This part describes the reasons for establishing the working party, summarises the views of the working party on the content and objectives of international conduct of business principles and considers briefly methods for elaborating conduct of business rules in various countries.

I - THE EVOLUTION OF INTERNATIONAL FINANCIAL MARKETS AND THE DEVELOPMENT OF CONDUCT OF BUSINESS STANDARDS

4 - The increased focus on conduct of business standards stems from the profound transformation which the world's financial markets have gone through, to varying degrees, since the end of the 1970s. This transformation can be attributed in part to the major phenomenon of internationalization. Issuers, intermediaries, investors and regulatory authorities have all had to respond to this important development. Issuers have resorted increasingly to the international markets to raise capital and to diversify the markets where their financial products are traded. Many intermediaries have established subsidiaries or branches on most of the main financial markets worldwide. Investors have sought to internationalise their portfolios to spread their risks across different financial markets.

5 - Regulatory authorities are confronted with internationalization on three fronts, challenging their traditional methods of operation:

• the internationalization of the intermediaries whose activities they regulate;
• the increasing volume of cross-border investment;
• the development of transnational markets which are more difficult to supervise.
  

6 - The pace of internationalization has been accelerated by rapid advances in technology facilitating cross border transactions of financial services business. Technological changes have changed the mechanism for dissemination of information, and the techniques used in effecting transactions and portfolio management. New methods of trading and information dissemination have, by making possible 24 hour trading, contributed to the globalisation of financial markets. Moreover, developments in trading technology and techniques have created unprecedented challenges to market transparency.

7- The transformation of the world's financial markets can also be attributed in part to increasing institutionalization of markets, with a growing share of the various financial markets being taken by institutions managing increasingly large financial portfolios, in particular, insurance groups, pension funds, unit trust and portfolio managers. The increasing market share of institutional investors has been accompanied by a reduction in direct investment by small shareholders. Although institutional investors may be able to obtain appropriate services and to protect their own interests (although this is not always the case) smaller investors generally may be at a disadvantage in dealing with financial services firms with superior market information and more sophisticated trading techniques. Smaller investors, whether they participate directly in the markets, or indirectly through mutual funds or pension funds, continue to be considered vital to the functioning of the markets. Their continued participation depends upon confidence in the integrity of the market and in the firms with which they deal.

8 - Accordingly, developments in increasing internationalization and institutionalization require attention to be given to the conduct of business of financial services firms. The formulation of conduct of business principles and the implementation of rules based on such principles can boost investor confidence in the market. In order to reflect the realities of today's markets, such rules of business conduct should be flexible enough to differentiate between professional and non professional market participants.

9 - In addition, a further reason for considering the development of conduct of business principles has been the structural changes which have occurred in many countries. In particular, there has been a move away from single capacity and fixed commissions. Stockbroking is now carried out by multi-functional institutions, which may undertake market making, portfolio management and in many countries banking activities. This situation risks conflicts of interest among the various activities. Finding a solution to the challenges of these changes is a further reason for the introduction of conduct of business principles.

10 - All of these developments have, in one form or another, affected all financial markets. Some countries are responding to them by the elaboration of conduct of business rules.

II- REASONS FOR FORMULATING CONDUCT OF BUSINESS PRINCIPLES ON AN INTERNATIONAL LEVEL

11 - Clearly, one way of dealing with the challenges in different jurisdictions would be to establish separate sets of conduct of business rules or principles in each of those jurisdictions. However, the working group sees considerable advantage in the development of principles for the conduct of business at an international level, both for market participants and domestic regulators.

12 - As far as market participants are concerned, a set of common principles provides basic standards for business conduct, wherever the business is undertaken. This should facilitate cross border business, encouraging competition among firms, with increased consumer choice and lower costs. Commonly agreed principles should also enhance investor understanding, and hence confidence, and so increase investor participation in international markets.

13 - For domestic regulators, including self regulatory organizations, international formulation of conduct of business principles can help in two ways. Firstly, as conduct of business rules increasingly come to reflect principles adopted on an international plane, regulators will be able to draw more on solutions adopted in other countries when developing their own regulatory systems. Secondly, international principles can reinforce the measures adopted by national authorities.

14 - On the international front, the formulation of principles of conduct on an international basis should contribute to the effort of international organisations of regulators like IOSCO to resolve problems arising in the world's markets.

III - THE OBJECTIVES OF THE INTERNATIONAL CONDUCT OF BUSINESS PRINCIPLES

A) The scope of the working party's mandate

15 - Firstly, in accordance with its mandate, the working party stresses that it has seen its objective as to elaborate principles, rather than detailed rules of conduct. The working party also saw an important part of its objective as being to establish principles not only for international business but also for domestic business.

16 - The working party adopted the term conduct of business. rather than ethical conduct', as originally proposed by the Technical Committee. The change of terminology reflects the working party's conclusion that its objective is to prepare principles which set high standards of behaviour in financial markets. The working party considered that the concept of ethics involved moral standards which might go beyond this pragmatic objective.

17 - Similarly, the working party adopted the expressions "protecting the interests of customers" and "best interests of customers" rather than the expression "promoting the primacy of the interest of the client" which was contained in the mandate of the Technical Committee. It was felt that the latter expression tended to have a more direct reference to ethical. standards of behavior. The "best interests of customers" phrase employed in the principles was considered to be better related to high standards of business practice.

B) The contents of the principles

18 - Conduct of business principles can be defined as those principles of conduct which should govern the activities of financial services firms in protecting the interests of their customers and the integrity of the market.

19 - The proposed principles focus upon financial intermediaries (brokers, banks, portfolio managers, financial analysts, investment advisers...) and other market participants. The purpose of conduct of business rules is to protect customer interests and enhance market integrity. The second objective widens the scope of the first. It is necessary to protect the interests of all market participants and not just the financial intermediary's own customers.

20 - It is also necessary to distinguish conduct of business provisions from those which address market conduct and practice on such matters as insider trading, market manipulation or fraud. These offences are usually defined in legislation and may be interpreted further through case law. They cover all participants in the markets, both private investors and professionals and may be backed by criminal sanctions. Conduct of business rules however are frequently determined by the professionals themselves, may be applied only to them and may lead only to professional or civil - not criminal - sanctions.

21 - Moreover it is important to distinguish conduct of business rules from capital requirements and liquidity and debt ratios, which are devised to promote market security. In fact, all these rules complement each other in order to assist the smooth operation of the market.

IV - THE IMPLEMENTATION OF CONDUCT OF BUSINESS PRINCIPLES

22 - The working party is firmly of the view that competence for implementing the international conduct of business principles lies with each domestic authority. In this way, implementation will be adapted to local circumstances.

23 - In regulating the conduct of business, domestic authorities all face the same tasks: elaboration of rules, monitoring and enforcement, but the solutions need to be adapted to the local circumstances. The working party considered that it would be useful to discover some information about the variety of methods adopted and issued a questionnaire to its members for that purpose. The following comments are based on the responses received.

The elaboration of conduct of business rules

Sources

24 - Members of the working group referred to two possible sources for conduct of business rules: professional, when the content of the rules stems from a consensus among the professions concerned; and state, in so far as the content of the rules meets the requirements of the public authorities. It is unlikely that any one system has recourse to only one of these sources and that in each system there is likely to be a mixture of the two in varying proportions. The objectives of rules of business conduct - the smooth running of an activity that is relatively well defined - may nonetheless imply that the professional source will in most cases play a very important role.

The implementation of conduct of business rules

25 - Conduct of business rules are implemented by the different member organisations in a variety of ways: laws; regulations; internal rules within a company or institution; unwritten principles and customs; case law.

Monitoring and enforcement

26 - The competence of the monitoring authority can be based on the nature of the establishment being controlled (institutional criterion), or on the nature of the activity (functional criterion). It appears, however, that most of the working party members have recourse to both types of control.

27 - Frequently the regulatory functions carried out by central public bodies are combined with those of professional authorities, to whom the task of regulation is often delegated. These functions are also occasionally combined with those carried out by banking authorities.

28 - In certain countries, breaches of rules of business conduct are not subject to sanctions in the strict sense of the word. They result simply in recommendations by the authorities to the parties concerned.

29 - When sanctions do exist, they vary in nature:

• disciplinary sanctions may be taken either against individuals or legal entities;
• administrative sanctions may be implemented by public authorities or self regulatory organizations;
• penal sanctions.

and in their content:

• fines;
• temporary suspension of authorisation to practice an activity;
• permanent deprivation of authorisation to practice an activity.

V - CONCLUSION

The principles which have been agreed by the working group are contained in the second part of the report. Although IOSCO members have varying degrees of responsibility to regulate conduct of business in their respective countries the working party recommends that they should, in the interests of assisting the development of the international markets, commit themselves to implementing the principles within their own regulatory structures and to promote their wider application, particularly vis a vis other authorities in their own countries.