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May 19, 2000


"Model for Effective Self-Regulation"
Presented at IOSCO Conference, Sydney, Australia

Good afternoon. My name is Karen Wuertz. I am the Senior Vice-President for Strategic Planning at National Futures Association.

For the past two years I have served on a subcommittee designated by IOSCO's SRO Consultative Committee and co-chaired by National Futures Association and the Counseil des Marches Financiers. This subcommittee was charged with preparing a paper advocating the use, value and efficiencies of self-regulation as part of the overall regulatory structure in the financial services industry. The subcommittee included a cross-section of self-regulatory organizations, in terms of geographic location, type of market and type of self-regulatory organization. The subcommittee held meetings to discuss the content material for the paper and to discuss important issues impacting the various marketplaces around the globe. The subcommittee also reviewed a large amount of material written on the topic of self-regulation. Additionally, a questionnaire was distributed to solicit specific information regarding the activities of each organization. Copies of these questionnaires are available upon request.

It is my pleasure today to present to you the highlights of the subcommittee's paper, entitled "Model for Effective Self-Regulation."

I would like to begin by giving you a brief definition of self-regulation as it applies to the financial services industry and then spend a few minutes outlining specific elements of effective self-regulation.

Self-regulation typically involves a unique combination of private interests with government oversight. Self-regulation has proven to be an effective and efficient form of regulation in several markets and countries around the world. In fact, in several jurisdictions around the world, effective self-regulation existed before statutory regulation. As markets developed, market participants recognized that regulation was necessary in order to protect the integrity of the market. Industry participants recognized that those who were most familiar with the customs and practices of a particular trade were best suited to create rules related to that trade, to enforce those results and to resolve the disputes that arose from those rules.

Many different forms of self-regulation currently exist. There are industry self-regulatory organizations, exchange self-regulatory frameworks and private associations that define and encourage adherence to standards of best practice among its participants. Self-regulation typically focuses on oversight of the market itself, qualification standards for market intermediation and oversight of the business conduct of intermediaries, including their relationship with their client market-users.

However, one of the major reasons for the success of SROs is their flexibility to adapt regulatory requirements to a rapidly changing business environment. This flexibility will be even more important as advances in technology and telecommunications create global markets that trade without regard to national boundaries. The regulatory framework must be continuously evaluated so that it does not lag behind or act as an impediment to market innovations.

Although it is beyond the scope of this project to try to reconcile differences in regulatory principles that exist across countries or across different financial markets' regulatory regimes within a country, there are several important common elements that contribute to the effectiveness of self-regulation.

First, self-regulatory bodies offer industry specialized knowledge. This knowledge base is an invaluable source of expertise for statutory regulators during the rule development process. It also allows the SRO to design, implement and evaluate effective compliance programs. Hand-in-hand with industry knowledge is industry representation. Both statutory regulators and SROs recognize that industry representation provides each regulator the capacity to react quickly to changes in the marketplace. Industry representation provides the knowledge and the institutional background so that both can identify trends and determine the regulatory implications of those trends.

The second element of effective self-regulation is industry motivation. Self-policing systems and the general concept of self-regulation work because of the business incentive to operate a fair, financially sound and competitive marketplace. Reputation and competition are powerful motivating forces for sustained proper behavior, especially in today's global environment where market participants have virtually immediate, 24-hour access to a range of competing markets and products. Incorporating self-regulation into the regulatory framework will result in better regulation because the statutory regulator's statutes and rules are supplemented and enforced by those entities directly involved in the regulated activity, which will have more detailed knowledge of the operational or technical aspects of the activity. Additionally, self-regulation may result in better compliance with rules because it may be more easily accepted by the regulated parties. One way an industry can demonstrate its commitment to self-regulation is by demonstrating its willingness to pay for self-regulation. In the United States, for example, National Futures Association is funded entirely by the futures industry. No federal, state or city taxes are used to finance the Association.

A strong contractual relationship between the SRO and the individuals and entities it regulates is the third element of effective self-regulation. This relationship can have a global reach, crossing national boundaries. It may reach where statutory powers may not. It also provides more flexibility and allows SROs to react more quickly because it is based on the SRO's rulebook and the agreement by the SRO's members that they will comply with the requirements of the SRO's rulebook. Self-regulation does not mean self-interest. That's why transparency and accountability are elements of effective self-regulation. An SRO's compliance programs should be transparent and accountable to ensure that SROs follow professional standards of behavior on matters including confidentiality and procedural fairness. To assure this transparency and accountability, SROs can make their rules accessible to the public in printed form or over the Internet, publicize significant disciplinary actions taken by the SRO and conduct educational outreach programs. The SRO should also include public and industry professionals on its governing body and encourage public participation in deliberations pertaining to regulatory policy and rulemaking.

Another important element of self-regulation is a flexible compliance program. By flexibility, I mean that the regulatory framework should allow market participants to respond to inevitable change in an innovative, timely and sensitive manner. This flexibility should not be shackled by a rigid agency review and approval process by the statutory regulator.

In addition to flexibility, an SRO's regulatory programs must have clear guidelines that can be objectively applied. The SRO Consultative committee of IOSCO conducted a survey regarding each SRO's regulatory obligations and the methods used in fulfilling those obligations. The survey indicated several common regulatory practices and objectives, including:

  • Enforcing rules and regulations through investigations and disciplinary action;
  • Conducting financial/operations and sales practice examinations;
  • Conducting fitness screening for access to the marketplace;
  • Handling customer complaints;
  • Having surveillance programs to detect violative conduct;
  • Sharing information and cooperating with other SROs; and
  • Providing a dispute resolution forum.

Obviously, as the markets become more globalized, coordination of market oversight becomes more important. That's why coordination and information sharing are two more important elements of effective self-regulation. In fact, coordination and information sharing must be a priority among markets in order to address cross-market issues.

SROs are an excellent forum for bringing together different interests on regulatory issues. Fortunately, the development of advanced communication technologies will continue to improve the quality, amount and timeliness of shared information.

I cannot stress the importance of this element strongly enough. Cooperation by national regulators and SROs in an increasingly global financial environment is not an option-it is a necessity. And this coordination and cooperation should not occur after a problem arises. Rather, coordination and communication should be structured to address potential problems before they happen.

Organizations like IOSCO can play a valuable role in bringing about harmonization through developing general principals and promoting understanding of regulatory differences that may exist across countries. IOSCO continues to increase in importance to statutory bodies and SROs because of the global aspects of regulation. It is important to solicit industry participation in international standards-setting projects to ensure that the standards adequately reflect legitimate business considerations.

Now, before I present a model template for an effective self-regulatory organization, I would like to take a few minutes to discuss the role of regulatory oversight of SRO functions and the relationship between the regulator and the SRO.

Effective self-regulation must be defined within the context of government oversight. In fact, government oversight is an essential element in the self-regulatory structure because it ensures that all interests are given the proper consideration and voice in all regulatory activities. It provides the proper system of checks and balances and avoids potential conflicts of interest.

The governing statute should clearly delineate the respective roles of the statutory regulators and the SROs. The paper we are presenting today recommends giving SROs the clear authority to act as self-regulating bodies with the power to make and enforce their own rules, while the statutory regulator's role should truly be an oversight one.

This relationship between the statutory regulator and the SRO is very important. In some jurisdictions, SROs submit new rules and rule changes to the statutory regulator to ensure they are consistent with the protection of investors, as well as other standards. However, we believe that SROs with an established track record of success should be given both the authority and the responsibility to determine and evaluate what rules are appropriate to govern the conduct of their members. The statutory regulator should step in only if a self-regulatory organization shirks its responsibilities and allows its members to endanger customer funds or engage in fraud, manipulation and other illegal conduct. This would allow the statutory regulator to focus its limited resources where there is the most risk rather than creating an unnecessary layer of review and regulation. An effective regulatory framework also should ensure that there is little or no duplication of the regulatory work performed by SROs and the statutory regulators. One way to eliminate or at least reduce duplication of efforts is the development of memoranda of understanding, or MOUs, between the statutory regulators and the SROs. These MOUs delineate the responsibilities between the front-line regulator and the oversight body and provide for a separation of functions.

Now that I have described the elements necessary for an effective self-regulatory organization, I would like to take a few minutes to discuss how these elements can be used to develop a self-regulatory model. Of course, I realize that each marketplace has its own distinct characteristics and environments. That's why this template was designed to be flexible and diverse. It should be recognized as a menu of options and not a rigid format.

First, let's look at a list of basic areas to be considered in the template:

  • Internal rulemaking procedures;
  • Authorization and access to marketplace, including fitness/qualification standards for market intermediaries;
  • Establishment and enforcement of financial, operational and sales practice standards;
  • Surveillance of market activity;
  • Investigation, prosecution and adjudication of rule violations;
  • Administration of dispute resolution forum;
  • Development and implementation of education programs for market participants and public investors; and
  • Sharing information and cooperating with other SROs and statutory regulators.

There are several ways in which financial markets around the world can use this template. First, developing SROs can use the template to aid in the design and development of their regulatory objectives and programs. Existing SROs can use the template to review and evaluate their regulatory programs, especially in the face of the structural changes occurring in the markets due to technology and telecommunications.

Perhaps more importantly, the development of a template could lead to a process in which SROs regularly exchange "best practice" information as a means of continuously improving the effectiveness of self-regulation in the regulatory framework. By "best practices" I mean the types of procedures which different SROs use to effectively meet their regulatory objectives. These best practices must be frequently updated to reflect changes occurring in the industry.

Keep in mind that the successful implementation of a self-regulatory model will vary depending on the maturity and sophistication of the marketplace and its existing regulatory environment. In a less mature and less sophisticated market, resources will be needed to educate statutory regulators and market participants about the benefits of self-regulation. A successful self-regulatory program can be implemented over time as an SRO demonstrates its effectiveness to the marketplace and to the statutory regulators.

There are many hurdles to be cleared while an effective self-regulatory organization is developed. But we believe the reasons for incorporating self-regulation into a regulatory framework far outweigh any hardships you may face.

Here are just a few of those reasons:

  • Self-regulation has a long history of working effectively. SROs are motivated to act responsibly, developing best practices and monitoring their markets out of economic, reputational and regulatory self-interest.
  • SROs possess the flexibility to adapt to regulatory requirements of a rapidly changing business environment. SROs are close to their markets and market users and can tailor their rules and surveillance techniques to the specific characteristics of their markets.
  • SRO contractual relationships can reach across international boundaries. SROs may be more effective in dealing with global issues because self-regulation is defined by contract-the rulebook-versus national legislative act.
  • Industry input and representation contribute to a strong and effective compliance culture. SROs are in a good position to balance the benefits of their regulation relative to the costs and avoid unnecessary regulatory costs.
  • Self-regulation generally imposes fewer costs than government regulation. Incorporating self-regulation into the regulatory regime should diminish the need for tax dollar financing, provided that SROs and government regulators cooperate and coordinate with one another to avoid duplicating activities.
  • SROs provide an intimate knowledge of the markets and products. SROs have the experience, resources and commitment to play a constructive role in examining issues and arriving at creative and effective solutions.

Based on the subcommittee's research and findings while preparing this paper, we strongly believe that IOSCO committees and their respective working groups should consider, recognize and incorporate self-regulatory approaches in the guidelines or standards they develop for the specific regulatory issues they examine.

Thank you for your time and attention this afternoon. I will be happy to answer any questions you might have.

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