1. Introduction

This document sets out three objectives upon which securities regulation is based. Although there are local differences in market structures, these objectives form a basis for an effective system of securities regulation.

The document also sets out thirty principles of securities regulation that give practical effect to the objectives. The discussion provides some examples of current practices, recognizing that these practices will and should change as the markets change and as technology and improved coordination among regulators makes other strategies available.

The securities and derivatives markets are vital to the growth, development and strength of market economies. They support corporate initiatives, finance the exploitation of new ideas and facilitate the management of financial risk. Further, since retail investors are placing an increasing proportion of their money in mutual funds and other collective investments, securities markets have become central to individual wealth and retirement planning.

Sound and effective regulation and, in turn, the confidence it brings is important for the integrity, growth and development of securities markets.

IOSCO is the leading international grouping of securities market regulators. Its current membership comprises regulatory bodies from 91 countries who have day to day responsibility for securities regulation and the administration of securities laws.

The Preamble to IOSCO's By-Laws states:

Securities authorities resolve to cooperate together to ensure a better regulation of the markets, on the domestic as well as on the international level, in order to maintain just, efficient and sound markets:

• to exchange information on their respective experiences in order to promote the development of domestic markets;
• to unite their efforts to establish standards and an effective surveillance of international securities transactions;
• to provide mutual assistance to ensure the integrity of the markets by a vigorous application of the standards and by effective enforcement against offences.

IOSCO recognizes that sound domestic markets are necessary to the strength of a developed domestic economy and that domestic securities markets are increasingly being integrated into a global market.

The IOSCO By-Laws also express the intent that securities regulators, at both the domestic and international levels, should be guided by a constant concern for investor protection.

The international regulatory community should provide advice, and a yardstick against which progress towards effective regulation can be measured. This document further evidences IOSCO's commitment to the establishment and maintenance of consistently high regulatory standards for the securities industry. As the leading international grouping of securities regulators, IOSCO accepts responsibility for helping to establish the high standards for regulation.

Consistently high regulatory standards and effective international cooperation will not only protect investors but also reduce systemic risk.

Regulators should be prepared to address the significant challenges posed by the increasing importance of technology and particularly developments in the area of electronic commerce.

Increasingly globalized and integrated financial markets pose significant challenges to the regulation of securities markets. At the same time, markets, particularly some emerging markets which have seen much growth in recent years, have been prone to effects of cross-border and cross-asset interactions, and some also are susceptible to higher short term volatilities after economic shocks or during periods of great uncertainty. Therefore, in a global and integrated environment regulators must be in a position to assess the nature of cross-border conduct if they are to ensure the existence of fair, efficient and transparent markets.

An increasingly global market place also brings with it the increasing interdependence of regulators. There must be strong links between regulators and a capacity to give effect to those links. Regulators must also have confidence in one another. Development of these linkages and this confidence will be assisted by the development of a common set of guiding principles and shared regulatory objectives.

Many of the topics addressed in this document are already the subject of IOSCO reports or Resolutions. ³ The reports published by IOSCO and the Resolutions adopted by its membership are also a valuable source of information on the principles that underly effective securities regulation and the tools and techniques necessary to give effect to those principles. This document draws upon those reports as a primary source. IOSCO's reports generally provide a more detailed treatment of the particular topic. Reference is made to those reports and resolutions in the notes to this document and they should be consulted when considering particular topics. Full copies of the text of reports and resolutions can be obtained from the IOSCO Secretariat. ⁴

2. Implementation

IOSCO members through their endorsement of this document express their commitment to the objectives and principles it sets out. Insofar as it is within their authority, they intend to use their best endeavours within their jurisdiction to ensure adherence to those principles. To the extent that current legislation, policy or regulatory arrangements may impede adherence to these principles, they intend that changes should be sought.

There is often no single correct approach to a regulatory issue. Legislation and regulatory structures vary between jurisdictions and reflect local market conditions and historical development. The particular manner in which a jurisdiction implements the objectives and principles described in this document must have regard to the entire domestic context, including the relevant legal and commercial framework.

Depending upon the matter in question and the arrangements within a particular jurisdiction, implementation may require any or all of: a change in legislation or regulation; a change in policy or practice by the regulatory authority; or a bilateral or multilateral agreement.

The regulator should frequently review the particular way in which securities regulation is carried out in its market. This document is not exhaustive in its treatment of all areas of market activity, the markets themselves are in a constant state of development and the content of regulation must also change if it is to facilitate and properly regulate those changing markets. The means to give effect to the principles described in this document should, therefore, be expected to change over time.

3. Structure of the Document

The paper is divided into three parts.

Part I provides an introduction to the paper and a statement of the objectives and the principles of securities regulation. There is a brief discussion of each of the objectives.

Part II describes the desirable attributes of a regulator and the potential role of self-regulatory organizations. It also considers the enforcement and market oversight work of the regulator and the need for close cooperation between regulators.

Part III considers the practical implications of the objectives in securities regulation with particular reference to issuers, collective investment schemes, market intermediaries, secondary trading and the clearance and settlement of transactions. Each substantive section in Parts II and III includes a boxed subsection that provides a summary list of the principles to be addressed in giving effect to the objectives.

4. Objectives of Securities Regulation

4.1 Objectives of Securities Regulation

The three core objectives of securities regulation are:

• The protection of investors;
• Ensuring that markets are fair, efficient and transparent;
• The reduction of systemic risk

4.2 Discussion of the Objectives

The three objectives are closely related and, in some respects, overlap. Many of the requirements that help to ensure fair, efficient and transparent markets also provide investor protection and help to reduce systemic risk. Similarly, many of the measures that reduce systemic risk provide protection for investors. Further, matters such as thorough surveillance and compliance programs, effective enforcement and close cooperation with other regulators are necessary to give effect to all three objectives. The aforementioned objectives of regulation are further described below. In Parts II and III of the document the means to satisfy these objectives, articulated in 30 principles, are explored in greater detail in the context of actual market structures and arrangements.

4.2.1 The Protection of Investors

Investors should be protected from misleading, manipulative or fraudulent practices, including insider trading, front running or trading ahead of customers and the misuse of client assets.

Full disclosure of information material to investors' decisions is the most important means for ensuring investor protection. Investors are, thereby, better able to assess the potential risks and rewards of their investments and, thus, to protect their own interests. As key components of disclosure requirements, accounting and auditing standards should be in place and they should be of a high and internationally acceptable quality.

Only duly licensed or authorised persons should be permitted to hold themselves out to the public as providing investment services, for example, as market intermediaries or the operators of exchanges. Initial and ongoing capital requirements imposed upon those license holders and authorised persons should be designed to achieve an environment in which a securities firm can meet the current demands of its counter parties and, if necessary, wind down its business without loss to its customers.

Supervision of market intermediaries should achieve investor protection by setting minimum standards for market participants. Investors should be treated in a just and equitable manner by market intermediaries according to standards which should be set out in rules of business conduct. There should be a comprehensive system of inspection, surveillance and compliance programs.

Investors in the securities markets are particularly vulnerable to misconduct by intermediaries and others, but the capacity of individual investors to take action may be limited. Further, the complex character of securities transactions and of fraudulent schemes require strong enforcement of securities laws. Where a breach of law does occur, investors should be protected through the strong enforcement of the law.

Investors should have access to a neutral mechanism (such as courts or other mechanisms of dispute resolution) or means of redress and compensation for improper behaviour.

Effective supervision and enforcement depend upon close cooperation between regulators at the domestic and international levels.

4.2.2 Ensuring that Markets are Fair, Efficient, and Transparent

The regulator's approval of exchange and trading system operators and of trading rules helps to ensure fair markets.

The fairness of the markets is closely linked to investor protection and, in particular, to the prevention of improper trading practices. Market structures should not unduly favour some market users over others. Regulation should detect, deter and penalise market manipulation and other unfair trading practices.

Regulation should aim to ensure that investors are given fair access to market facilities and market or price information. Regulation should also promote market practices that ensure fair treatment of orders and a price formation process that is reliable.

In an efficient market, the dissemination of relevant information is timely and widespread and is reflected in the price formation process. Regulation should promote market efficiency.

Transparency may be defined as the degree to which information about trading (both for pre-trade and post-trade information) is made publicly available on a real-time basis. Pre-trade information concerns the posting of firm bids and offers as a means to enable investors to know, with some degree of certainty, whether and at what prices they can deal. Post-trade information is related to the prices and the volume of all individual transactions actually concluded. Regulation should ensure the highest levels of transparency.

4.2.3 The Reduction of Systemic Risk

Although regulators cannot be expected to prevent the financial failure of market intermediaries, regulation should aim to reduce the risk of failure (including through capital and internal control requirements). Where financial failure nonetheless does occur, regulation should seek to reduce the impact of that failure, and, in particular, attempt to isolate the risk to the failing institution. Market intermediaries should, therefore, be subject to adequate and ongoing capital and other prudential requirements. If necessary, an intermediary should be able to wind down its business without loss to its customers and counterparties or systemic damage.

Risk taking is essential to an active market and regulation should not unnecessarily stifle legitimate risk taking. Rather, regulators should promote and allow for the effective management of risk and ensure that capital and other prudential requirements are sufficient to address appropriate risk taking, allow the absorption of some losses and check excessive risk taking. An efficient and accurate clearing and settlement process that is properly supervised and utilises effective risk management tools is essential.

There must be effective and legally secure arrangements for default handling. This is a matter that extends beyond securities law to the insolvency provisions of a jurisdiction.

Instability may result from events in another jurisdiction or occur across several jurisdictions, so regulators' responses to market disruptions should seek to facilitate stability domestically and globally through cooperation and information sharing.

5. The Regulatory Environment

Implicit throughout this document is the belief that regulation should facilitate capital formation and economic growth. In the context of regulation, there should also be a recognition of the benefits of competition in the market place.

Regulation is necessary to ensure the achievement of the three core objectives. Nevertheless, inappropriate regulation can impose an unjustified burden on the market and inhibit market growth and development.

It is possible to identify general attributes of effective regulation that are consistent with sound economic growth:

• there should be no unnecessary barriers to entry and exit from markets and products;
• the markets should be open to the widest range of participants who meet the specified entry criteria;
• in the development of policy, regulatory bodies should consider the impact of the requirements imposed;
• there should be an equal regulatory burden on all who make a particular financial commitment or promise.

More generally, there must be an appropriate and effective legal, tax and accounting framework within which the securities markets can operate. Securities law and regulation cannot exist in isolation from the other laws and the accounting requirements of a jurisdiction.

Matters of particular importance in the legal framework are set out in Annexure 3. This Annexure is not intended to be an exhaustive list of matters to be addressed in domestic legislation but rather to identify some matters that particularly impact upon the securities markets. ⁵

The accounting framework may also be considered an aspect of the legal framework but it (particularly the preparation of financial statements) is discussed in the context of disclosure by issuers in Section 10.