Wednesday, 3 March 2010

Profit-driven regulator? Competition is the key

Although it’s been around for about 10 years now, it would be fair to say that the idea of a profit-maximising market regulator like the Singapore Exchange (SGX) has not gained widespread acceptance with a sceptical local public, because of the inherent conflict of interest in such an arrangement.


Guanyu 道 said...

Profit-driven regulator? Competition is the key

01 March 2010

Although it’s been around for about 10 years now, it would be fair to say that the idea of a profit-maximising market regulator like the Singapore Exchange (SGX) has not gained widespread acceptance with a sceptical local public, because of the inherent conflict of interest in such an arrangement.

To be fair to SGX, the primary market regulator is actually its supervisor, the Monetary Authority of Singapore (MAS), which means SGX’s main regulatory duties comprise enforcement of its own listing and continuous disclosure rules. However, SGX still performs daily market surveillance, investigation of other infractions like price rigging and manipulation, disciplining of brokers and censuring of companies - responsibilities it believes it is best placed to perform, given its proximity to the ground.

Problem is, these are roles which other countries which used to have profit-driven exchanges have been progressively divesting to separate, non-commercial, non-exchange entities. Australia provides the best and most recent example.

Last month, Canberra passed legislation stripping the Australian Securities Exchange (ASX) of its market surveillance responsibilities and transferring that role to the independent Commonwealth-funded, non-profit Australian Securities and Investments Commission (ASIC). To quote from the financial press Down Under, ‘the shake-up of market supervision was driven largely by allegations of a conflict of interest against the ASX in its role as both markets supervisor and profit-driven listed company, as well as the onset of competition’ (Australian Financial Review, Feb 10).

Breaking a monopoly

It is the latter development which holds the greatest interest - change, it appears, was forced upon the Australian regulatory framework because of competition when low-cost, high-speed exchanges such as Chi-X, Liquidnet and AXE ECN (some of whom are also ‘dark pool’ operators) applied to offer their services in competition with ASX two years ago.

These applications were put on hold due to the onset of the financial crisis but now that the dust has settled on that sorry episode, the Aussie government is ready to break ASX’s monopoly. According to latest reports, Europe-based Chi-X is expected to begin operations in October, after all the necessary legislative revamps have been made to the country’s regulatory model in June. In response to the competitive threat, ASX has in the past few months been busy ramping up its offerings to customers. It will scrap its existing, four-year-old trading platform and replace it with various alternatives, including Nasdaq’s OMX Genium, which offers faster speed and greater capacity.

Another new service being planned is a platform to trade managed funds, and a third is PureMatch, an ultra-fast trading service to lure high-frequency traders who seek to arbitrage between fleeting differences in stock prices on multiple exchanges - a market segment Chi-X is believed to be targeting.

Regular readers of this column would also be aware that ASIC will likely soon be granted fresh and enhanced powers to police the market, including tapping of telephones and covert tracking of emails in order to detect insider trading, rigging and market manipulation, and that the penalties for such crimes have been significantly raised - the maximum jail sentence, for example, will be doubled to 10 years (BT, Hock Lock Siew, Feb 9, ‘Governance will work only with solid deterrence’).

ASX, meanwhile, has been left with only a bare minimum of regulatory powers - mainly enforcement of its own listing rules, including those on continuous disclosure, rights issues and capital raisings. It is estimated the loss of regulatory powers will cost ASX between A$7 million and A$11 million (S$8.8 million to S$13.8 million), including redundancy costs for up to 20 staff and amortisation of its now-redundant surveillance software.

Guanyu 道 said...

Unfair to new entrants

Note that the transfer of the bulk of regulatory, investigative and enforcement powers to an independent body is entirely logical in an environment where competing exchanges are allowed to enter the market since it would be unfair to new exchange entrants if the incumbent also wields supervisory powers. Similarly, it would be difficult to expect a profit- driven regulator to impose the necessary discipline on companies if alternative listing platforms exist for those companies. In Singapore’s case, a move towards this set-up depends on whether the local market is considered large enough to accommodate more competition and whether the entry of alternative exchanges would benefit the end-customer.

Potential does exist; for example, because of a reliance on an archaic and inefficient trading mode known as contra trading, where no capital is required when purchasing stocks, Singapore brokerage rates are uncompetitively high in order to cover credit risk (some might argue they are not high enough). As such, there has to be plenty of room for lower-cost, more efficient alternative broking models.

Much would also depend on whether the government is prepared to significantly augment the powers of any new, independent market regulator by increasing the penalties for market crimes and, more importantly, whether that regulator would have the gumption to take the necessary hardline approach to supervision. ASIC, for example, has shown that it is more than willing to undertake market-unfriendly but firm regulatory steps - for example, in the past few months it has pursued court actions against company directors, issued a discussion paper on whether rumours should be regulated and is looking to make brokers sign confidentiality agreements when assisting companies in capital raisings.

Competition is the next logical step in an evolving market, and this has meant the book on regulatory best practice is being rewritten in other developed markets. Hopefully, this will provide plenty of food for thought for SGX, MAS and anyone with an interest in strengthening the Singapore regulatory and governance framework.