The report offers a set of key recommendations for policy makers and regulators looking to attract and better regulate institutional investors in their jurisdictions. It highlights the importance of the legal protection of property and ownership rights. It also emphasizes the need to ensure reasonable transaction costs, develop flexible trading and hedging mechanisms, remove undue administrative impediments on product authorization processes, build a multi-pillar pension system with tax incentives and provide a level playing field for foreign investors. Finally, the report recommends that regulators periodically review the regulatory framework and coverage, combine deregulation with enhanced supervision and enforcement, and improve coordination with other regulatory bodies to monitor, mitigate and manage systemic risk.
The IOSCO Emerging Markets Committee (EMC) established a Project Team to review the development and regulation of institutional investors in Emerging Markets (EMs), to identify and analyze the issues and challenges for the development and regulation of institutional investors, and to make recommendations that EM regulators may consider as they supervise their respective markets. The Project Team
According to the report institutional investors are playing an increasingly important role in the development of EMs. Markets with large numbers of institutional investors tend to be less volatile and allocate resources and capital more efficiently to companies requiring funding. Highly specialized and managing substantial capital, institutional investors are better positioned to put pressure on corporations and their management to improve corporate governance and transparency. By pooling assets, institutional investors can achieve economies of scale, employ high quality investment professionals, develop better investment strategies and build solid risk management systems, all of which result in higher and more stable returns for investors, says IOSCO.
The report emphasises that in light of the challenges ahead, the development of institutional investors in the EMs calls for concerted efforts by both regulators and the market. It requires a pragmatic and sequenced approach by regulators to ensure that such efforts do not destabilise the financial system, and that adequate safeguards are established at both market and regulatory levels.
The report also contains a number of recommendations to help EM regulators and policy makers develop and regulate institutional investors; most of which are obvious. However, it is acknowledged that some frontier markets lack the appropriate financial markets infrastructure to sustain the evolution of sustainable capital markets and investment. We reproduce the key recommendations below.
Capital Market Environment. The foundation of a well-functioning capital market is the protection of property and ownership rights. In addition to a sound legal system, regulators need to promote proper corporate governance standards and other investor protection measures. A capital market that is favorable to institutional investors should have reasonable transaction costs (both explicit and implicit), a broad range of potentially high-quality investment products and flexible trading and hedging mechanisms.
Product Offering and Innovation. The authorisation process for new product issuance should be simple, fast and free of administrative obstacles. It should also be accompanied by strict post-issuance supervision and prompt regulatory actions when risks and violations occur. A multi-tier issuance regime could be used to lower issuance costs and broaden the product offering. Insofar as risks are manageable, regulators should support innovations that improve market efficiency or broaden investor-friendly product offerings.
Multi-pillar Pension System. The aging population is a major concern in many jurisdictions because it burdens the national pension and social security system. This burden could be shared by private pensions and personal savings plans. The development of a multi-pillar pension system, however, requires an appropriate set of tax incentives. Given that the financial performance of pension plans affects future pensioners’ standards of living, institutional investors in this market should be subject to higher prudential and professional standards.
Distribution Channels and Practices. Regulators should broaden the product distribution channels by increasing the type and number of distributors institutional investors can use. Regulators should introduce detailed rules for distribution practices and encourage Self Regulatory Organizations (SROs) to establish best practice standards on suitability, disclosure, marketing and fees.
Market Openness. Regulators should ensure a level playing field for foreign and domestic investors. Policy makers should gradually loosen or remove restrictions on fund repatriation and capital controls. Regulators should also break down barriers that prevent domestic investors from investing abroad.
Human Capital and Professional Integrity. Regulators and SROs should seek to improve the quality and availability of human capital by training and developing local talent and attracting professionals from other industries or overseas. The incentive structure should align the interests of the professionals with those of the investors. Sound licensing, record keeping and supervision systems should be established for industry professionals.
Regulatory Framework and Financial Stability. In accordance with the IOSCO Principles, regulators should prevent market abuse by building sound surveillance capacity and periodically reviewing their regulatory framework and coverage. Regulators should work together domestically and across jurisdictions, to monitor, mitigate and manage systemic risk.