The International Organization of Securities Commissions (IOSCO)

The International Organisation of Securities Commissions (IOSCO), a global level apex organisation, has been providing international best practices and perspectives on derivatives markets. The member agencies forming the International Organization of Securities Commissions have resolved, through its permanent structures:

• to cooperate together to promote high standards of regulation in order to maintain just, efficient and sound markets;

• to exchange information on their respective experiences in order to promote the development of domestic markets;

• to unite their efforts to establish standards and an effective surveillance of international securities transactions;

• to provide mutual assistance to promote the integrity of the markets by a rigorous application of the standards and by effective enforcement against offenses.

The Preamble to IOSCO's By-Laws states:Securities authorities resolve to cooperate together to ensure a better regulation of the markets, on the domestic as well as on the international level, in order to maintain just, efficient and sound markets:

• to exchange information on their respective experiences in order to promote the development of domestic markets;

• to unite their efforts to establish standards and an effective surveillance of international securities transactions;

• to provide mutual assistance to ensure the integrity of the markets by a vigorous application of the standards and by effective enforcement against offences.

IOSCO recognizes that sound domestic markets are necessary to the strength of a developed domestic economy and that domestic securities markets are increasingly being integrated into a global market. The IOSCO By-Laws also express the intent that securities regulators, at both the domestic and international levels, should be guided by a constant concern for investor protection.

The international regulatory community should provide advice, and a yardstick against which progress towards effective regulation can be measured. This document further evidences IOSCO's commitment to the establishment and maintenance of consistently high regulatory standards for the securities industry. As the leading international grouping of securities regulators, IOSCO accepts responsibility for helping to establish the high standards for regulation. Consistently high regulatory standards and effective international cooperation will not only protect investors but also reduce systemic risk.

Regulators should be prepared to address the significant challenges posed by the increasing importance of technology and particularly developments in the area of electronic commerce

Increasingly globalized and integrated financial markets pose significant challenges to the regulation of securities markets. At the same time, markets, particularly some emerging markets which have seen much growth in recent years, have been prone to effects of cross-border and cross-asset interactions, and some also are susceptible to higher short term volatilities after economic shocks or during periods of great uncertainty. Therefore, in a global and integrated environment regulators must be in a position to assess the nature of cross-border conduct if they are to ensure the existence of fair, efficient and transparent markets.

An increasingly global market place also brings with it the increasing interdependence of regulators. There must be strong links between regulators and a capacity to give effect to those links. Regulators must also have confidence in one another. Development of these linkages and this confidence will be assisted by the development of a common set of guiding principles and shared regulatory objectives.

In 1990, the IOSCO published the Principles for Oversight of Screen Based Trading Systems for Derivatives Products. It was suggested that all the jurisdictions adopt (SEBI, being a member organization, has adopted these principles,) the 10 non-exclusive general principles for the oversight of screen based trading systems for derivatives products which identify areas of common regulatory concern. These principles basically relate to compliance by system sponsor with the regulatory requirements relating to legal standards, regulatory policies, risk management mechanisms and adequate disclosures of attendant risks.

These 10 principles were reviewed by IOSCO and 4 additions were proposed in the year 2000 (IOSCO 2000) for derivatives products operating on the cross-border basis. The 1990 principles also anticipated IOSCO Objectives and Principles of Securities Regulations of 1998 relating to protection of investors, fairness and transparency of markets and reduction of systemic risk. The additional regulations suggested include, regulatory coordination and cooperation to avoid potential duplication, inconsistencies and gaps, sharing of relevant information and adequate disclosure and transparency of regulatory requirements in jurisdictions. The IOSCO report on the "International Regulation of Derivative Markets, Products and Financial Intermediaries" released in December 1996 provides a description of various models or approaches to the regulation of derivatives markets based on regulatory summaries prepared on common framework of analysis (IOSCO 1996b). It was observed that while there was no single model for the regulation of derivatives markets, there was substantial similarity in perceived regulatory objectives. The IOSCO framework identifies the three objectives of regulation, which need to be specified by the regulatory framework of the securities markets. These are market efficiency and integrity, customer protection/fairness and financial integrity (IOSCO, 1996a).

International practice suggests that such derivatives markets must be "recognized," authorized by the statute or otherwise created by grant before trading can start. Derivative products are similarly specifically recognized and must satisfy a test of economic utility. Further, domestic trading houses must also be recognized, authorized and approved by regulators. Many markets prescribe regulatory requirements for product design. The contract design is supposed to address the functional priorities of risk shifting and price discovery. It is felt that a well designed derivatives contracts is the first line of defence against market manipulation. The underlying must be specifically defined to facilitate hedging. Specific features of derivatives instruments have implications for regulatory authorities. Since in the derivatives contract, the transfer of underlying interest occurs as part of a separate transaction unless the contract is extinguished by offset, there is no limit to the number of outstanding open positions of a particular derivatives instrument. The regulatory concern is, therefore, reflected into emphasis on fairness and efficiency, concern on concentration of positions and delivery processes.