FINANCIAL SERVICES COMMISSION. Presentation. Does Financial Regulation Prevent Institutional Failure? Terra Nova Hotel, Kingston.

Transcription

1 FINANCIAL SERVICES COMMISSION Presentation Does Financial Regulation Prevent Institutional Failure? FSC 10 th Anniversary Investor Briefing Terra Nova Hotel, Kingston 2011 March 23 Rohan Barnet Executive Director Financial Services Commission Good evening, ladies and gentlemen. The FSC as the securities, insurance and private pension s market regulator in Jamaica welcomes the opportunity that this event provides for us to engage you, investors and the wider public in dialogue on issues related to the regulatory environment. How do we operate and do what we do? Currently, there are five sets of statutes and associated regulations, which provide the framework for the FSC to effectively carry out its mandate of protecting investors and promoting transparency through the supervision of these industries. These 1

2 statutes set out the FSC s obligations as well as the requirements for the supervised industries. The five statutes are as follows: 1) The Financial Services Commission Act and associated regulations, which outline the responsibilities of the FSC as they pertain to all prescribed financial institutions; 2) The Insurance Act and regulations, which prescribe provisions for the regulation of insurance business in Jamaica; 3) the Securities Act and regulations, which provide requirements for the licensing, operation and supervision of entities dealing in securities; 4) The Pensions (Superannuation Funds and Retirement Schemes) Act and regulations, which provide requirements for the licensing, operation and supervision of private pension funds; and 5) The Unit Trust Act and regulations, which provide requirements for the licensing, operation and supervision of unit trust schemes. The FSC Act states For the purpose of protecting customers of financial services, the Commission shall- (a) Supervise and regulate prescribed financial institutions; (b) Promote the adoption of procedures designed to control and manage risk, for use by the management, boards of directors and trustees of such institutions; (c) Promote stability and public confidence in the operations of such institutions; 2

3 (d) Promote public understanding of the operation of prescribed financial institutions; (e) Promote the modernization of financial services with a view to the adoption and maintenance of international standards of competence, efficiency and competitiveness. In so doing, the FSC promotes transparency among the financial institutions it regulates, which increases investor protection. The FSC employs a number of strategies as it seeks to protect investors. Eight important strategies are the use of: 1. Fit and Proper Requirements, 2. Filing Requirements, 3. Prudential and Governance Requirements (including minimum capital requirements), 4. Examinations of the Market Intermediaries (i.e., dealers and investment advisors), 5. The Registration of Issuers, 6. Continuous Disclosure Requirements 7. Techniques for the Identification and Prosecution of Market Abuse and, finally, 8. Public Education. 3

4 The first four areas in this list are focused on the supervision of market intermediaries, whilst the last four address strategies aimed at fostering greater market discipline through disclosure and other aspects of market conduct. The focus of the title institutional failure will be examined in the context where an event, including a run on a financial institution, leads to a closure, temporary management, merger, takeover or large-scale government intervention of a systemically important financial institution or groups of institutions. Ten years ago, on August 2, 2001, the FSC came into being. The FSC was created in order to undertake the regulation and supervision of all financial services that do not involve the taking of deposits. This organization was born out of a need to reform the way business is conducted in Jamaica. Many of us present today will remember the financial crisis of 1990s and though we have had other crises since then, the FSC and its regulated institutions have for the most part demonstrated a level of resilience and strength that countries around the world strive to emulate. In the last two years the effectiveness of financial regulation and the role of financial regulators have constantly been called into question as financial systems on all continents were disrupted by events which originated in the United States. 4

5 Given the persistence of financial crises, I will put to you that this is not an indication that regulators have been unsuccessful in their efforts to promote financial stability but that regulatory measures have and continue to make regulated entities fit and more resilient. As it has been said, There is no education like adversity, 1 and as such, some of the current regulatory tools are products from the lessons learnt from past financial crises at home and overseas. These lessons and subsequent regulatory reforms have significantly aided in reviving financial institutions and by extension the financial markets. Certainly, in Jamaica, the regulatory framework that was instituted after our own financial crisis has rectified the weaknesses that contributed to the meltdown. For example, the current legislation encourages the adoption of proper corporate governance and the application of sound risk management techniques. Furthermore, it also places limitations on (i) investments, (ii) leveraging and (iii) related party transactions. These features aided in insulating many of our Jamaican companies from the direct impact of the global financial crisis as the balance sheets of our institutions were not compromised by toxic assets or excessive speculation. Even when the parent companies of two local general insurers were adversely affected by the crisis, the local subsidiaries remained in good financial health. This was also the case when, the CL Financial conglomerate containing CLICO, collapsed. Furthermore our regulatory obligations also deterred CLICO when the company tried to enter the 1 Disraeli, See 5

6 Jamaican market. This success is not isolated and by no means limited to Jamaica. Canada and Australia are considered to have among the world s soundest banking systems and their financial markets remained relatively insulated from the global financial crisis. 2 The FSC as a regulator is driven by two objectives: namely, protecting investors; and promoting integrity, efficiency and transparency in the market. With these purposes in mind, the first and most urgent task of a regulator in a crisis is to design short-term policies so as to at least limit the adverse impact. I want to emphasize that I used the word limit and not eliminate. Being cognizant of the fact that any crisis will have contagion effects on the wider macro economy, central banks, regulators and finance ministries work as a team to design these policies. This is a typical response, as you can recall that many countries executed a wide range of unprecedented interventions to save as many financial institutions as possible from collapsing. Regulators such as the FSC exist to increase the likelihood that financial institutions make prudent decisions in the acquisition and use of their customers funds and also try to ensure that the customers of these entities receive all the information they need in order to make prudent financial decisions. 2 The Washington Post, Worldwide Financial Crisis Largely Bypasses Canada See also & Reuters at 6

7 In short regulations serve to decrease certain risks and their impact on the overall system. The notion that any financial regulator can totally prevent the failure of a financial organization is false. The FSC would also like to make it clear that no system of regulation can ever eliminate the possibility of corporate reporting or governance failures; in short, I would submit that it is impossible to achieve zero failure and any attempt to do so would destroy wealth rather than facilitate its creation as the regulatory measures that would be employed would artificially constrict market activity. Regulation can, however, influence the actions of those responsible for corporate reporting and governance. In the event of a financial failure of an intermediary, regulation is expected to reduce the impact on investors wealth, other financial institutions, and the national economy. The efforts of the FSC (and other regulators) alone are insufficient to ensure that customer s funds are safe. By far the best way for the customers of financial institutions and investors in financial markets to protect their monies is to do research, ask questions and play an active role in monitoring their investments. Loss of wealth is a major outcome from investing with any fraudulent or unregulated financial operations. For example let us examine the impact of the collapse of probably the biggest one the Bernard Madoff scheme which was estimated to be around US $50 Billion. Now according to the British Broadcasting Commission: 7

8 Many wealthy people appear to have been wiped out, financial institutions around the world are counting the cost and saddest of all, some charities are being forced to close because of their losses. 3 It is being argued that had the United States Securities Exchange Commission (SEC) been more vigilant or indeed if hedge funds had not been excluded from regulation, the Madoff Ponzi scheme might not have grown to the extent that it did. Given the disruption that unregulated financial organizations have caused globally, the FSC will continue to ensure that any entity or individual who makes investment products available to the public are registered or licensed to conduct such business. Jamaican law prohibits all persons from engaging in such activities without the relevant registration or license as the case may be. The FSC is currently in a process of stakeholder consultation aimed at proposing legislative amendments to strengthen our antifraud and enforcement capabilities in order to protect investors from fraud. However apart from protection of investors, the Financial Services Commission Act and the other statues and regulations, that guide the FSC s operations, were also designed to facilitate, for issuers, the raising of capital efficiently and at low 3 BBC, 2008, Madoff Vanishing Millions [online] Available at [17, February 2009] 8

9 costs. As Professor David Ruder of Pace University School of Law and former Chairman of the SEC recently concluded that the regulator s pursuit of investor protection is aligned with interests of capital formation because honest markets are the best markets. If investors are comfortable that they will not be defrauded, the cost of capital will be lower as investors will have no reason to discount for potential dishonesty. 4 Furthermore the FSC s role does not only reap benefits for investors but has a positive multiplier effect on the economy as it builds confidence and enhances transparency and efficiency in the capital markets. Dr. Charles Asembri, former General Manager for the Ghana Stock Exchange and former Director-General of Ghana s Securities Regulation Commission, explained how the capital markets impacts the economy when he expressed the following:. Today capital markets have become important instruments for economic growth and development around the world. They exist to provide issuers 4 Barbara Black Jill I. Gross, 2005, School of Law Pace Law Faculty Publications, The Elusive Balance Between Investor Protection and Wealth Creation, [online] Available at [Accessed: March 18, 2009] 9

10 of securities or users of capital with an avenue to raise capital from the public. Indeed, the capital market is an extremely important engine for a country s economic development as it serves to meet the funding needs of companies, enabling them to grow and thereby provide jobs. The interplay of all the above, namely issuers of capital, as well as individual and institutional investors, can produce real benefits for the players in the pursuit of wealth creation or profit maximization 5 Being cognisant of the importance of the capital markets, the FSC strives to have effective regulation of the financial markets which are vital to consumers, investors, pensioners, capital formation, job creation, and economic growth. So does financial regulation prevent institutional failure? No it does not. In fact, I would argue that the reality of the economic cycle is that periods of stability and prosperity will necessarily be followed by periods of contraction. As we can see, in every decade of the last 40 years, there have been periods of economic uncertainty and instability. The extent to which institutions remain viable is not driven by regulation, but by the decisions and conduct of the principals of those institutions. 5 Dr. Charles Asembri, 2007, Securities and Exchange Commission, Ghana, Wealth Creation: The Role of the Regulator [online] Available at %20%20Speech.doc [Accessed: March 17, 2009] 10

11 Accordingly, investors must recognize their power and exercise their power in contributing to the efficiency and strength of the financial system. In doing so investors should Always request written information; Ask if the firm and product are registered by the regulator; Check out the company or organization carefully; Ask what recourse you would have should you make a purchase and are not satisfied; and Ask for balance sheets and income statements of the issuer. There is also some other basic information that investors must be cognizant of. As investors, we need to be mindful that because periods of great returns are invariably followed by a decline, long-term investment portfolios tend to be less volatile and more growth oriented. If you are being promised or guaranteed extremely high short term returns, that sound too good to be true, they probably are. In closing, the FSC also believes that a regulatory framework impacts the attractiveness of the financial market. That is, the actions of the regulator can either stimulate or dampen the demand and supply of financial services. Enhancing public confidence and understanding of the financial markets can increase the demand for financial products. But our function cannot replace the responsibility of the prudent institution or individual investor. 11