Regulations: Do They Really Work?

It’s a burning question in finance and economic circles whether stock market regulations actually work. There are two primary schools of thought on the matter. The first comes from the free market supporters. On the extreme edge, these believers in Adam Smith’s invisible guiding hand of capitalism deem any regulation evil and fruitless. In their eyes regulations are the problem, instead of giving solutions to the issues they are designed to solve. Government interference of any type into freely trading markets causes friction that damages the market’s integrity, these hard line anti regulators assert. On the other end of the regulatory spectrum are the people who believe that the government should regulate the financial industry to the point of total control. They don’t trust the free market system, thus want the government to control the financial markets.Well, of course both these extremes are just that – extremes. Regulatory reality rests somewhere in between these two examples. Good regulations protect the integrity of the market from those who wish to exploit it. However, proper regulations allow the free market to work with as little oversight as possible. It’s a fine line, yet one that has proven to be effective.

Let’s take a closer look at the current state of financial regulation. In the US, the Dodd Frank Wall Street Reform and Consumer Protection Act is the latest regulatory response to the global financial crisis. The European Union and Asia are working on similar legislation. The primary sticking points to global regulatory framework appear to centered on the derivative marketplace rather than equities. In the US, the Dodd Frank Act seeks to strengthen the original rule based framework with a greater role for rules, while in Europe the EU struggles with what new regulations to institute and what regulatory body should be in charge. The European crisis and fragile European banking system creates a difficult environment as regulations must not only solve the current issues, but must prevent reoccurrence.

The booming economy in Asia creates an entirely different regulatory framework. Local flexibility appears to trump heavy regulations in Asia. Many observers believe that the financial centers of Hong Kong and Shanghai will develop their own brokerage, banking and asset management sectors in reaction to what they see as the over-regulation of the western economies.

In the United States, the governing securities regulatory body – the Securities and Exchange Commission (SEC) – is built upon two primary pillars. The first is that companies must tell the truth about their businesses, the securities they are selling and the risks involved in investing in them. Second, people who sell and trade securities must treat investors fairly and honestly, putting their interests first. While the final verdict of whether or not regulations work in the manner they are supposed to work remains debatable, one thing seems to make the most sense: sticking to the SEC’s root pillars is a great place to start for future regulations in the stock market. Often, the simpler the regulation, the more effective.

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