SSE/EFI Working Paper Series in Economics and Finance
Where to Go after the Lamfalussy Report? - An Economic Analysis of Securities Market Regulation and Supervision
Abstract: Financial securities market regulation is subject to
increasingly rapid reforms. Despite the political interest in different
forms of reforms, economic analyses of the rationales for specific
securities market regulation are primarily focused on specific issues such
as insider trading. An overall analysis of securities markets regulation is
rare. The purpose of this paper is to fill this gap.
I identify three
reasons – based on market failures – for specific securities market
regulations, systemic risk, investor protection and efficiency problems.
The systemic risks first emanate from the clearing and settlement systems
and second stem from the financial intermediaries’ substantial dependence
on securities markets for funding and risk management. Regulation may also
be warranted, for efficiency reasons, due to externalities in the markets.
The investor protection arguments are more problematic. The most persuading
argument is based on a combination of a) the principal agent problem, b)
the free riding problems resulting in monitoring difficulties, c) the
long-term aspect of many investment services, and d) an assumption that the
public sector has a responsibility for some minimum living standards. I
also analyze why securities markets should not be regulated based on a) an
analysis of the motives of the regulator, b) the potential of creating
negative side effects, c) moral hazard, d) enforceability, and e) the risk
of consumer over-protection. The paper further discusses the pros and cons
of self-regulation, as well as some trends affecting the regulatory process
Finally, the paper concludes with some policy
recommendations. First, there is a risk that the new EU-wide securities
regulation in practice will lead to a government re-regulation, at the
expense of well-functioning self-regulations. Second, even though the EU
regulatory harmonization has the objective of increasing competition by
creating a single market for investment services, there is a clear risk
that it will hamper a necessary regulatory com-petition. Third, there is a
clear trend of motivating new regulations using consumer protection
arguments, without a serious discussion of the market failures involved. A
larger focus on such an analysis is necessary.
Keywords: Securities markets; regulation; self-regulation; supervision; (follow links to similar papers)
JEL-Codes: G15; G18; (follow links to similar papers)
77 pages, December 20, 2001
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