Ill of the Bank Act, supra note 36. Berkeley Business Law Journal Vol. 4.2, 2007 its role as liaison among national and supranational regulators and as a gap- filler.43 Rather than being the primary mode of regulation of market infrastructure institutions, self-regulation may be assuming an important, but subsidiary, role in the oiling of the market machinery. The IOSCO principles merit one last observation in this context. In the absence of a supranational regulator, internationalization of markets has prompted IOSCO to develop international standards and principles, giving guidance to market institutions. The various IOSCO principles, having been heavily influenced by 1990s regulatory models from the United States, may overweigh the importance of self-regulatory principles. In other words, the markets may have outpaced them.

VIII. CONCLUSION

At present, it is not easy to isolate an optimal allocation of regulatory authority for market institutions. There are too many variables at play in a complex, rapidly changing environment. Market participants, institutions and regulators themselves demonstrate sharply divided views on the implications of the dramatic changes affecting the structure and governance of exchanges and other market institutions. Some market institutions continue to insist on the virtues of self-regulation and the powerful incentive of their "brand" to produce appropriate regulatory outcomes, even as such authority is slipping away. On the other hand, commentators have little trouble pointing to the scandals and failures of self-regulation 44 and even market participants find the "brand" 45 argument less than convincing. In some cases, such as Hong Kong and London, self-regulatory concepts, once a primary source of regulation, have been quickly shoved to the margin. In others, such as Toronto, in the absence of a strong federal capital markets regulator, a pragmatic approach to the separation of regulatory and commercial exchange function has been adopted. With few regrets, the TSX aspects of 46 itself quickly shuffled off market regulatory authority to another entity.

43. IOSCO, REGULATORY ISSUES ARISING FROM EXCHANGE EVOLUTION: RESPONSES TO THE CONSULTATION REPORT (June 2006), available at http://www.iosco.org/library/pubdocs/pdf/ IOSCOPD221 .pdf. 44. Karmel, supra note 5, at 28 n.82 (Karmel notes the Report Pursuant to §21(a) of the Securities Exchange Act of 1934 regarding the NASD and the Nasdaq Market, Exchange Act Release No. 37542 (Aug. 8, 1996); see also Press Release, Securities Exchange Commission, SEC Charges the New York Stock Exchange with Failing to Police Specialists (Apr. 12, 2005), available at http://www.sec.gov/news/press/2005-53.htm. 45. IOSCO, supra note 43, at 42-45, R4.2(a). 46. The market regulatory authority of the TSX has been transferred to Market Regulation Services Inc. See History of Market Regulation Services, Inc., available at http://www.rs.ca/en/about/history.asp?printVersion=no&loc I=about&loc2=history. However, the corporate governance of an issuer is regulated by the securities regulators pursuant to National Instrument 58-101, Disclosure of Corporate Governance Practices, available at http://www.tsx.com/en/pdf/NI58- 101_DisclosureOfCGPracticesAprl 5-05.pdf. Which Way for Market Institutions

Where you find consolidated regulation of financial institutions, the presence of the unitary regulator tends to oust self-regulation and, incidentally, may produce a more prudential approach to capital markets regulation. The potential for heavy-handed regulatory intervention by such a regulator, a spectre haunting the markets, may be offset by the regulatory approach itself (for example, "principles-based" as opposed to "rules-based"). The United Kingdom government certainly makes this assertion fairly convincingly, touting its "light touch" regulation as one competitive advantage of the London 47 markets. The United States market on the other hand has witnessed a gradual shift in influence from self-regulatory bodies to greater government oversight and direct intervention. Roberta Karmel capably argues that this is a time of tension and compromise between self-regulation and government intervention in the United States.48 Attempts are being made to maintain the faqade of self- regulation (for example, a market-neutral SRO with governmental members, a third party SRO supplying regulatory services, or constituency representation dominating SRO boards), while in reality, shifting to another form of regulation. Overlapping oversight and shared responsibilities are now characteristic of United States market regulation, which is a function, Karmel maintains, of market evolution, technology, and international pressures. It may also be a manifestation of longstanding tensions attributable to the historic 49 undercurrents in the United States legal system discussed above. Australia, with its long tradition of self-regulatory market institutions inherited from the United Kingdom (but without the same United Kingdom political dynamic at work) demonstrates similar tension and compromise in its overlapping oversight approach. The political complexity of a federal system is one likely factor contributing to this situation; unlike in the United Kingdom (a unitary state), sharp changes in course pose a more difficult proposition in Australia. Australia has also been an innovator, not the first but definitely in the vanguard of change, when it comes to market institutions.50 It is learning by experience. The pressures of market evolution, technology, and internationalization, which Karmel identifies in the United States, are also having full play in Australia.

47. Press Release, City of London, London Stock Exchange: City Welcomes Treasury Commitment to "Light Touch" Regulation (Sept. 13, 2006), available at http://www.cityoflondon.gov.uk/Corporation/media centre/files2006/London+Stock+Exchange+City+w elcomes+Treasury+commitment+to+light+touch+regulation.htm; see also Norma Cohen, IOSCO to Push for Regulatory Consistency, FIN. TIMES, Nov. 15, 2006, available at http://www.fl.com/cms/s/7f4cd74a-744d- II db-8dd7-0000779e2340.html. 48. Government Intervention, supra note 27. 49. Karmel, supra note 5, at 29. 50. Government Intervention, supra note 27, at 21; Australian Securities Exchange, ASX Overview & Structure, available at http://www.asx.com.au/about/asx/asx-overview.htm (the ASX demutualized in 1988 and was one of the first exchanges to do so). Berkeley Business Law Journal Vol. 4.2, 2007

So, which way for market institutions? It depends. Self-regulation will persist in the United States, although perhaps not in as vigorous and unchallenged a form as in the past. The industry, which prefers to mind its own shop, is sophisticated, politically savvy, and well-financed. Congressional action is unlikely, except in response to a perceived crisis which would reach the level of general public awareness. The SEC appears determined to change the legacy of the implementation of Sarbanes-Oxley-the perception of a 5 1 heavy-handed regulatory intervention. Nevertheless, in the wake of Sarbanes-Oxley, there have also been calls for the United States to look abroad to find new regulatory approaches, in particular to the United Kingdom, which, as noted above, has more or less abandoned a self-regulatory approach to exchange regulation, at least ostensibly. This call to look abroad for regulatory solutions is atypical (the United States prefers homegrown solutions) 52 and for that reason is also intriguing. There have been numerous suggestions in the past that the United States demonstrates greater deference to non-U.S. regulatory approaches, 53 and while the NYSE itself has done some creative borrowing from abroad,54 no audacious soul had so far suggested overtly importing foreign regulatory solutions. Despite the blue ribbon credentials of the source of this suggestion,55 it is unlikely to provoke a regulatory about-face on the part of the SEC. 56 Legal and regulatory systems are notoriously path-dependent, and none more so than

51. See Press Release, Securities Exchange Commission, SEC Votes to Propose Interpretive Guidance for Management to Improve Sarbanes-Oxley 404 Implementation (Dec. 13, 2006), available at http://www.sec.govlnews/press/2006/2006-206.htm. The SEC announced modifications to the application of Sarbanes-Oxley, among other things, in an attempt to meet mounting criticism of the regulatory burdens imposed. 52. There are interesting historical reasons behind this reluctance to learn from experience elsewhere. These date back to the end of the 19th century when the United States entered a period of "nation-building" after a terrible and divisive civil war. U.S. legislators and regulators looked to create indigenous solutions and institutions, to the despair to this day of comparativists. Even where regulatory solutions were obviously modeled on foreign sources (e.g., the Uniform Commercial Code (UCC)), no acknowledgement is made. Karl Llewellyn, a U.S. academic trained in Germany and principal draftsperson of the UCC, is said to have commented that to acknowledge a foreign source was the "kiss of death" for proposed US legislation. See Marietta Auer, "Good Faith " and its German Sources: A Structural Frameworkfor the "Good Faith" Debate in General Contract Law & Under the Uniform Commercial Code, 14 n.36 (2001) available at http://www.law.harvard.edu/academics/graduate/ publications/papers/auer.pdf. 53. Edward F. Greene et al., Hegemony or Deference: U.S. Disclosure Requirements in the InternationalCapital Markets, 50 Bus. LAW. 413 (1995). 54. See, e.g., NYSE Rules on Corporate Governance. 55. The Committee on Capital Market Reform (the "Paulson Committee") mobilized the great and the good of the US securities practicing bar and academic community. It was only one of three committees struck more or less simultaneously to consider the competitive threat to the U.S. capital markets. The Commission on the Regulation of U.S. Capital Markets in the 21st Century reported, at the behest of the U.S. Chamber of Commerce in March 2007. See U.S. Chamber of Commerce, Commission on the Regulation of U.S. Capital Markets in the 21st Century - Report and Recommendations, http://www.uschamber.compublications/reports/O703capmarketscomm. 56. See Robert Bruce, Oceans Apart on the Rights and Wrongs of Control, FIN. TIMES (LONDON), Jan. 18, 2007, available at http://www.ft.com/cms/s/2ad35f58-a699-1 I db-937f-0000779e2340.html. Which Way for Market Institutions

that of the United States. As for the United Kingdom, despite appearances to the contrary, self- regulation has not completely bit the dust. As noted by Sir Howard Davies, the situation is more complex than it may appear on the surface. Despite the authority to the FSA, some strong forms of self- massive shift of regulatory 57 regulation persist, even at the LSE. The NOMAD system for the AIM market, for example, substitutes the judgment and integrity of a seasoned market professional for direct regulatory oversight and accountability. The AIM market has been booming lately58 although there are some indications of 59 troubles brewing in paradise. Concepts of self-regulation continue to pop up in some unlikely corners of the world: small or emerging markets are attempting to modemize their regulatory structures and claim a place in the international arena. These markets often have a considerable advantage over developed markets in terms of their ability, at a formal level at least, to effectuate legislative and regulatory change. What the minister of finance wants, the minister of finance gets. Rather perversely, however, the attempts at modernization may be undermined by recourse to outdated or inappropriate regulatory concepts, including self-regulation. Both IOSCO and international financial institutions, such as The World Bank, share some responsibility in this regard. The IOSCO Objectives and Principles of Securities Regulation, despite their extensive interpretative glosses and tweaking at the edges, is essentially backward- looking, based on United States regulation and institutions in the heyday of the 1990s as they existed prior to the great soul-searching of the post-Enron era. 60 Self-regulation features prominently. Even where it may not be intuitively obvious, many governments in small or emerging economies have felt compelled to ape the old self-regulatory models of the 1990s (even where they may have dramatically changed in their place of origin, such as the United Kingdom). One motivation for this has been "signaling" to international markets and investors that the government is adopting international best practice. Somewhat slavish adoption of IOSCO principles, including the emulation of concepts of self-regulation, has been further reinforced by the Financial Sector Assessment Program (FSAP) of the

57. A Nomad is a Nominated Advisor. All Nomads must be approved by the LSE and a Nomad is generally responsible for ensuring that a company adheres to AIM's rules and regulations. For more information, see http://www.londonstockexchange.com/engb/products/companyservices/ourmarkets/aim-new/About+Al M/choosingadvisersl .htm. 58. Note the increase in listings in 2006, ostensibly at the expense of NYSE and NASDAQ. For more information, see Norma Cohen et al., Top SEC Official Calls Aim a "Casino," FIN. TIMES, Mar. 9, 2007, available at http://www.ft.com/cms/s/fa3488b8-cde4- II db-839d-O00b5df1 0621 .html. 59. Id. 60. IOSCO, OBJECTIVES AND PRINCIPLES OF SECURITIES REGULATION (May 2003), available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD 154.pdf. Berkeley Business Law Journal Vol. 4.2, 2007

International Monetary Fund (IMF) and The World Bank.6' With various international principles in hand, teams of experts led by IMF and World Bank staff have roamed the world, assessing financial systems and making recommendations for improvement. Countries take these assessments seriously; recommendations tend to find expression in loan "conditionalities" imposed by the IMF and the World Bank, and thus have an immediate and tangible 62 economic impact. There is no doubt that much good has come of the FSAP experience, which has resulted in a great wave of useful and pertinent technical assistance being provided to regulators. However, along with the good have come some outdated concepts as well. To close on a more cheerful note, there are indications that the role of self- regulation may be evolving in response to the times. As the ICMA has pointed out, self-regulation can be a useful gap-filler, particularly in times of rapid change and for the international markets where there may not be an obvious regulator to which to look. Since the international markets are primarily composed of sophisticated players and serve as the testing grounds for innovation in financial products, this development is a welcome and appropriate one. So though self-regulation appears here to stay; it just might not be staying where it used to be.

61. The Financial Sector Assessment Program (FSAP) originated in 1999 as a joint initiative of the International Monetary Fund (IMF) and The World Bank in the wake of the Asian Financial crisis of 1997, The IMF had been criticized for having been taken by surprise by the suddenness and severity of the Asian financial crisis, and the FSAP was designed to identify strengths and vulnerabilities of country financial systems to determine how risk was being managed and help prioritize policy responses. Detailed assessments of the observance of numerous financial sector standards and codes, which give rise to Reports on Observance of Standards and Codes (ROSCs) as a by-product, are a key component of the FSAP. FSAPs are conducted on a voluntary basis at the request of the individual country government. Teams of IMF and World Bank staff and outside experts spend several weeks in a country conducting the assessments of the banking, insurance, capital markets and other sectors. The FSAP findings feed into IMF surveillance efforts, particularly with respect to macroeconomic stability and the capacity of the financial sector to absorb macroeconomic shocks. They are also used as the basis for determining ongoing technical assistance in the financial sector and may also be the source of exigencies required of government by the international financial institutions as a condition of lending. Dozens of countries have participated in the FSAP exercise, both in the developed and developing world. The first participant was that good international citizen, Canada. Notably absent among the volunteers has been the United States. 62. Id.