Chapter 1 · International Regulatory Environment

Financial regulators around the world share three broad objectives:

1. Market confidence + integrity — investors and firms need to trust that markets are fair, orderly, and free from abuse
2. Consumer / investor protection — especially retail clients who lack the sophistication or bargaining power of institutional counterparts
3. Financial stability — the "systemic" objective added post-2008: prevent failures that could cascade through the whole system

The FSB, BCBS, IOSCO and IAIS all trace their mandates back to some combination of these three.

Textbook market failures that regulation addresses:

• Information asymmetry — sellers know more than buyers (mis-selling risk)
• Externalities — one firm's failure hits others (systemic risk)
• Moral hazard — firms take risks knowing someone else absorbs the downside
• Principal-agent conflicts — advisers put their own interests ahead of clients'

Regulation is not always the best fix, but where markets self-correct too slowly or the harm is too severe, state intervention is justified.

LAW = passed by the legislature (Parliament, Congress, etc.), enforceable through the courts, changes slowly (usually years).

REGULATION = made by regulatory bodies (FCA, SEC, MAS…) under authority DELEGATED by law. Enforceable through regulatory sanctions AND (sometimes) criminal courts. Changes much faster than primary law.

Example: UK Financial Services and Markets Act 2000 (LAW) gives the FCA (REGULATOR) power to write and enforce the FCA Handbook (REGULATION).

RULES-BASED — detailed, prescriptive requirements. Firms follow the specific rule. Example: "you must file X form within 30 days." Advantages: certainty, easy to check compliance. Disadvantages: rigid, encourages "letter not spirit" behaviour, can't cover every scenario.

PRINCIPLES-BASED — high-level principles that firms must apply using judgement. Example: "treat customers fairly." Advantages: flexible, harder to game, applies to novel situations. Disadvantages: subjective, harder to challenge in court, requires strong firm culture.

MOST REAL REGIMES ARE HYBRID. UK FCA uses 12 high-level Principles + a detailed Handbook of rules underneath. Post-financial-crisis (2008), the trend has moved toward MORE principles + toward stronger enforcement of "spirit of the rule".

Self-regulation = industry regulates itself (usually via a self-regulatory organisation, SRO). Common historically; largely superseded by statutory regulation after the industry couldn't police its own conflicts.

Remaining SROs include:

• FINRA — US broker-dealer SRO (technically self-regulatory, actually delegated by SEC)
• Exchanges — some retain SRO functions over their own listings and members
• Professional bodies — CISI, CFA Institute, ICAEW etc. regulate their own members' conduct (parallel to state regulation)

Financial products structured to comply with SHARIA law. Key prohibitions:

• Riba — no interest / usury
• Gharar — no excessive uncertainty (limits speculation, some derivatives)
• Haram — no financing of prohibited activities (alcohol, gambling, pork, adult entertainment, conventional interest-based finance)

Compliance is verified by a firm's Sharia Supervisory Board. Standards issued by AAOIFI (accounting), IFSB (prudential). Growing market especially in the GCC (UAE, Saudi Arabia, Malaysia).

Extraterritorial reach = a rule from one jurisdiction applies to conduct in another. The four most commonly-tested examples:

The most powerful example of extraterritorial reach: US OFAC sanctions apply to any transaction that touches:

• A US person (citizen, resident, US entity)
• The US dollar (cleared through US correspondent banks)
• US-origin goods or technology
• US financial infrastructure

This is why global banks obsess about US sanctions even when they have no direct US presence — BNP Paribas paid $8.9bn in 2014 for sanctions breaches without a single transaction "in" the United States.

MiFID II (2018) sets four categories of trading venue in Europe. Same broad structure adopted elsewhere. Learn the differences — the exam LOVES this one.

KEY DIFFERENCES:

• RM and MTF are multilateral (multiple buyers meet multiple sellers) and non-discretionary (rule-based).
• SI is bilateral (the firm is always the counterparty) — a market-maker on its own account.
• OTF is multilateral but discretionary — operator can choose how orders match. NOT for equities.

IOSCO's core standards for securities regulation. 38 principles across 10 categories including regulator objectives, self-regulation, enforcement, issuers, auditors, CIS, market intermediaries, secondary markets, systemic risk, market abuse, and (added post-2008) OTC derivatives.

Countries are assessed on their implementation of these principles as part of the IMF-World Bank Financial Sector Assessment Program (FSAP). Weak implementation = reputational damage + market-access consequences.

Multilateral Memorandum of Understanding — signed by 130+ securities regulators globally. Enables:

• Cross-border sharing of INVESTIGATION information (bank records, trading data, beneficial ownership)
• Cooperation on enforcement actions
• Compelled assistance regardless of local secrecy laws

NOT a rule-making body. NOT a treaty. Just an enforcement information-sharing framework — but a powerful one, particularly for cross-border market abuse and insider dealing cases.

Home state = country where the firm is HEADQUARTERED / authorised (has the primary licence).

Host state = country where the firm operates a branch or subsidiary.

General rule for cross-border banking (Basel Concordat, refined post-BCCI collapse 1991):

• Prudential supervision (capital, solvency) → primary home state responsibility
• Conduct of business (customer treatment, local rules) → primary host state responsibility

For large cross-border banks, home + host regulators coordinate via a supervisory college — regular meetings to share information, plan resolution, and align supervisory approach. Global systemically-important banks (G-SIBs) all have colleges.

Financial services activities generally require prior AUTHORISATION from the local regulator. Common regulated activity categories:

• Deposit-taking (banking)
• Dealing in investments (broker-dealer)
• Advising on investments
• Managing investments
• Insurance underwriting / distribution
• Home finance (mortgage lending / broking)

Firm requirements to obtain and maintain authorisation:

1. Adequate CAPITAL (prudential threshold — Basel for banks, Solvency II for insurers)
2. Adequate SYSTEMS + CONTROLS
3. FIT AND PROPER senior management
4. Conduct-of-business rules (client treatment, complaints, disclosure)
5. Compliance function (see [[Ch 2 — The Compliance Function]])
6. Ongoing REPORTING to the regulator