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A brief history of stock exchange regulation

July 1, 2009

At this year’s World Economic Forum, in Davos Switzerland, financial institutions were generally considered the culprit of the global crisis. The usual suspects took the blame. Greedy bankers, brokers and fund managers coupled with the light regulation of regulators have driven fear into shareholders. Yet stock exchanges perform an indispensable role. Going forward, how markets perform this role will be scrutinised more closely. Restoration of confidence (and consequently trade and new listings), new regulatory rules are a few challenges facing executives of stock exchanges.

The London Exchange in its search for a new chief executive has borne this in mind. A glance at the profile of Mr Xavier Rolet, the frontrunner for the job, gives an idea of the kind of leadership the LSE is seeking. Currently chairman of the LSE’s Strategic Advisory Group, his experience spans equity trading at some of the then heavyweight investment banks.

Intermediation, globalisation and communication
As an organised market it facilitates the buying and selling of financial instruments eg, stocks and bonds. Brokers, on behalf of clients, and dealers, from their own portfolio, facilitate liquidity of these assets. Effectively, the stock market, through these individuals/firms, provides funding for businesses and government. That is, the ability to raise a sum of money today. In return, they make a stream of payments to investors.

A well functioning market has become part and parcel of developed and developing markets. By providing long term financing in the form of shares or debt, businesses have resorted to the market as an alternative to bank funding. Governments and private enterprises have been able to raise money from the market. Cross-border trading has ridden on the tide of information communication and technology (ICT). Moving billions of dollars to and fro different capital markets is done at the click of a button. Securities of all shapes and sizes, moving at such a speed have created work for regulators.

That attention is focused on how the US will embark on re-regulating its financial system is no surprise. US financial services firms are considered the originators and distributors of the cause of the present crisis. Besides, the US economy’s growth was spurred by its financial system, which it must now renew. In addition, the US economy is notable for always bouncing back after each crisis.

For instance, some institutional aftermaths of the stock market crash and Great Depression are the Reconstruction Finance Corporation (RFC) in 1932, Federal Deposit Insurance Corporation (FDIC) in 1933, Securities and Exchange Commission (SEC) 1934 and Social Security Administration (SSA) in 1935. Amidst economic booms and busts (there have been twelve recessions including the present one), the New York Stock Exchange, the child of an economic crisis, offers a lot of lessons. Its story is an interesting read on how a self-regulatory body can renew itself in response to external and internal storms.

The NYSE was established in 1790 when the US government issued $80 million to repay Revolutionary War debt (the first recorded recession was between 1764 and 1768). What stands out among the NYSE’s numerous highlights eg, record of volumes traded, technology, expansion etc, is the revamp of its own governance in 2003. Some features of the re-organised NYSE are worth noting. To ensure transparency and independence of NYSE board members, it established a self-reliant “Board of Directors; a board of Executives composed of constituent representatives to advise on NYSE marketplace issues; an autonomous Chief Regulatory Officer; and separation of the CEO and Chairman roles.”

This 219-year institution, responsible for managing trillions of dollars of trade in company and government securities the world over – six cash equities exchanges in five countries and six derivatives exchanges – made far-reaching changes to better fulfil its role: market integrity and investor protection. To strengthen this role, NYSE Regulation Inc. was set up as a not-for-profit corporation. Its regulatory duties also include enforcing marketplace rules and federal securities laws, and overseeing its other exchanges that trade in different securities.

The independence of the board of NYSE Regulation is made possible because it is composed of directors with no links with any other NYSE board. A subsidiary of NYSE Euronext (the parent company), NYSE Regulation’s board of directors is comprised of a majority of directors unaffiliated with any other NYSE board. As a result, NYSE Regulation is independent in its decision-making. This structure: one company operating two wholly owned, but separate, subsidiaries has its advantages.

That is, one company, a limited liability company, focuses on running the market while the other, an NGO, “preserves and extends the separation yet pervasive communication of between business and regulatory activities”. More importantly, it protects the regulatory arm of the NYSE from contradictions that come with being a publicly owned company. The chief executive officer of NYSE Regulation reports solely to the NYSE Regulation board of directors ie, he or she does not report to NYSE Euronext’s chief executive officer (who does not have a seat on the NYSE Regulation board). NYSE Regulation Inc. also ensures that companies listed on the NYSE meet the NYSE’s financial and corporate-governance listing standards.

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