Latin American Capital Markets

58 REENA AGGARWALtoday's global, efficient market SROs are also typically closer to market participantsand usually have more flexibility than government agencies do in responding to marketneeds and creating appropriate rules.The combination of commercial interest andproximity to the markets makes SROs suited to carry out some of the regulatoryrole.They are in a position to set rules, enforce the rules, and resolve disputes thatarise from those rules. Flexibility is extremely important in today's fast-changing financialworld. Government agencies typically do not have the financial resources andhuman resources necessary to carry out all aspects of the regulatory function. It isalso easier for the market to self-police itself. Self-imposed rules are more easily acceptedthan those imposed by a third party, particularly if marketplace competition isfierce and technology allows market participants to quickly take their transactions tothe government agency.However there are major challenges with the implementation of self-regulation.SROs are generally the stock exchange, clearing agencies, and sometimes otherprofessional associations. This model of regulation assumes that the industry has thecapability to police itself. Self-regulation also assumes that the industry has the incentiveto operate fair and efficient markets and requires competition among market participantsso that they will monitor each other. If conflicts of interest undermine therole of self-regulation, the benefits of controlling the activities of members and enhancinginvestor and issuer confidence may not be highly valued. In emerging markets,there is typically only one stock exchange, so there is no competition. Issuers and investorsdo not have the option of using an alternative if they are dissatisfied.Global competition threatens countries with low liquidity because they do nothave enough trading volume and liquidity to support the emergence of other tradingsystems or new exchanges in their markets. Even in a developed country with competition,such as the case of the NASDAQ stock market, collusion between dealers ispossible, to the detriment of investors. SROs can be driven by the short-term interestsof their own market. For example, if exchanges are interested in obtaining moreforeign listings, they may establish more lenient listing requirements for foreign issuers.In emerging markets, there is also concern that SROs may not have enoughresources (financial and human capital) to carry out effectively their responsibilities.And it might be problematic if only a handful of financial intermediaries are membersof the SRO or have too much influence.The governance structure of the SRO playsa major role in determining the effectiveness of its oversight activities. If more thanone SRO has overlapping surveillance and enforcement activities, then market participantshave to abide by several sets of rules, incurring substantial costs.The SRO approach might not be prefect, but it is better than other options.A costly alternative would be to have the securities commission perform all the reg-Copyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub