LAW OF SECURITIES AND FINANCIAL

MARKETS

The Role of self-regulatory organizations in Securities

Markets Effectiveness and Challenges

Submitted by:- Submitted to:-

Sourav Punia Dr. Sujata Roy
LLM075223
WB NUJS
 Introduction
The Securities and Exchange Board of India (SEBI) established self-regulation
organisations (SROs) with the goal of regulating the securities market. Globally,
it is evident that self-regulation organisations were crucial to the growth of the
securities market. One essential element of the global financial system is the
securities market. It offers a trading platform for a range of financial assets,
including derivatives, commodities, equities, and bonds. To successfully
navigate the complicated finance world, novice and experienced investors must
grasp the fundamentals of securities markets. In the world of finance, securities
are the financial assets that are bought and sold on the market. These can
include stocks, bonds, options, and futures contracts. Each type of security has
its own unique features and benefits for the investor. Bonds are loans made to a
company or government, while stocks represent partial ownership of a
company. It is important for investors to understand the differences between
these various types of securities before making any investment decisions.
Securities are the financial assets purchased and sold on the market in finance.
These can consist of futures contracts, bonds, equities, and options. Every kind
of security has special qualities and advantages for the investor. Stocks indicate
a portion of a company's ownership, whereas bonds are government or business
loans. Before making any investing decisions, investors should be aware of the
distinctions between these different kinds of securities. Primary and secondary
markets are the two different categories of securities markets. The primary
market is the first venue for the sale of recently issued securities. Businesses can
generate money by going to investors and selling securities, including bonds or
initial public offerings (IPOs). In the secondary market, investors can exchange
securities that were initially issued and sold in the primary market. In this
situation, prices are determined by market forces, and liquidity is maintained
through investors' buying and selling activities. Many things can affect the stock
markets, including how investors feel, political events, and the state of the
economy. Stock prices can go up and down because of changes in how many
people want to buy or sell them, as well as other important factors like interest
rates and company profits.

Official regulatory frameworks for Self-Regulatory Organizations (SROs) in

India have emerged relatively recently, but the country has a history of self-
regulation that has developed over time. The Foreign Exchange Dealers
Association of India (FEDAI) was established in 1958 to set the terms and
conditions for the foreign currency market, specifically for Authorised Dealers
operating in India. Like legal practices in other countries, Indian stock
exchanges have traditionally taken on responsibilities similar to those of SROs.
In 2004, the Securities and Exchange Board of India (SEBI) issued regulations
concerning SROs, specifying requirements for their recognition, eligibility,
roles, and responsibilities. More recently, in 2020, the Reserve Bank of India
(RBI) introduced a framework for payment system operators to identify and
work with self-regulatory organizations in the payments and settlement sector.

AMFI
The Association of Mutual Funds in India (AMFI) was founded in 1995 as a
non-profit organization by mutual funds registered with the Securities and
Exchange Board of India (SEBI) and all registered Asset Management
Companies (AMCs). The establishment of AMFI aimed to create a dedicated
organization to regulate mutual funds in India, focusing on enhancing
professionalism and transparency in the industry. AMFI's main objective is to
protect the interests of mutual fund unit holders while promoting the growth and
credibility of the Indian mutual fund market.1
1
Bhardwaj, S. (2024, March 6). AMFI (Association of Mutual Funds in India) - Role, Objectives, Committee.
Smallcase.
The Association of Mutual Funds in India (AMIF) not only helps create a
positive environment for mutual fund transactions in the Indian market but also
serves key purposes such as:

 Addressing issues and concerns faced by unit holders, AMFI members,

and other stakeholders promptly and efficiently.
 Acting as a bridge for discussions on policy matters related to mutual
funds between the Government of India, SEBI, RBI, and other relevant
authorities.
 Setting benchmarks and guidelines for Asset Management Companies
(AMCs) to ensure consistency in their functioning and processes.
 The company's official website and other platforms offer vital details on
mutual funds, such as Net Asset Values (NAVs), performance figures, and
industry updates aimed at educating the Indian public about mutual funds.

Some of the key achievements and milestones of AMFI India include: 2

 Introducing successful programs to educate and empower individuals on

investing in mutual funds, enabling them to make informed financial
choices.
 Pioneering the adoption of the Know Your Customer (KYC) process to
create a safe investing environment, enhancing investor protection and
preventing fraudulent activities.
 Helping with the launch of the innovative Mutual Fund Utility (MFU)
platform, which simplifies investor investment management by offering a
centralized hub for overseeing and conducting transactions with various
mutual fund companies.
 Setting and upholding industry standards and recommendations in
collaboration with regulatory agencies and industry members to guarantee
ethical behaviour, equity, and transparency in the mutual fund sector.
2
Supra note 2.
 SECURITIES AND EXCHANGE BOARD OF INDIA (SELF
REGULATORY ORGANIZATIONS) REGULATIONS, 2004

It took SEBI almost a decade to enforce the SEBI (Self-Regulatory

Organisations) Regulations, 2004. In a notice from March 2013, SEBI stated
that companies wanting to become SROs for mutual fund distributors and
portfolio managers could now apply, marking the start of a new phase in
securities regulation in India. According to IOSCO, an international
organization of national securities regulators, using self-regulatory organizations
(SROs) in emerging markets is crucial for enhancing securities regulation and
market integrity. The traditional exchange-based SRO model is being closely
examined due to the commercialization of exchanges, the limitations of
statutory regulatory bodies in handling new regulatory areas, and the
globalization of capital markets.3

After the 2008-2009 global financial crisis, there has been a trend towards
adding an independent Self-Regulatory Organization (SRO) to existing
securities regulators. Different countries have different opinions on the role of
an SRO. European countries rely more on statutory regulators for most
regulatory tasks, using SRO sparingly. In contrast, the United States prefers an
independent SRO to have a more active role. This shift was driven by concerns
about the fragmented nature of exchange-based SRO models, increasing
conflicts of interest, and the growing complexity of the marketplace.

In order to enhance surveillance quality, an independent self-regulatory

organization (SRO) can engage practitioners' assistance and provide them with
fair compensation. Rather than focusing solely on regular monitoring tasks, the
3
Securities and Exchange Board of India (Self Regulatory Organizations) Regulations, 2004. (n.d.).
latestlaws.com.
regulatory body will be better equipped to address critical sectors and
significant systemic risks. It is worth noting that some well-established SROs,
like the Investment Dealers Association (IDA) in Canada and the National
Association of Securities Dealers (NASD) in the United States, originated from
industry groups with limited legal authority. Currently, the proposed SRO by the
Securities and Exchange Board of India (SEBI) is restricted to mutual fund
distributors and lacks extensive rule-making abilities. Therefore, it will be
interesting to see how SEBI encourages more effective regulation through the
establishment of SROs or a unified SRO.

India's financial market is on the rise, with significant steps taken toward
establishing a self-regulatory framework. In August 2012, the Securities and
Exchange Board of India (SEBI) gave the green light for an SRO in the mutual
fund distribution sector. By January 2013, SEBI had proposed updated
regulations, paving the way for India's inaugural financial services self-
regulatory body.

A successful Self-regulatory organisation

When assessing the value of self-regulation in today's marketplaces, we must
weigh its advantages against the requirements of the environment in which it
functions. Currently, investors and the general public are distrusting the markets
and the efficient control they provide.4

According to a study by the CFA Institute 2012, investors feel very skeptical
about the financial markets. Out of the 6,783 participants in the survey, more
than half believe that the lack of ethics in financial institutions is causing a

4
India - Role of self-regulatory organizations in securities market regulation (English). Washington, D.C.: World
Bank Group.
decline in investor trust. The problem is exacerbated by a system that rewards
decision-makers regardless of how well their businesses are actually performing
and by issues like market manipulation, greed, and insider trading. These factors
are all contributing to the current crisis of confidence among investors. The
general public may question the trustworthiness of regulatory bodies when a
major institution like LIBOR is found to be influenced by dishonesty and
selfishness. It is crucial to regain and maintain trust in the honesty of regulatory
systems. Additionally, in order to rebuild investor confidence, there must be
increased accountability and transparency from all involved in the market,
including regulators. In order to thrive, self-regulation must prove itself as a
trustworthy system with fair and consistent processes in a climate of distrust. It
should also highlight the benefits of self-regulation in promoting market
innovation and supporting primary regulators like the SEC rather than hindering
them with excessive obstacles.5

In order to have a successful self-regulatory system, we need to follow the 12

recommendations in the 2007 CFA Institute article "Self-Regulation in Today's
Securities Markets." These rules are crucial for evaluating how well a self-
regulatory organization (SRO) performs. Among these recommendations, two
are especially important for dealing with the various types of SROs.

1. An essential element for an SRO to be effective is its ability to maintain

vigilant surveillance, oversight, and enforcement. Without these key
components, an SRO risks losing credibility with investors, regulators,
and the market. It is crucial for an SRO to have a robust surveillance
program, a transparent enforcement process with due diligence, and a
commitment to investigating any questionable behaviour by its members.
In other words, without these essential functions in place, an SRO will
struggle to fulfill its purpose effectively.

5
Self-Regulatory Organisations (“SRO”) - Another step towards compliance. (n.d.).
 2. The second important factor in an SRO's effectiveness is its capability to
create and enforce rules. An SRO's credibility is impacted by where its
authority comes from. An SRO established by law or officially
recognized by the main regulator is likely to be taken more seriously than
one formed out of voluntarism or providing industry guidance to its
members.

Organizations with the authority to create rules need to be distinguished from

those that primarily advocate for specific causes. When evaluating different
types of authority, it is important to note that advocacy organizations do not
have enforceable rules or a disciplinary process for their members. An
organization that has formal self-regulatory powers is typically held in higher
regard than a trade association, even though the latter may have important goals
such as advocating for industry interests and providing educational resources to
its members. The presence of an advocacy function within an organization may
lead some to question whether it is truly a regulatory body or more of a trade
association. To operate effectively in a global market, the organization must
establish itself as a legitimate authority.

In addition, when assessing the efficiency of self-regulation or any regulatory

framework, it is crucial to consider the significance of staying proactive.
Supporters of self-regulation argue that having market knowledge and a focus
on innovation is essential for creating rules and monitoring in advance.
Regulators often rely on enforcement measures to address breaches of
regulations post occurrence.6

Regulators need to be proactive rather than just responding to events in the fast-
paced and innovative securities markets of today, as seen during the most recent
global financial crisis. Simply reacting to a crisis or implementing numerous
6
Pawlak, M., & Csizér, K. (2022, April). The impact of self-regulatory strategy use on self-efficacy beliefs and
motivated learning behavior in study abroad contexts: The case of university students in Italy, Poland and
Turkey. System, 105, 102735.
new regulations to address perceived gaps in the regulatory system will no
longer suffice to ensure the stability of the global markets. While new laws may
provide a temporary sense of reassurance to the public, many restrictions
quickly become outdated as technology advances and new methods are
developed to bypass them.

Global securities markets are currently grappling with the challenge of finding a
harmonious equilibrium between fostering innovation and implementing
regulations that protect investors. The top regulators of today need support from
"frontline" regulators, known as SROs, especially in overseeing market
activities due to the vast and intricate nature of modern markets. This allows
primary regulators the freedom to focus on other critical issues related to
maintaining market integrity.

Self-regulatory organizations (SROs) are required to supervise members,

establish and implement regulations, and uphold robust monitoring mechanisms
in order to guarantee market integrity and safeguard investors. They must
establish confidence in the markets they manage and prove they can just and
efficient regulation. Particularly in developing countries, trust-building must be
given top priority when establishing stable regulatory frameworks.

SROs in particular sectors can drive market innovation by identifying when

stricter regulations are necessary for new platforms and products. This expertise
is crucial in developing innovative regulations. With their deep understanding of
risks, SROs may be able to suggest rules more promptly than primary
regulators, enabling them to offer monitoring and protection before a crisis
occurs. For securities markets to remain dynamic, rules must allow for this
evolution, which can be a balancing act.

Around the world, in particular, contexts where striking the correct balance is
essential, this delicate balancing act is taking place. Self-regulation techniques
are also becoming more and more common. Despite the difficulties and
potential harm to reputation, it is time to weigh the benefits and drawbacks of
self-regulation in the financial markets as well as the novel and future
applications of SROs globally.7

Challenges and Opportunities

Even while self-regulation is not commonly practiced globally, more financial
markets are starting to recognise its advantages and capitalise on its
effectiveness. It is becoming more possible to implement self-regulation under
the securities laws of emerging markets. Examining the possibilities of self-
regulatory organisations (SROs) in developing nations is crucial, particularly in
light of projections that these areas may account for 50% of the global economy
by 2020.

Due to a lack of funding and manpower, emerging nations may find it difficult
to establish both a central regulatory agency and a self-regulatory organisation,
particularly if their financial sectors are still developing. Some nations'
securities markets are less competitive than others, which could lead to a trading
monopoly rather than just and effective supervision. Nonetheless, there is a
compelling argument for these developing nations to embrace the self-
regulatory approach that has worked well in other nations. Rather than being a
barrier, self-regulation might be crucial for these markets to flourish.8
Emerging markets require robust infrastructure and dependable regulations in
order to flourish and innovate. Without adequate regulation, these markets find
it difficult to draw in investors and promote economic expansion. Comprising of
market professionals, self-regulatory organisations (SROs) are essential in

7
Frankel, T. (2002). Comment, Regulation and Investors’ Trust in the Securities Markets. SSRN Electronic
Journal.
8
Pritchard, A. C. (2002). Self-Regulation and Securities Markets. SSRN Electronic Journal.
overseeing brokers/dealers, implementing regulations, and keeping an eye on
market activities.

The absence of funds and power poses a difficulty for key securities regulators
in emerging markets, impeding the implementation of appropriate disciplinary
procedures and enforcement tools. The power to cancel licences for infractions
committed by their members is one way that Self-Regulatory Organisations
(SROs) might assist in closing this gap. This gives SROs the ability to keep an
eye on and control their membership in situations where government regulators
might not have the required authority.

This capacity could be very beneficial to governments trying to establish

equitable marketplaces. Large portions of the market can be overseen and
regulated by SROs, relieving primary regulators of lesser responsibilities like
assessing and resolving individual claims—much like FINRA manages
customer disputes for all exchanges.

The knowledge that members contribute to rule drafting and surveillance efforts
would be beneficial to healthy SROs in emerging markets since it enables a
quicker reaction to market developments than the government can offer.

It's no wonder that emerging market countries are moving towards harmonizing
their regulations across borders, considering the interconnectedness of today's
financial markets on a global scale. By collaborating through SROs, regional
harmonization presents numerous advantages for market participants aiming for
market growth. A strong market structure with effective oversight and
enforcement mechanisms is essential for fostering innovation and expansion in
the market. While governments may be slow in establishing securities market
agreements or mutual recognition pacts, setting up an efficient cross-border
monitoring and enforcement system is challenging and could take years.9

9
Pichhadze, A. (2011, May). Regulatory systemic risk in US securities regulation. Law And Financial Markets
Review, 5(3), 176–182.
Financial regulators and Self-Regulatory Organizations (SROs) can address this
problem by establishing agreements with counterparts in different countries that
allow for investigating securities market violations in foreign jurisdictions. Such
agreements can foster collaboration and information sharing among
neighbouring countries, thereby promoting the establishment of robust market
infrastructures.

One benefit of cross-border trade is that countries can combine their resources
to boost the total capital in the area. This can be particularly beneficial for
emerging markets with insufficient volume to grow independently. By
harmonizing trade regulations and practices across the region, markets can
expand quickly and efficiently.

Incorporating cross-border licensing, disciplinary procedures, joint

examinations, and other licensing issues into a unified framework for self-
regulatory organizations (SROs) would be a simple task. By collaborating
across borders, SROs in developing markets could work together to provide the
necessary services to advance their markets, benefiting all nations involved.
This approach is particularly effective for overseeing exchanges, listing
platforms, and brokers/dealers. To establish regulated securities markets in
emerging-market nations, collaboration between SROs and exchanges is crucial.
Relying solely on government authorities is not enough. The introduction of
integrated market self-regulation in emerging markets shows potential for
growth, as business deals can now bypass bureaucratic government processes.

Some regions are considering the idea of doing just that. This is evident in the
Eastern Caribbean, the East African Securities Regulatory Association, the Latin
American Integrated Market (formerly the Mercado Integrado Latino
Americano, or MILA), and the Eastern European Balkans.10

10
Sawer, G. (1975, September). Australian Securities Markets and Their Regulation*. Economic Record, 51(3),
379–387.
MILA is a great example of how countries can work together to create a
sustainable market, even when they are just starting out. The integrated market,
formed in May 2011, includes the stock exchanges of Peru, Colombia, and
Chile. This market allows for increased trade between the nations and makes it
easier for capital to flow throughout the region. By signing agreements with
each other, these exchanges are able to grow and facilitate trade that benefits the
entire region, something that would not be possible if each nation was working
alone. One writer pointed out that politicians are scrambling to keep pace with
the advancements made by the private sector in order to reap the benefits.

MILA has achieved great success and has a lot of potential, leading the Inter-
American Development Bank to offer funding for development. This has
sparked interest from others in the region, with Mexico considering joining
MILA in 2014. Costa Rica and Panama have also shown interest in becoming
part of the alliance. This approach highlights that collaborating is the most
effective way to compete.

Conclusion
The efficacy of SROs in overseeing a market that is impacted by trading
algorithms, dark pools, high-frequency trading, and indistinct lines between
investment advice and sales has been called into question in recent times.
Nevertheless, we think that despite modifications to the regulatory environment
since SROs were established, their knowledge and services are now more
important than ever. Given how complicated the securities markets are
becoming, it makes sense to use SROs more often to take advantage of their
comprehension of market dynamics. The necessity of this criterion is influenced
by the situation of financial market regulation. Due to national legislation in
some countries that prohibit recruiting professionals in the industry or to
budgetary constraints that keep them from competing with salaries provided in
the financial industry, regulatory agencies may not always be able to hire people
with experience in the business sector. As a result, although regulators are
skilled at creating policies that work, they might not be knowledgeable about
intricate financial products and trading systems. They can also find it difficult to
predict future developments in the sector. An essential function of self-
regulatory organisations is to preserve the integrity and stability of the securities
market. These organisations have been granted authorization by the Securities
and Exchange Commission (SEC) to oversee their respective industries and
guarantee adherence to industry norms and guidelines.