Chapter 5 Market Operator and Self-Regulating Organisations PDF

CHAPTER 5 Market Operator and Self-Regulating Organisations  DISCLAIMER □ Brunei Darussalam Central Bank (BDCB) is not responsible for the results of any action taken on the basis of information in this licensing examination study manual or any errors...

CHAPTER 5 Market Operator and Self-Regulating Organisations  DISCLAIMER □ Brunei Darussalam Central Bank (BDCB) is not responsible for the results of any action taken on the basis of information in this licensing examination study manual or any errors or omission; □ BDCB expressly disclaim all and any liability to any person in respect of anything and of the consequences of anything done or omitted by a person in reliance, whether whole or partial, upon the whole or any part of the contents of this licensing examination study manual; and □ BDCB do not purport to provide legal or other expert advice in this licensing examination study manual and if any legal or other expert advice is required, the services of a competent professional person should be sought.  ABBREVIATIONS AMBD Autoriti Monetari Brunei Darussalam AAOIFI Accounting and Auditing Organisation for Islamic Financial Institutions BDCB Brunei Darussalam Central Bank BDCBO Brunei Darussalam Central Bank Order, 2010 BOD Board of Directors CMSL Capital Markets Services Licence CMSRL Capital Markets Services Representative’s Licence CIS Collective Investment Scheme CFD Contracts for Differences CSD Central Securities Depository ECF Equity Based Crowdfunding FCA Financial Conduct Authority FIMM Federation of Investment Managers Malaysia FinTech Financial Technology IOSCO International Organization of Securities Commissions IFRS International Financial Reporting Standards IMF International Monetary Fund ISAF Internal Syariah Audit Framework ICM Islamic Capital Market MMOU Multilateral Memorandum of Understanding OTC Over the Counter P2P Peer-to-Peer SMO, 2013 Securities Markets Order, 2013 SMR, 2015 Securities Markets Regulations, 2015 SFSB Syariah Financial Supervisory Board SFSBO Syariah Financial Supervisory Board Order, 2006 SRO Self-Regulating Organisation SAB Syariah Advisory Body SGF Syariah Governance Framework SPV Special Purpose Vehicle Contents CHAPTER 5 – MARKET OPERATOR AND SELF-REGULATING ORGANISATIONS..................2 Learning Goals:..................................................................................................................................................2 Overview...............................................................................................................................................................2 5.1 Regulated market, market operators and market infrastructure.....................................2 5.2 General requirements.............................................................................................................................4 5.2.1 Licensed securities exchange and clearing house............................................................4 5.2.2 Licensed trading facility................................................................................................................5 5.2.3 Licensed credit rating agency.....................................................................................................5 5.2.4 Recognised foreign securities exchange, clearing house, trading facility and credit rating agency....................................................................................................................................6 5.2.5 Designated foreign securities exchange, clearing house, trading facility or credit rating agency....................................................................................................................................6 5.3 Self-Regulating Organisations.............................................................................................................7 5.3.1 Introduction........................................................................................................................................7 5.3.2 General requirements – self-regulating organisations..................................................7 5.3.3 Notification requirements............................................................................................................8 5.3.4 Central securities depository......................................................................................................8 5.3.5 CSD – trust status, dematerialised securities, indemnity insurance, default fund.....................................................................................................................................................................9 5.4 Revocation....................................................................................................................................................9 5.5 Direction or Court Order.................................................................................................................... 10 Summary............................................................................................................................................................ 10 Looking ahead................................................................................................................................................. 11 Questions........................................................................................................................................................... 11 Additional recommended reading......................................................................................................... 11 1  CHAPTER 5 – MARKET OPERATOR AND THE SELF-REGULATING ORGANISATIONS Learning Goals: LG1. To explain the concepts of and the interrelationships between a regulated market, a market operator and infrastructure. LG2. To discuss the key requirements for the licensing, recognition and designation of a market operator and market infrastructure provider. LG3. To outline what may trigger the revocation of licence, recognition or designation status. LG4. To outline the Authority’s powers to give directions to comply. LG5. To discuss the key requirements for the Self-Regulating Organisations. Overview As discussed in Chapter one (1), the capital market is a place where the entities that need to raise funds may do so by issuing securities. In the Brunei context, these securities are investment instruments such as shares, debentures and units in collective investment schemes. Investors that purchase or subscribe to these securities would provide funds to the securities issuers. Hence, the capital market provides an avenue for investors with surplus funds to invest, and for entities to raise funds by issuing securities. This chapter deals with the SMO’s requirements in respect of the market operator, market infrastructure and the self-regulating organisations. We begin by defining the regulated market and the market operators and market infrastructure in Section 5.1. Section 5.2 discusses the requirements for a regulated market operator under three regimes: licensing, recognition and designation. Section 5.3 provides the requirements for a self- regulating organisation. Section 5.4 examines the circumstances which may allow the Authority to revoke these organisations’ licence, recognition or designation status. Finally, Section 5.5 discusses the Authority’s power to direct or apply for a Court Order. 5.1 Regulated Market, Market Operators and Market Infrastructure A regulated market, in general, is an exchange or trading system through which securities are traded. The market operators are the entities that facilitate the exchange or trading 2 of these securities amongst market participants and investors. Such market operators must be licensed, recognised or designated under the SMO. Finally, market infrastructure refers to the entities that set up and maintain the platform and provide services which facilitate the exchange of funds and securities. There are three (3) types of market operators, namely: (1) Securities Exchange – an entity that facilitates the buying and selling of securities which are listed or traded on the securities exchange; (2) Clearing House – an entity that provides facilities for clearing or settlement of transactions in exchange-traded securities, guarantees the settlement of such transactions and any other clearing or settlement as allowed by the Authority; and (3) Trading Facility – an entity that provides an electronic system which connects various pertinent parties to facilitate the buying and selling of securities. There is another additional entity that also provides specified services and support to the capital market that is regulated under the SMO, namely the credit rating agency. A credit rating agency is an independent body that professionally issues or updates the credit ratings that reflects the creditworthiness of: (1) an entity, debt or financial obligation, or security; or (2) an issuer of debt or financial obligation, or security. This will be further elaborated in Section 5.2.3-5.2.5. Each type of market operator can be sub-divided into three (3) categories of regulatory regime, namely: (1) Licensing – a locally incorporated market operator that applies for a licence and meets the licensing requirements shall be granted a licence by the Authority to operate in Brunei Darussalam. (2) Recognition – a foreign market operator incorporated in a jurisdiction other than Brunei Darussalam that applies for a recognition and subject to meeting the requirements, shall be granted a recognition by the Authority. (3) Designation – a foreign market operator incorporated in a jurisdiction other than Brunei Darussalam which has been designated by the Authority to operate in Brunei Darussalam without requiring the need for the foreign market operator to make any application to the Authority. 3 The requirements for market operators and market infrastructure shared in the ensuing sections are covered under Part III of the SMO. 5.2 General Requirements This section covers some of the noteworthy general requirements for the operators of securities exchange, clearing house, trading facility, credit rating agency and SRO based on the three (3) regulatory regimes. There are slight differences in the licensing requirements for each aforementioned operator as provided under Sections 5.2.1-5.2.3. Recognition and designation regimes, however, have similar requirements as explained in Sections 5.2.4 and 5.2.5. 5.2.1 Licensed Securities Exchange and Clearing House The Authority will grant a licence only if it is satisfied that the applicant complies with the SMO’s requirements and regulations and its licensing is in the interest of Brunei Darussalam. An applicant who is granted a licence to operate as a licensed securities exchange or clearing house is subject to the Authority’s continuous supervision. He must comply with the requirements for the initial licensing and any other continuing obligations as specified by the SMO. Among the key requirements for a licensed securities exchange and clearing house are as follows: (1) A person who directs these businesses must be reputable and experienced a. The Authority shall be notified in advance of any proposed change in these persons. (2) To have in place the following organisational arrangements: a. To identify and manage potential conflicts of interest; b. To implement adequate risk management arrangements and systems; c. To have sound management of its systems’ technical operations; d. To have clear regulations and procedures to serve its members in a fair and orderly manner; e. Arrangements for efficient and timely completion, clearance and settlement of the transactions; and 4  f. Sufficient financial resources to ensure its services are functioning in an orderly manner. (3) Clear regulations to govern the admission of securities to trading so that they are traded fairly, orderly, efficiently and are freely negotiable. (4) To ensure any outsourcing of important operational functions must not materially affect the quality of its internal control and the Authority’s ability to supervise its compliance with the SMO. (5) To notify the Authority of any changes to its regulations or guidelines. 5.2.2 Licensed Trading Facility The main requirements for a licensed trading facility are broadly similar to licensed securities exchange and clearing house. In exception to the above, the Authority will assess whether to grant a licence to an operator of a trading facility only if it is satisfied that the applicant complies with the SMO’s requirements and regulations. 5.2.3 Licensed Credit Rating Agency The Authority will grant a licence only if it is satisfied that the applicant complies with the SMO’s requirements and regulations and its licensing is in the interest of Brunei Darussalam. An applicant who is granted a licence to operate as a licensed credit rating agency is subject to the Authority’s continuous supervision. He must comply with the requirements for the initial licensing and any other continuing obligations as specified by the SMO. Among the key requirements for a licensed credit rating agency are as follows: (1) A person who directs these businesses must be reputable and experienced a. The Authority shall be notified in advance of any proposed change in these persons. (2) To have in place the following organisational arrangements: a. To identify and manage potential conflicts of interest; b. To implement adequate risk management arrangements and systems; c. To have sound management of technical operations; d. To verify the sufficiency and quality of the information used to derive the ratings; 5  e. To disclose the models, methodologies and key assumptions used to derive the ratings; f. To publish an annual transparency report; g. To establish an internal function to review the quality of their ratings; and h. Sufficient financial resources to ensure its services are functioning in an orderly manner. 5.2.4 Recognised Foreign Securities Exchange, Clearing House, Trading Facility and Credit Rating Agency An applicant who applies to be a recognised foreign securities exchange, recognised foreign clearing house, trading facility or credit rating agency is subject to the same requirement under the SMO. It must have a service address in Brunei Darussalam and also meet the following three (3) requirements: (1) Protection provided to investors by the foreign securities exchange or clearing house is similar to the protection provided to investors of a licensed securities exchange or clearing house; (2) The applicant is able and willing to co-operate with the Authority; and (3) There are adequate arrangements for the applicant’s home country’s supervisory authority and the Authority to co-operate. As for the recognition of foreign securities exchange and clearing house, it also has to ensure that it has adequate procedures for dealing with a member who fails or is unlikely to meet the obligations relating to the market contracts. Once recognised by the Authority, the foreign securities exchange, clearing house, trading facility and credit rating agency are subject to the Authority’s yearly reporting requirements. 5.2.5 Designated Foreign Securities Exchange, Clearing House, Trading Facility or Credit Rating Agency The criteria to become a designated foreign securities exchange, clearing house, trading facility or credit rating agency are similar for all. The Authority may by order, designate a foreign securities exchange, clearing house, trading facility or credit rating agency if the 6 Authority is of the opinion that the operators offer the same protection to investors as the requirement for recognition as provided under section 5.2.4 of this Chapter. The Authority may withdraw the designation if the operator: (1) No longer complies with the requirements for investor protection, or (2) Has breached the SMO requirements 5.3 Self-Regulating Organisations 5.3.1 Introduction The preceding sub-sections discussed the requirements for the regulated organisations. This section discusses the requirements for a self-regulating organisation (SRO). An SRO is an entity that regulates any kind of investment business by enforcing rules on its members. Examples of SROs in Malaysia are the Federation of Investment Managers Malaysia (FIMM) and Bursa Malaysia. The Authority will grant recognition only if it is satisfied that both the organisation and its systems comply with the SMO’s requirements and regulations, and its recognition is in the interest of Brunei Darussalam. Under the SMO, an applicant who is granted recognition to operate as a recognised SRO is subject to the Authority’s continuous supervision. He must comply with the requirements for the initial recognition and any other continuing obligations as specified by the SMO. 5.3.2 General Requirements – Self-Regulating Organisations Similar to the requirements for the regulated market operators, among the requirements for a recognised SRO are as follows: (1) A person who directs an SRO’s business and operations must be reputable and experienced: 7  a. The Authority shall be notified in advance of any proposed change in these persons. (2) To have in place the following organisational arrangements: a. To identify and manage potential conflicts of interest; b. To implement adequate risk management arrangement and systems; c. To have sound management of its systems’ technical operations; d. To have transparent and non-discretionary regulations and procedures in order to serve its members fairly and in an orderly manner; and e. Sufficient financial resources to ensure its services are functioning in an orderly manner. 5.3.3 Notification Requirements The SRO may also be subjected to notification requirements specified by the Authority. Additionally, if an SRO amends, revokes or adds to its regulations or guidelines, the SRO must inform the Authority within seven days of when these proposed changes are made. 5.3.4 Central Securities Depository (CSD) An entity that applies for recognition as an SRO may do so in relation to the provision of central securities depository (CSD) services. A CSD is an entity that usually provides the following services, as described in Wendt, Katz and Zanza (2019): (1) Securities accounts – securities issuers may place their securities into a CSD which enables investors to hold and trade these securities in a centralized system; (2) A securities settlement system – enables securities to be transferred and settled based on some predetermined multilateral rules; (3) Central safekeeping services – for market participants; (4) Asset services – administration of corporate actions and redemptions; and (5) Registrar services – maintenance of record of legal ownership of securities. A CSD supports capital market development through the provision of a central clearing and settlement service. Hence, it facilitates trading, capital formation and market liquidity (Wendt, Katz and Zanza, 2019). In Brunei Darussalam, Section 102(5) of the SMO lists the CSD’s activities as follows: (1) Custodial services; 8 (2) Maintenance of registry books for issuers; and (3) Other related functions that the Authority may determine. Membership of a CSD and access to its services may be open to CMSL holders and other entities as the Authority prescribes. A CSD cannot distribute dividends. 5.3.5 CSD – Trust Status, Dematerialised Securities, Indemnity Insurance, Default Fund Securities and other property held by a CSD for its member remain those of the member. The CSD is merely holding them in trust for the member who owns the securities and other property. These securities include those that are dematerialised, i.e. those that are in electronic rather than physical certificated forms. In fact, the Authority may require that a CSD: (1) Holds securities only in dematerialised form, and (2) Has systems and procedures that accurately record the number of securities deposited in the CSD. The CSD’s management must act prudently in the interest of its members’ accounts. The CSD is liable for losses caused by its negligence or non-compliance with the SMO or relevant regulations. Hence, a CSD must have sufficient professional indemnity insurance to cover the management’s negligence relating to the loss of cash, securities or other assets of the CSD. Besides, the Authority may also require the CSD to establish a default fund. This default fund is to guarantee fast and accurate clearance and settlement of transactions executed on a securities exchange. 5.4 Revocation The Authority may revoke the status of a securities exchange, clearing house, trading facility, credit rating agency or SRO (as being licensed, recognised or designated) if the Authority finds that the organisation: (1) Does not engage in the approved regulated activity(ies) within twelve (12) months, renounces the licence or has not provided the services for the last six (6) months; (2) Obtained the licence by making false statements; 9 (3) Is failing or has failed to satisfy the licensing, recognition or designation requirements and comply with other obligations imposed under this Order; and (4) Is assessed to be not fit and proper to be licensed, recognised or designated. The Authority may also revoke the recognition of a recognized SRO if it appears to the Authority that: - It is no longer desirable to continue its recognition due to the existence of one or more other organisations which have been or are to be recognized as an SRO, or that It is the interest of Brunei Darussalam to revoke the recognition of the recognized SRO. 5.5 Direction or Court Order The Authority has the power to give directions in cases of a market operator’s non- compliance. The Authority may direct the securities exchange, clearing house, trading facility or credit rating agency to take specified steps so as to comply with certain requirements or any other obligation. The situation differs for an SRO. Should there be non-compliance to any requirement and obligation, the Authority may choose not to revoke the SRO’s recognition or to direct the SRO itself. Instead, the Authority may apply to the High Court to give direction to the recognized SRO to comply with such requirements and obligations. Please refer to the SMO for more information on the requirements. Summary This chapter discussed the types of regulated market operators and infrastructure which are regulated by the Authority. It outlined the requirements imposed on a securities exchange and clearing house, a trading facility and a credit rating agency. For each type of market operator and infrastructure, three categories exist, namely licensed, recognised and designated. This chapter also discussed the meaning of an SRO. In particular, the central securities depository’s roles and functions in the capital market were outlined. The additional 10 requirements for the fulfilment of an SRO’s recognised status and the requirements to notify the Authority were also highlighted. Finally, this Chapter discussed the events and criteria which may trigger the Authority to revoke a regulated market organisation’s or SRO’s status of being licensed, recognised or designated. Alternatively, the Authority may choose to direct or apply for a Court Order should there be non-compliance. Looking ahead The next chapter discusses the regulations and the guidelines in conducting the Islamic investment business. Questions 1. What are the types of market operators and infrastructure which are regulated by the Authority? 2. Briefly describe the key roles of each type of market operator and infrastructure. 3. The SMO states that there are only three regulatory regimes for regulating the regulated market operators. Name these three regulatory regimes and briefly describe what each means. 4. Discuss the key general requirements for a licensed securities exchange and clearing house. 5. Under what circumstances would the Authority be likely to revoke the licensed, recognition or designation of a securities exchange, clearing house, trading facility and credit rating agency? 6. What is a self-regulating organization? 7. What is a central securities depository? What are its main function and role in the capital market ecosystem? 8. What are the events which may cause the Authority to revoke the recognised status of a self-regulating organisation? 9. What notification requirements may the Authority impose on an SRO? Additional recommended reading 1. Brunei Darussalam Central Bank (2013), Securities Markets Order, 2013. 11 2. Carson, J. (2011), Self-Regulation in Securities Markets, Policy Research Working Paper 5542, The World Bank, available at https://documents1.worldbank.org/curated/en/337711468340157842/pdf/WPS5 542.pdf 3. Wendt, F; Katz, P; Zanza, A. (2019), “How to organize Central Securities Depositories in Developing Markets: Key considerations”, International Monetary Fund, Monetary and Capital Markets, How to Notes, IMF: Washington 12