The Regulatory And Supervisory Framework For Government Securities Markets June 17-19, 2003 Johannesburg, South Africa F

1. The Regulatory And Supervisory Framework For Government Securities Markets June 17-19, 2003 Johannesburg, South Africa Francis O. Odubekun Government Debt Issuance And Management Advisor Office Of Technical Assistance U.S. Department Of Treasury

2. Features Of Government Securities • Government securities are “special" in the following ways: • The liquidity, integrity and efficiency of the market are essential for the execution of fiscal and monetary policy. • Both issuer and securities are exempt from registration. • Government securities, because they are “special”, require special regulatory treatment.

3. Disclosure of Sovereign Credit and Economic Factors • Budget law should provide for disclosure of the budget • Treasury Act should provide for disclosure of cash position • Debt law should: • Specify security • require disclosure of liability position • Specify right to be repaid • Permanent & indefinite appropriation • Permanent authority to refund

4. Features Of Government Securities (cont.) • Govt. securities markets tend to be a market for professional participants • Settlement risks are a key concern • Banks tend to be active participants, and instl. investors tend to predominate • Typically come to market via public auctions • The issuer is also the regulator • Special objective to execute monetary as well as fiscal policy

5. Review of General Securities Regulations Purpose: • To protect investors • To protect counter parties • To instill confidence/integrity in the market • To ensure that markets are fair, efficient and transparent

6. Review of General Securities Regulations (Cont.) Applicability • Issuers • Intermediaries • Investors • Ratings Agencies • Accountants

7. Review of General Securities Regulations (Cont.) Rule makers • Fiscal authorities • Securities regulators • Bank regulators/monetary authorities • Market operators • Self–regulatory organizations (SROs)

8. Review of General Securities Regulations (Cont.)Regulatory Themes In Primary Markets: • Underwriting • Registration • Disclosure • Sales Practice (e.g., anti-fraud, anti-manipulation, etc.) • Trading on material, non-public information • Failure to make a bona-fide public offering

9. Review of General Securities Regulations (Cont.)Regulatory Themes In secondary markets: • Ongoing disclosure • Registration and supervision of broker-dealers (B/Ds) and B/D reps. • Business conduct – marketplace practice rules and regulations • Trade practices and conventions • Financial requirements • Disciplinary rules • Arbitration

10. Features Of Government Securities Markets • Government securities markets tend to be a market for professional participants • Typically come to market via public auctions • Banks tend to be active participants, and instl. investors tend to predominate • Settlement risks are a key concern, due to volume and size of transactions • Used to execute monetary & fiscal policy

11. Government Securities Regulatory Themes In primary markets: •  Public Auctions (rules and guidelines) • Anti-collusion • Position limits • Trading on material, non-public information

12. Government SecuritiesSecondary MarketSales Practice Regulatory Themes • Market Place Regulations (anti- fraud, anti- manipulation, etc.) • Sales practice guidelines (e.g. suitability guidelines, for institutional investors) • Business conduct rules (displaying and honoring quotes, etc.) • Clearing and settlement practices and conventions (Fails, DKs, Buy–in procedures, etc.) • Record-keeping rules (Preparation and maintenance of Books and Records)

13. Government SecuritiesSecondary MarketFinancial Regulatory Themes • Capital Adequacy Rules: • Minimum net capital requirements • Maintenance margin requirements • Mark-to-markets and “Haircuts” • Customer Protection Rules: • Custody and control of customers’ excess margin and fully-paid for assets

14. Unique Aspects of Government Securities Special concerns • Magnified settlement risks due to volume & size of transactions • Issuer is also regulator – conflicts of interest • No prospectus/disclosure requirement • Treasury could favor itself, disadvantage competitors and pressure customers • Monetary policy considerations • Potentially justifiable cases of differentiated access and exclusivity

15. Unique Aspects of Government Securities (Cont.) Monetary Policy Considerations • Organized and efficient market provides immediacy and more precision for OMO • Risk-free securities improves transmission of OMO policy signals by eliminating noise due to price of credit risk • Eliminates credit risk from Central Bank balance sheet • Least complicated tool for discount window operations in times of crisis. • Primary dealer system may reduce counter-party risk

16. Rights: Exclusive participation Exclusive counter-parties for central bank Obligations: Committed purchase Market-making Primary Dealer Systems • Fair, not necessarily equal, access. • Typical rights and obligations:

17. Primary Dealer Systems When are they useful? • Should be consistent with public debt management objectives • Obligations for PDs should be useful for MOF to meet debt management objectives

18. Should Regulation Apply To Government Securities? • The cost of regulation is substantial. It is accepted by market participants in return for specific benefits. • Ministry of finance has the right and obligation to ensure adequate regulation of the government securities market. • An erroneous presumption is that government securities investors are always sophisticated about all investments and therefore, may not require protection that could raise costs. • It should be recognized that most investor rights are created outside the regulatory framework.

19. Costs vs. Benefits of Regulation Benefits: • Efficient price discovery and transparency • Fairness and anti-fraud protection • Ownership integrity and property rights • Reduced counter party risk • Reduced market imperfections/failures/moral hazard • Enhanced investor confidence, broadened investor base and more effective savings mobilization

20. Recommendations (Cont.) • Ministry of Finance (MOF) should retain rule–making authority • MOF may delegate other regulatory activities, using three tiered regulatory approach • Beware of over-regulation • Increases costs • Rapidly drives trading to other countries • Does not necessarily address risks

21. Recommendations For Developing Regulatory Systems • Status of “exempt” securities should not jeopardize the integrity of the market • Regulation may be phased to match development of the gov’t securities market • If significant retail activity develops, the next logical step is assurance of ownership integrity • Effective regulation should include: • Regulation of market intermediaries • Regulation of the secondary market and, • Self regulation

22. Review of General Securities Regulations (Cont.) Three tier regulatory approach: Apex regulatory authority • Oversees brokers/dealers and SROs, to ensure compliance with statutory regulations Self Regulatory Authority (SRO) • Regulates members and, where capable, enforces compliance with securities law and its own rules Broker/dealer • Has regulatory obligation to supervise employees and enforce compliance with securities laws, SRO regs and in-house rules

23. Self-regulatory Organizations (SROs) Pros of SROs: • Typically possess better expertise and more market information; • Respond to market changes more quickly; • Are more familiar with the problems and better able to find solutions; • Have greater incentive to promote information sharing among members

24. Self Regulatory Organizations (SROs) Cons of using SROs • An SRO might transform into a cartel and jeopardize competition • An SRO may be unable to enforce its rules or impose sanctions for non-compliance • Scarcity of resources may constrain the quality of an SRO’s oversight • With limited competition in securities markets, SROs not enough to ensure totally safe and efficient markets

25. Recommendations:Direct Regulation Of Market Intermediaries • May be necessary, particularly when the market is not well organized • Set minimum entry standards • Require initial and maintenance capital • Require operators to comply with strict standards for internal organization and control • Require proper management of risk • Provide procedures for dealing with the failure of an intermediary

26. ConclusionKey Points • Government securities, because they are “special”, require special regulatory treatment • The status of “exempt securities” should not jeopardize the integrity of the secondary market • Effective regulation should include: • A clear legal framework • Regulation of market intermediaries • Regulation of the secondary market and promotion of self regulatory organs

27. ConclusionKey Points • MOF should retain rule-making authority for the govt. securities market • MOF may delegate application and enforcement to SROs or bank regulators • Avoid over-regulation • Clarify regulators and their roles • Develop legal/regulatory framework to match the various stages of market devt.

28. End of Part One Thank You

29. Conclusion • Key elements of a legal framework are: • Clear borrowing authority • Rules for the issuance of government securities • Rules governing the organization and functioning of the primary and secondary market • Rules setting out the legal status of government securities • Clearing and settlement rules and conventions

30. Legal and Regulatory Framework for Transactions Settlement • Legal framework should support: • The enforceability of trade contracts • The protection of customer assets • Dematerialization of securities and the transfer of securities by book entry • Netting arrangements and securities lending • Arrangement for achieving DVP, • Rules addressing the consequences of a participant’s default

31. Legal and Regulatory Framework • Regulation and oversight • Central bank and financial regulator should cooperate with each other and with other relevant authorities • The objectives and responsibilities of the regulators with respect to the clearing and settlement system should be clearly defined and publicly disclosed • The regulators should gather information on clearing and settlement systems and assess the operation and design of the system

32. Oversight of SROs • Ensure that SRO Rules are fair and based upon market stability and efficiency principles • Monitor SRO membership and sanctioning criteria, and ban unfair or discriminatory practices • Ensure that information, monitoring and control systems are equitable and in accordance with principles of fair trade • Ensure that SRO rules and operations are not anti-competitive and/or unfair to smaller participants and investors

33. Legal Framework As Source of Basic Investor Rights Regulation is not the primary source of investor rights The majority of investor rights will be found in: • Public debt law • Bankruptcy and reorganization law • Property rights and conveyance law • Secured transactions law • Contract enforcement

34. Sources of Investor Rights • Budget and public debt law • Governmental audit law • Bankruptcy law • Property ownership law • Secured transaction law • Tax law • Central bank law • Contract enforcement law • Capital repatriation law

35. Thank You