By Amy Leisinger, J.D.
The Board of the International Organization of Securities Commissions has published a report considering instances of fragmentation in cross-border markets and suggesting means by which regulators can minimize its adverse effects. Fragmentation, the separating of markets into segments by location or product and/or participant type, can arise as an unintended consequence of regulation, according to the organization. However, the use of deference can mitigate the potential adverse effects of fragmentation, IOSCO states, and enhanced cooperation in the process could help as regulators interact with businesses operating in multiple jurisdictions.
Fragmentation. The report identifies a variety of instances where respondents to a survey noted that financial regulation may have given rise to harmful fragmentation in the securities and derivatives markets in the form of a reduction in cross-border flows, increased costs, and potential regulatory arbitrage. According to IOSCO, fragmentation arising from regulation can be due to differences in jurisdictional implementation of financial reforms, a lack of international harmonization, or jurisdictional inability or lack of authority to engage in deference. Respondents indicated that Brexit, discontinuation of benchmarks, and emerging new sectors could lead to additional fragmentation going forward, the report states.
Deference. In 2015, IOSCO released a report including three approaches for cross-border regulation: (1) exemptions or substituted compliance; (2) recognition of a foreign regime as equivalent; and (3) passporting with a common set of rules governing firms operating in multiple jurisdictions. Deference among regulators through the use of these cross-border regulatory tools has increased significantly, according to IOSCO, and bilateral arrangements such as Memoranda of Understanding (MoUs) are now a common tool. The use of deference can help to mitigate the risk of fragmentation for global cross-border markets, the organization states.
However, IOSCO finds, challenges exist for jurisdictions using deference. A lack of clear processes and procedures and decreased transparency regarding the criteria that will form the basis of a deference assessment can create uncertainty, according to the organization. Respondents also indicated that developing a clear understanding of individual regulatory frameworks and comparing regulatory systems that operate on different bases can be a challenge, the report notes, and that keeping up with foreign legislative changes is also difficult. Some respondents proposed to standardize the process for deference and to encourage jurisdictions to develop high-level comparability summaries of their requirements versus international standards, the reports states.
Potential solutions. IOSCO explains that enhancing cooperation among authorities could further assist in addressing adverse effects on the financial system stemming from market fragmentation, and the organization is building a central repository of MoUs between jurisdictions to provide more transparency regarding cooperative efforts. The report also proposes other potential measures that IOSCO and other authorities could consider to minimize the risks of fragmentation of global markets. In particular, the report suggests that IOSCO could serve as a forum for the exchange of information among its members about other jurisdictions’ markets and legislative frameworks and varying approaches to cross-border regulation. This also could serve as a means by which to facilitate a discussion of whether there are sound practices that can be put in place regarding deference tools, the report explains.