A comparative analysis of the US and EU retail banking markets - Wsbi

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4.3.2 United States 4.3.2.1 Background During the 1920s in the US, approximately 20 million small and large shareholders were trading $50 billion’s worth of securities on the stock market. It is estimated that half of these securities became worthless following the 1929 crash 198 . As early as 1933, the US Congress passed the first two laws that govern the securities markets as a response to the stock market crash: the Securities Act of 1933 and the Securities Exchange Act of 1934. In response to the events of 1929, the 1933 Act introduced laws that require full and fair disclosure of the character of securities to ensure that investors receive sufficient information to be able to make informed investment decisions. Another objective was to prevent misinterpretation and fraud associated with the trading of securities. The 1934 Securities Exchange Act set the basis to establish the Securities and Exchange Commission (SEC), a regulatory agency independent of federal government, but still under the oversight of a number of congressional committees. The SEC was assigned high level regulatory and enforcement powers: power to register, regulate and oversee the exchanges, broker-dealers, investment advisors, transfer agents and clearing agencies 199 . The Act also introduced the obligation for all publicly traded securities to be registered with the SEC, bringing in more transparency by requiring companies to disclose all relevant information about their properties and businesses, a description of the security to be offered for sale, information about the management of the company and its financial performance. Several other Acts were adopted in the following years (Public Utility Holding Company Act of 1935, Trust Indenture Act of 1939, Investment Company Act of 1940 and Investment Advisers Act of 1940), but the next major change to the securities market was introduced in 1975 with the amendment to the 1934 Securities Exchange Act 200 . This legislative reform, which became known as the National Market System (NMS), required the SEC to facilitate the development of a national market system for the trading of securities. The objective of NMS is “promoting fair competition among individual markets, while at the same time assuring that all of these markets are linked together, through facilities and rules, in a unified system that promotes interaction among the orders of buyers and sellers in a particular NMS stock. The NMS thereby incorporates two distinct types of competition – competition among individual markets and competition among individual orders – that together contribute to efficient markets” 201 . In response, a number of key mechanisms were developed over the years to increase market efficiency, transparency and investor protection. - The best execution rule obliges investment firms to execute clients’ orders under the most favourable conditions to the client. Trading centres are obliged to publish monthly statistics about execution quality to enable investors to judge whether best execution was achieved. Moreover, investment firms must publish quarterly statistics with a list of venues to which orders are routed to give information on their relationship with the market and to avoid conflict of interests between investment firms and their clients. - Order handling rules (quote rule and limit order display rule) have the main objective to increase market transparency. These rules provide public information about the prices at which market makers are prepared to trade their securities. - Increased market interconnection makes it possible to easily gain access to numerous trading venues. These fundamental categories of measures set a solid basis for the development of the US capital market and served as a starting point for the new Regulation NMS which was adopted in 2005. All mentioned measures and the NMS Regulation are looked at in more detail below. 4.3.2.2 Applicable legislation 4.3.2.2.1 Best execution Whenever an investment company has a choice of executing its client’s order in more than one trading venue, it has a fiduciary obligation to choose the one where the conditions are most favourable to the client. This best execution rule is certainly one of the most important mechanisms designed to ensure investor protection. 198 US SEC «The investor’s advocate: how the SEC protects investors and maintains market integrity», July 2005. 199 Not all the powers mentioned were initially granted to SEC, but added subsequently over time. 200 The NMS was newly amended in 2005 as a response to market developments. This will be discussed in more detail below. 201 US SEC, Regulation NMS, Release No. 34-51808; File No. S7-10-04, June 2005. 66
The best execution rule was first mentioned in the 1934 Securities Exchange Act and upheld by the NMS, however without specifying the actual scope of the company’s responsibility when executing its client’s order. For the first time, in the 1996 Order Execution Obligations Act, the SEC stated that “the duty of best execution requires a broker/dealer to seek the most favourable terms reasonably available under the circumstances for the execution of a customer’s transaction” 202 . Although this definition indicates the core of the best execution rule, one could argue that it is also rather vague, as it does not provide a detailed description of the steps which an investment firm is expected to take to satisfy the requirement imposed by the rule. The SEC justified the lack of a precise definition by stating that “the scope of this duty of best execution must evolve as changes occur in the market that give rise to improved executions for customer orders, including opportunities to trade at more advantageous prices. As these changes occur, broker-dealers' procedures for seeking to obtain best execution for customer orders also must be modified [...]” 203 . A number of parameters which can affect the best execution were also identified (among which price, speed and probability of implementation), although no clear priority was assigned to any of them. To introduce some order, the SEC empowered Self Regulatory organisations (SROs) to define their own definition of best execution adapted to their trading mechanism 204 . In addition, each investment firm is required to define its best execution policy. Moreover, the SEC undertook some actions to link the prices on different markets and to make the system more transparent. It set up a national best bid and offer (NBBO) mechanism through which the best available ask price and the best available bid price is collected from all significant market centres and disseminated to the public. It is important to note that the best price available in the market is not necessarily NBBO and that the traders in the US are obliged to consider the possibility of price improvement, i.e. to obtain a price better than the NBBO through alternative markets. The SEC found that “at some market centres as many as 50% of certain orders, particularly market orders for small sizes (less than 500 shares), are executed at prices better than the public quotes” 205 . In its constant effort to enhance best execution rules, in 2001 the SEC adopted a rule to improve public disclosure of order execution 206 . Namely, it introduced an obligation on trading centres that trade national market system securities to publish monthly electronic reports with uniform statistical measures of execution quality in order to enable investors to judge for themselves whether best execution has been achieved 207 . Such uniform information should enable the investors to compare prices on different markets as well as to encourage a fair competition between trading centres. This information is necessary as the same securities are nowadays traded on different markets (e.g. on exchanges, over-the-counter market makers, electronic communication networks, etc.) making it harder to keep track of all offer prices and trading conditions. Finally, on the same day as the order execution rule, the SEC also adopted a rule on routing practices. It requires investment firms that route customer orders in equity and option securities to publish quarterly reports with a list of venues to which they routed a significant percentage (more than 5%) of clients’ orders 208 . Brokers must also identify the nature of their relationship with those venues, enabling the clients to observe and evaluate whether brokers’ routing practices are acceptable. This rule was imposed after the practice showed that some brokers who offer the lowest fees and a quick execution might not be the best choice for retail investors. A decision based only on these two parameters (low fees and quick execution) might limit opportunities for investors to obtain the best price and might lead to a conflict of interest between the broker and investor. 4.3.2.2.2 Order handling rules Order handling rules include the quote rule and the limit order display rule. Their purpose is to increase the information that is publicly available concerning the prices at which market makers are prepared to trade their securities. 202 US SEC, Order Execution Obligations Act, Release No.34-37619A, 6 September 1996. 203 Idem. 204 Each SRO can create unique rules to regulate the business conduct of its members with regard to equities trading, but on the condition that it recognises national securities laws and various directives issued by the SEC. Some examples of SROs are NYSE, AMEX, NASD and regional stock exchanges. 205 US SEC, Disclosure of Order Execution and Routing Practices, Release No. 34-43590, 17 November 2000. 206 US SEC, Disclosure of Order Execution and Routing Practices, Release No. 34-43590, 17 November 2000. 207 Disclosure of Order Execution and Routing Practices, Rule 11Ac1-5. 208 Order Execution and Routing Practices, Rule 11Ac1-6. 67
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September 2006 RESEARCH A COMPARATI
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IE UK FR BE NL LU DK DE SE CZ AT SL
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The following WSBI/ESBG committees
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4 Regulation and supervision compar
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6.5 Issues of competition in retail
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To finish, if we had to pick from a
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In the US, credit institutions have
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Page 21 and 22: 3. INSTITUTIONAL COMPARISON 3.1 Sec
Page 23 and 24: The market share of the US banking
Page 25 and 26: FDIC-insured commercial banks are i
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Page 43 and 44: 4. REGULATION AND SUPERVISION COMPA
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Page 59 and 60: Although younger than CESR, both CE
Page 61 and 62: 4.2.5.1.1.1.1 Limitation of the geo
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Page 65: Another important common feature be
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Page 71 and 72: The ISD set a basis for the develop
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Page 76 and 77: The decline of savings institutions
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The residential mortgage market in
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Funding by retail deposits represen
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In sharp contrast, the US mortgage
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6.2.3.1.2 Lenders to small business
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The securitisation process requires
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Factoring is also continuously gain
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6.2.3.2.4 Securitisation of small b
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The above fears can hardly be allay
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- ACH credits and debits: the stati
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6.3.2.1.2 Financial intermediaries
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It should be noted that two of the
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Assuming that technology, globalisa
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The report adds: “although it bou
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Graph 19: Use of different distribu
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In terms of funding of the business
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Since then, established banks have
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MoU Memorandum of Understanding OTC
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Annex 2: Statistical appendix Table
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Table F: Share of US banking indust
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Table L: Structure of the liabiliti
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Table R: Number of ATMS in the EU a
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F - Federal Deposit Insurance Corpo
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A comparative analysis of the US and EU retail banking markets - Wsbi

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