WEEK 5 ADMINISTRATIVE LAW AND MARKET REGULATION | Quizlet

2 capital markets

1. Primary market —> investors buy directly from the issuing company (e.g. an initial public offering —> IPO)

2. Secondary market —> securities are traded after the company has sold its offering on the primary market

- Investors trade securities among them (e.g. New York Stock Exchange, European New Exchange Technology)

Types of investment products e.g.

Shares; bonds; derivatives; packaged retail investment products (investment funds, investment insurance); crypto-assets (e.g. Bitcoin)

3 main types of investment services

1. Execution-only

- Cheapest option

- Can buy or sell financial instruments on the stock exchange and decide which instruments yourself

2. Investment advice

- Provision of advice to retail investors by an investment firm

3. Portfolio management

- Most costly

- Extensive role of portfolio managers —> professional investment firms that manage your portfolio

- Buy and sell investments for you

Major challenge for conduct of business regulation

How to empower and protect retail investors at the same time?

Given characteristics of financial markets: complexity, uncertainty, fragmentation, ungovernability, dynamism

Investment product lifecycle

- Investment product is a contract

- Product development —> product distribution —> product 'use' —> product 'termination'

Product disclosure regulation

Regulatory tools —> information requirements:

a. Form

b. Content

c. Provision

- e.g. Packaged Retail and Insurance-based Products Regulation

Distribution regulation

Regulatory tools:

- General duty of loyalty

- Information requirements: form; content; provision

- Know your customer rules

- Third-party commission ban

Product regulation

Regulatory tools:

- Ex ante product authorisation

1. Product governance —> oversight of product development processes

2. Ex post product intervention: e.g.

- A ban on the marketing of certain products to retail investors; a total product ban

Product governance

- An investment firm which manufactures financial instruments for sale to clients should maintain, operate and review a process for the approval of each financial instrument and significant adaptations of existing financial instruments before it is marketed or distributed to clients

- The product approval process should:

1. Specify an identified target market of end clients within the relevant category of clients for each financial instrument

2. Ensure that all relevant risks to such identified target market are assessed

3. The intended distribution strategy is consistent with the identified target market

- An investment firm should regularly review financial instruments it offers on markets

- An investment firm should provide distributors with all appropriate information on the financial instrument and the product approval process (incl. the identified target market)

Product intervention

- NCAs may permanent prohibit or restrict the marketing, distribution or sale of financial instruments or a type of financial activity or practice

- European Securities and Markets Authority (ESMA) may adopt temporary product intervention measures

What is Fintech?

- Computer programs and other technology used to support or enable banking and financial services

- Technology-enabled innovation in financial services that could result in new business models, applications, processes or products with an associated material effect on the provision of financial services

- e.g. online platforms, AI, big data analysis, machine learning, distributed ledger technology (DLT)

What is sustainable finance?

- Process of taking due account of environmental, social and governance (ESG) considerations when making investment decisions in the financial sector, leading to increased longer-term investments into sustainable economic activities and projects

- ESG e.g. climate change mitigation, pollution prevention, circular economy, human rights issues, management structures

FinTech opportunities and risks

Opportunities

1. Ensure efficiency supply of accurate ESG data from firms and their translation into standardised and comparable data

2. Increase access to sustainable products and services for retail investors (e.g. through 'green' crowdfunding platforms)

Risks:

- Retail investor protection:

1. Information asymmetries / imbalance of bargaining power

2. Lack of sufficient data protection

3. Price discrimination

4. Financial exclusion

3 limits of regulatory standards

1. The problem of inclusiveness

- Standards are generalisations

- Generalisations are simplifications of complex events, objects or courses of behaviour

- The risk of over or under-inclusiveness

2. The problem of indeterminacy

- Standards are inherently indeterminate —> particularly open-ended standards

- Causes of indeterminacy:

a. The nature of language

b. Inability of rule-makers to anticipate all future events and possibilities

c. Rule-makers' reliance on others for their application

3. The problem of interpretation

- Standards need a sympathetic audience:

-- A purposive interpretation can ameliorate some of the limitations of standards

-- But the purpose of the standards could be defeated if it is interpreted literally

- Standards need an informed audience —> those who apply the standard should have a shared understanding of its context

3 enforcement modes

1. Public enforcement

2. Private enforcement

3. Hybrid enforcement

What is public enforcement?

Supervision and enforcement of regulatory standards by public authorities through public law means:

- Administrative law (e.g. a fine) —> designed to ensure ex ante compliance and deterrence

- Criminal law (e.g. imprisonment) —> aimed at punishment, but may also have deterrent effect

Strengths and weaknesses public enforcement

Strengths:

1. Concerned with the public interest

2. Information gathering powers

3. The ability to adjust the enforcement strategy to achieve the desired level of deterrence

Weaknesses:

1. Limited capacity to enforce given e.g. budgetary or stuff-related restrictions

2. The risk of regulatory capture

3. The high public costs involved —> particularly in the use of criminal law

3 occasions for regulatory conversations (public enforcement)

1. Guidance and waivers as to the application of rules in primary legislation —> e.g. European Securities and Markets Authority (ESMA)

2. Supervised rule formation for a particular firm —> e.g. US environmental regulation

3. Monitoring and enforcement —> e.g. a general duty of care of financial service providers

2 'ideal' enforcement styles (public enforcement)

1. Penal style

- Enforcement is reflective —> a matter of determining what harm was done, detecting the law-breaker and fixing the appropriate sanction

- Accusatory and adversarial (law as a threat)

- Punishment

2. Conciliatory style

- Enforcement is prospective —> a matter of responding to a problem and negotiating future conformity to standards

- Reliance on bargaining with regulated entities to attain compliance

- Persuasion

Braithwaite enforcement pyramid as a compromise (public enforcement)

Crucial question: when to punish and when to persuade?

Top-down:

1. License revocation

2. License suspension

3. Criminal penalty

4. Civil penalty

5. Warning letter

6. Persuasion

Concerns about the enforcement pyramid (public enforcement)

- Exclusively concerned with the effectiveness of enforcement in securing public goals —> pyramid not entirely in line with constitutional values

-- e.g. procedural fairness, proportionality between the severity of punishment and the seriousness of the offence?

- Constitutional values as constraints on law as a threat

What is private enforcement?

- Enforcement of regulatory standards by private parties through private law means (e.g. civil liability):

-- Functions ex post

-- Seeks to provide compensation, but may also have deterrent effect

- By whom? Individuals, groups

- Where? before civil courts (judicial enforcement); before alternative dispute resolution bodies (extra-judicial enforcement)

Strengths and weaknesses of private enforcement

Strengths:

1. A combination of compensation in the pursuit of private interests (interpersonal justice) with deterrence in the pursuit of public goals

2. An extra check on the integrity and competence of public enforcement authorities

3. Financed by private parties

Weaknesses:

1. Driven by the private interests —> private parties may lack incentives to sue (e.g. rational apathy and free riding problems)

2. Insufficient information gathering capacity

What is hybrid enforcement?

- The involvement of regulatory agencies in the provision of private redress

- Two models of the relationship between administrative enforcement and private law remedies within the agencies' operation —> complementarity; integration

Complementarity model (hybrid enforcement)

- Agencies may facilitate private redress indirectly by using:

1. Trying to use their administrative sanctioning powers or powers to initiate redress settlements AND/OR

2. To bring a collective action for damages before civil courts

- Deterrence and compensation complement one another

- The institutional separation between agencies and civil courts along the lines of deterrence and compensation is preserved

Integration model (hybrid enforcement)

- Agencies may secure private redress directly

- Compensation is integrated into administrative enforcement —> serves both deterrence and compensation

- The institutional separation between agencies and civil courts along the lines of deterrence and compensation abandoned