Direct Regulation of Markets
The second component of law’s response to financial markets is legal regulation of organised changes, investment firms [including banks], licensing of broker/dealers, and designation of a Financial Regulator to monitor market activity and enforce the legal scheme. Types, level, and degree of regulation take many forms throughout world.
The most thorough recent survey concludes that, around the world, there are three basic models of securities regulation: (1) a “Government-led model” under which the central government retains significant authority over securities market regulation typified by France, Germany, and Japan); (2) a “Flexibility Model,” which grants greater authority to the market participants to determine basic policies, but relies upon public agencies to set general policies and maintain some level of enforcement capacity (exemplified by the United Kingdom, Hong, and Australia); and (3) a “Cooperation Model,” which assigns a broad range of powers to market participants with respect to most aspects of policymaking, but also creates parallel and overlapping public oversight bodies with strong enforcement authority (the United States and Canada are the leading examples of this model…[T]he more important point is that all the civil law jurisdictions with major securities markets fall into the first category.(John C. Coffee, supra – see reference list)
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In spite of these differences, he worlds’ markets exhibit several common traits that form generic criteria for the purported purpose of building strong securities markets. Hence, it is worthwhile to review critical institutions and regulatory activity the literature deems necessary to develop a strong securities market.
The empirical work of La Porta, Lopez-de-Silanes and Schleifer in their article “ What Works in Securities Laws?” supports this conclusion (Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer, What Works in Securities Law?, 61 J. Fin. 1 (2006) – see reference list). The authors examined the securities laws of 49 countries to establish whether there was an empirical link between law and efficient markets, and if yes, the identification of the primary legal rules. While law’s efficacy in markets is still open to debate, their work provides evidence that legal systems use generic building blocks in the construction of their financial markets. The origin of the legal system does not significantly differ in textual legal content; rather, the differences in weight and flexibility of legal rules constituted the statistically significant variations between common and civil law countries.
The authors concluded that, “law matters” for the operation of an effective market. A principal hypothesis was that securities laws reduce the cost of contracting and resolving disputes and therefore encourages firms to raise equity in the capital markets (Ibid at 7 – see reference list). They found that four key elements: (1) disclosure of material information, (2) effective and low-cost liability remedies for breaches of required conduct, (3) an effective market Supervisor, and (4) investor protection through corporate law.
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Specifically, they found significant correlation between low burdens of proof for aggrieved investors seeking recovery, developed an index of “Supervisor attributes” arguing for broad powers, and significant relationship between reliance upon criminal and civil law as measures of investor protection. The four “families” of legal systems studied: English common law, French civil law, German civil law and Scandinavian law, while exhibiting common traits, produced differences in market significance in two primary areas: disclosure and enforcement. The common law countries that characteristically adopt these measures had the most significant financial market development as measured by numerous ratios employed by the authors.
