# **Strong Exchange SRO model**

In this model, the government regulator relies on an exchange to perform extensive regulatory functions that extend beyond its market operations. Those functions typically cover market regulation, regulation of members’ business conduct and operations, and listing rules. (See the list of regulatory responsibilities in appendix A for areas typically covered by an exchange in this model.) If the exchange operates a clearinghouse or CSD, then it also regulates clearing and settlement systems.

Benefits of this approach are greater use of industry expertise and resources in regulating markets and member firms, and a reduced burden on the government regulator. Many countries require a regulated market to perform self-regulatory responsibilities and to act in the “public interest.” Such factors can be especially important in emerging markets where budgets of statutory regulators are limited.

Nevertheless, this approach raises potentially serious conflict-of-interest problems because the exchange’s regulation responsibilities are extensive. (Again, see chapter 5 on conflicts of interest.) Because much management time and attention are consumed by regulation, the exchange is probably less focused on its primary mandate of business and market development. The extensive costs of regulation would also reduce the exchange’s competitiveness unless it can recover the costs by imposing additional fees.

By relying on an SRO to perform many responsibilities, the regulator has less control over detailed regulation or the day-to-day operations of markets and member firms. Regulators sometimes try to address this issue by imposing stringent oversight procedures on SROs, which add to costs and may lead to considerable duplication of effort.

# **Independent Member SRO model**

This model is similar to the strong exchange SRO model, so many of the benefits are the same. The government regulator relies extensively on an independent member SRO instead of an exchange to carry out regulatory functions. An independent member SRO is a member-owned, non-profit organization that is purely a regulatory body – it is independent of exchanges and other market operators and does not have significant business operations. In some cases, those organizations also have industry association functions – notably the JSDA and KOFIA – but such functions are segregated from SRO operations, thus mitigating conflicts between the two roles.

The major advantage of this model is that it minimizes concerns about conflicts of interest that arise in exchange SROs, because no conflicts with business activities arise. Independent SROs have a singular, clear mission to provide effective regulation. Independent SROs are also seen as neutral and unbiased regulators because they do not have any business interests to protect. For this reason, the first recommendation in a recent CFA Institute study on self-regulation is “Where self-regulation is practiced, establish an independent SRO body that is separate and distinct from exchange/market operations to oversee the regulation of the securities market.” The paper asserts that an independent SRO “removes the often subtle, yet effective, pressures regulatory and business arms can exert on each other” (CFA Institute 2007: 25).

20