The securities industry is one of the most highly regulated industries in the world, with a complex regulatory architecture created to ensure the stability of the market. The objective of securities market regulation is to supervise the flow of information about traded securities, monitor the market for the information abuse or intention to manipulate markets and prices as well as to supervise the corporate governance of organised markets.
Notwithstanding strict regulation and supervision of major financial markets, the global financial crisis in 2008 revealed considerable gaps in the securities regulations on both sides of the Atlantic.
What followed was a major regulatory overhaul of the financial industry to increase the resilience of the financial system and mitigate risks of financial institutions to fail, risk of spillovers from the financial sector to the broader economy and the risk for taxpayers to bear the cost of the future banking crisis.
European Securities Framework
EU securities market is regulated by ESMA, an independent European authority committed to safeguarding the stability of the EU’s financial system by enhancing investor protection and securing stable, efficient and orderly functioning of financial markets across the EU.
ESMA’s activities include direct supervision of specific financial entities across the EU, and assessment of risks to investors, markets and financial stability. This institution is also responsible for creating a single rulebook for EU financial markets and for supporting the convergence of financial supervision within the EU.
European legal framework for securities market regulation is based on EU Directives transposed into national legislation of individual member states. This, however, does not apply to EU Regulations, which are directly applicable in each member state.
Relevant EU regulatory framework includes:
- The Markets in Financial Instruments Directive (MiFID II)
- The European market infrastructure regulation (EMIR)
- The Prospectus Regulation
- The Market Abuse Regulation
- The Transparency Directive and
- The Short Selling Regulations.
The Foundation of EU Securities Legislation: The Markets in Financial Instruments Directive (MiFID II)
MiFID provides a unified framework for securities regulation in the EU, reconfiguring the landscape of market infrastructure since it came into force in 2007, the same year National Market System regulations reformed equities markets in the US. It was updated with MiFID II and MiFIR in 2018.
MiFID II applies to investment firms, Multilateral Trading Facilities (MTF), Regulated Markets (exchanges), Organised Trading Facilities and financial instruments (transferable securities, money market instruments, units in collective investment undertakings and derivatives with exception to bond and securitized debt).
The following are key MiFID features:
Market Fragmentation – MiFID recognises four trading platforms: regulated markets (RMs), multilateral trading facilities (MTFs), Organised Trading Facilities (OTF) and systematic internalizers (SIs). This market fragmentation was created to ensure market transparency but it also increased complexity and costs as market participants need to collect information from a multitude of trading venues. To stay compliant with MiFID, market participants must collect financial information from a large number of trading facilities, all of which come with different identifiers and formats, quality and technical requirements, which makes it a very costly and complicated regulation to comply with.
MiFID Passports allows firms authorized and regulated in their country of incorporation to provide services in other EU member states.
Categorization of Clients – MiFID recognizes three types of clients: eligible counterparties, professional clients and retail clients, each requiring a different level of protection.
Order Processing and Transparency – To ensure the best execution practice and safeguard clients with respect to order prioritization and aggregation, MiFID requires that certain information is recorded when accepting client orders. To secure post-trade transparency market participants must report the price, value, and time of all trades in listed shares, including those which are not executed on a regulated market.
The European Market Infrastructure Regulation (EMIR)
The European Market Infrastructure Regulation (EMIR) applies to activities involving derivatives trading. To reduce risk and achieve higher market transparency, EMIR imposes certain requirements such as reporting of all derivative contacts, mandatory centralized clearing of standardized OTC derivatives, risk mitigation techniques for non-centrally cleared OTC derivative transactions (timely confirmation of transactions, daily valuation, portfolio reconciliation, dispute resolution, portfolio compression), and enhanced collateral requirements.
EMIR reporting requires that all OTC contracts are reported to trade repositories by the following day. However, it also requires all trade repositories to reject all trade reports without a Legal Entity Identifier or LEI, regardless of the origin of market participants (EU or non-EU), evidencing the important role LEI codes play in modern financial systems.
As MiFID was created before EMIR, there are certain conflicting areas with EMIR’s derivatives trading and reporting obligations. For example, MiFID II requires market participants to use BICs (Business Identifier Codes) and other recognized and standardized counterparty IDs, which is not compliant with EMIR, which requires the use of LEIs.
US Securities Regulatory Framework
The objective of the US securities regulation is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. To ensure that these objectives are met, the US regulation and supervision of securities market are organised across three different levels: federal, state and the level of Self Regulatory Organisations (SRO).
A federal regulator is the Securities and Exchange Commission (SEC), mandated with the task of protecting investors and maintaining the integrity of securities markets. It also reviews all rules proposed by so-called self-regulatory organisations to determine if they comply with the Securities Exchange Act of 1934.
States are authorized to register and supervise broker-dealers and investment advisers who are not registered with the SEC.
Self Regulatory Organisations such as exchanges, trade repositories and the Financial Industry Regulatory Authority set rules and supervise business practices of their members.
The main securities regulator in the United States is the SEC, an independent government agency mandated with rulemaking and civil enforcement authority that administers the federal securities laws. The scope of its supervision includes public companies and their public disclosure of financial and other information to the public, securities exchanges, securities brokers and dealers, investment advisers, and mutual funds.
The Financial Industry Regulatory Authority (FINRA) is the largest non-governmental regulator of securities firms in the United States dedicated to investor protection and market integrity. As a government-authorized not-for-profit organisation, it oversees more than 624,000 US broker-dealers to ensure that industry operates fairly and honestly.
The Laws That Govern the US Securities Industry
Securities Act of 1933
Securities Exchange Act of 1934 was introduced to ensure that investors have access to important information about publicly traded securities and to prevent fraud by imposing disclosure of important financial information in the process of securities registration, enabling investors to make informed decisions.
Securities Exchange Act of 1934
The Securities and Exchange Commission was created with this Act, which granted it with the mandate to register, regulate, and supervise brokerage firms, transfer agents, and clearing agencies as well as the national self-regulatory organisations.
Investment Company Act of 1940 regulates collective investment schemes such as mutual funds.
Investment Advisers Act of 1940 requires that firms or sole practitioners compensated for advising registered investment companies or who have at least $100 million of assets under management must register with the SEC.
Sarbanes-Oxley Act of 2002
Introduced in the aftermath of the Enron scandal, the Sarbanes-Oxley Act of 2002 was characterized at the time as the biggest overhaul in the US business practices. The Act introduced a set of measures to enhance corporate responsibility, financial disclosures and prevent corporate and accounting fraud.
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
Following another crisis that shook up the securities market, the Dodd-Frank Wall Street Reform and Consumer Protection Act was introduced in 2010 to reconfigure the US regulatory framework as many areas demonstrated significant weaknesses during the crisis, including consumer protection, trading restrictions, credit ratings, regulation of financial products, corporate governance and disclosure, and transparency.
Jumpstart Our Business Startups Act of 2012
The Jumpstart Our Business Startups Act was introduced in 2012 to help businesses raise funds in public capital markets by minimising regulatory requirements.
International Regulatory Response in the Aftermath of the Financial Crisis 2008
The global financial crisis in 2008 revealed many vulnerabilities of the global financial system, one of the considerable being widespread difficulties in identifying and tracing financial transactions across the international financial markets. To address these challenges, the FSB published A Global Legal Entity Identifier for Financial Markets laying down 15 global LEI system High-Level Principles and 35 recommendations for the development of a unique identification system for parties to financial transactions.
In a data-driven world where the digital format of assets is dominant, a global identifier is a critical element for improving financial data and ensuring accurate and timely aggregation of entity-level data across different sources, which is particularly challenging on a cross-border basis. The direct results of the implementation of a global identifier include improved risk management, facilitation of orderly resolution, and higher quality of financial data overall, but also a better assessment of micro and macroprudential risks. With more than 1.6m LEI codes across 200 jurisdictions as of today, this unique global identifier is a vital support for supervisors and market participants when they assess and manage financial risks while reporting across various jurisdictions.