IOSCO Publishes Final Report on Guidelines for the Regulation of Conflicts of Interest Facing Market Intermediaries

The last few years have seen a significant growth in the involvement of market intermediaries in the financial market, which has led to increased complexity in the range of business services provided as well as the usage of financial products and instruments. The recent financial crisis and several corporate scandals have given rise to concern over the conduct of market intermediaries due to their inherent agency structure that gives rise to conflict of interests. Many cases have arisen where intermediaries are not acting in the best interests of their clients. Further, due to providing a wide range of services, market intermediaries are prone to conflicts of interest, which can lead them to diverge from adopting strategies and behavior to benefit their clients.

The evolving market scenario combined with an enhanced role of globalization in financial markets has prompted regulators to find improved regulations to address conflicts of interests faced by market intermediaries which pose a risk to the health of any financial system. There are apprehensions over the methods and strategies adopted for the regulation of market intermediaries to manage conflict of interests. Regulators have been criticised by various sections for using soft regulation in relation to market intermediaries. The increased role of globalization in the financial markets has also led to circumstances which have called for greater alignment in the regulatory scope of different jurisdictions. Therefore, regulation of financial markets needs to be developed with a focus on commonly accepted rules for the regulation of conflicts of interest. Consequently, an increasing number of the members of the International Organization of Securities Commissions (IOSCO) are in the process of adopting new regulations, to target conflicts of interest.

The Emerging Markets Committee (EMC) meeting held on 5 November 2009, mandated the Emerging Markets Committee's Working Group 3 (EMCWG3) on Supervision of Market Intermediaries to develop, for emerging markets regulators, Guidelines for Regulation of Conflicts of Interest Facing Market Intermediaries.

Market intermediaries provide a range of services and are hence placed at an informational advantage over other players in the financial market. Imperfections in the financial market and asymmetry of information are the prime reasons which can lead to the exploitation of conflicts of interest by market intermediaries. Difficulties with the regulation of conflicts of interest faced by market intermediaries arise due to problems in identifying all the situations which can cause a conflict. Robust regulation of conflicts can take away the advantages a market intermediary possesses through the means of economies of scope. On the other, hand light touch regulation will create an incentive for intermediaries to exploit their clients, which would lead to a loss in investor confidence. Therefore, the regulatory framework should create a balance between the two and most importantly aim to affect the behavior of the management of an intermediary through emphasizing the importance of adopting strict internal control measures to avoid conflicts of interest from arising.

This report examines the role of market intermediaries in financial markets and highlights different scenarios where conflicts of interest can take place. The report goes on to identify remedies and create suitable guidelines which can be used by EMC jurisdictions for better management of conflicts of interest.