Market Regulation: Ensuring Stability and Fairness | CFA Level I Equity Investments

Key Problems in Financial Markets

Before diving into market regulation, let’s discuss some of the main issues that could arise in financial markets:

1. Fraud and theft: Unsophisticated investors may be vulnerable to agents or investment managers who take advantage of their trust.
2. Insider trading: Market insiders with privileged information could have an unfair advantage, which may discourage other traders and reduce market liquidity.
3. High cost of market information: Expensive information access can hinder informational efficiency and discourage investment.
4. Risk of defaults: Market participants may fail to honor their obligations, leading to serious consequences for individuals and firms.

Effective regulation is essential for addressing these problems and ensuring the proper functioning of financial markets. Without it, liquidity declines, firms avoid risky projects, new ideas go unfunded, and economic growth slows down.

Regulatory Solutions

Here are some ways regulators can address the aforementioned problems:

• Prevent fraud and theft by requiring minimum competency standards and making it easier for investors to evaluate performance. The CFA Program and Global Investment Performance Standards contribute to this effort.
• Combat insider trading by making it illegal and enforcing rules strictly to ensure a level playing field.
• Require companies to report according to common financial reporting standards, such as IFRS or US GAAP, reducing information gathering costs and facilitating comparisons across companies.
• Enforce minimum capital requirements so that market participants can honor their long-term commitments, which is crucial for insurance companies and pension funds that individuals rely on for their financial future.

Regulation can be provided by governments, related entities, and industry groups. For instance, most exchanges, clearinghouses, and dealer trade organizations are self-regulating organizations that regulate their members. Governments sometimes delegate regulatory authority to such organizations.