The evolution of trading poses regulatory challenges

“The transformation of exchanges from mutual ownership to for-profit entities … has contributed to increased competition, technological advancements, and the emergence of new types of trading venues,” the report said. “In addition to their traditional market functions, most exchanges now also engage in other diverse activities such as data services and technology provision.”

In turn, the changes that have altered the way that exchanges, and exchange groups, are structured “can potentially create new conflicts of interest, as well as operational and organizational interdependencies,” the report said.

This can also create challenges for the exchanges’ regulatory functions and novel supervisory issues.

“While these changes create opportunities for increased efficiency and revenue diversification, they also introduce new regulatory challenges, such as preserving the independence of the regulatory function, potential conflicts of interest and organizational complexities,” the report said, pointing to the added risks of reduced accountability and managerial autonomy.

Changes in governance practices — such as the use of “dual hatting,” which allows directors to sit on multiple boards within an exchange group to reduce the cost and complexity of multiple boards — also create potential conflicts of interest and may compromise the independence and accountability of board members and senior management, the report noted.

Similarly, while the use of multiple reporting lines within an organization can improve the strategic alignment of managers, it can curtail managerial autonomy, which “may especially be the case with regard to the performance of the regulatory functions of an exchange,” IOSCO said.

Multiple reporting lines can also cause conflicts between managerial groups who may have different regulatory responsibilities and may have to compete internally for human, financial and technological resources, as well as conflicts between the regulatory and commercial functions of an exchange.

The report noted that the broad use of outsourcing can enhance the efficiency and scalability of trading venues, but it creates potential risks too, including operational or financial dependencies, reducing the adaptability of trading venues and hampering oversight.

Further, the diversification of exchanges into other business lines, such as market data, analytics, corporate trust services, benchmark development and technology services can help stabilize exchanges’ revenues, while also posing new risks to investor protection, financial stability and market integrity.

To address these risks, the report sets out a series of best practices and tools for regulators to use in supervising exchanges, including practices to address the organization of exchanges and exchange groups, the oversight of exchanges and alternative trading systems within exchange groups, and the supervision of multi-national groups.

“The evolving landscape of exchanges presents new regulatory challenges. The good practices in this report will help regulators maintain oversight while ensuring market integrity and investor protection,” said Isadora Tarola, chair of IOSCO’s committee on regulation of secondary markets, in a release.