Preconditions for Effective Securities Market Regulation
Effective securities regulation depends on the existence of a number of “preconditions.” The IOSCO core principles recognize that “securities law and regulation cannot exist in isolation from the other laws and the accounting requirements of a jurisdiction” (IOSCO
2003b, 8). In particular, the principles note that “there must be an appropriate and effective legal, tax and accounting framework within which the securities markets can operate” (IOSCO 2003b, 8). The preconditions are not formally part of the core principles because they are outside the jurisdictional authority of most securities regulators. IOSCO identifies in an annex to the core principles certain elements of the legal framework that are particularly important for effective securities regulation. These elements include (a) company law; (b) a commercial code or established contract law, including recognition and enforcement of property rights; (c) clear and consistent tax laws, especially with respect to the treatment of investments and investment products; (d) bankruptcy and insolvency laws; (e) competition law; (f) banking law; and (g) a fair and efficient judicial system or other dispute resolution system in which orders can be enforced and illegal behavior sanctioned (IOSCO 2003b, annex III).
Weaknesses in the preconditions can have a significant deleterious impact on the effectiveness of securities regulation and on market development. Investor protection must be grounded in a legal framework for investors to have confidence in the markets. For example, without an effective bankruptcy law, investors will be reluctant to risk investing in a company that may fail because they will be without any legal recourse. Similarly, investors would be reluctant to leave assets in accounts with a securities firm or an asset management company if bankruptcy and property law did not support a clear separation of client assets from the general assets of a firm. Without uniform accounting standards, companies will not be able to present a consistent and meaningful financial picture to investors. The absence of a fair and impartial judicial system that can mediate disputes or enforce sanctions will weaken the credibility and effectiveness of securities regulation.
As part of the IOSCO assessment, it is important to gain an understanding of the relevant preconditions in a particular country, which will require access to information from a wide variety of other sources, including assessments of other financial sector components. Information will be needed from country authorities other than the securities regulator and from market participants. Assessments of the legal system and accounting standards would provide information on shortcomings, if any, that might affect securities regulator’s activities. In addition, when considering actions to enhance securities regulation, country authorities will need to determine whether the preconditions themselves should be addressed first to ensure that the proposed action will achieve its objective.
