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World Bank Working Paper
rules: 1) requirements for investment firms and broker dealers to have in place arrangements to prevent conflict of interest; 2) adequate systems, resources and procedures in order to assure continuity in business services; 3) responsibilities when outsourcing to third parties; 4) sound accounting and administrative procedures and 5) policies and procedures on personal transactions of employees and tied agents.8 The organizational requirements for exchanges are broader in the United States than in Europe and are focused on the exchanges’ disciplinary role, rather than on internal systems and policies which is mostly the case in Europe. The common feature in the two regulatory frameworks is the promotion of fair and orderly trading and transparency in transactions. The U.S. exchanges must demonstrate that they have in place solid disciplinary and enforcement procedures in order to exercise their complementary function in securities markets regulation (SRO role). On the other side, the main objective of the organizational requirements for Regulated Markets in Europe is the prevention of operational risks and system disruptions, and ensuring sufficient resources in order to carry on business activity. The difference between the SRO disciplinary role of the U.S. exchanges and the more limited role of the EU exchanges is the main reason why operational requirements on EU exchanges are lighter. Capital requirements for investment firms/brokers and dealers: Regulatory capital requirements are different in Europe and in the United States. While in Europe capital requirements are risk based, in the United States the Net Capital Rule (Rule 15c3 1) for broker dealers is based on the concept of maintaining a highly liquid core of capital. This rule is “to oblige broker dealers to have at all times enough liquid assets to be able to satisfy the claims of customers in the case a broker dealer goes out of business.�9 Investment firms in Europe are required to comply with the Capital Requirement Directives for credit institutions.10 Under the SEC rule broker dealers must have in place minimum capital levels, subject to the type of securities activities they are engaged in and based on certain financial ratios. For example, a broker dealer that carries customer or broker dealer accounts and receives or holds funds or securities for those persons is required to maintain a minimum net capital of US$250,000. Large broker dealers that hold customer funds and securities often choose to calculate their net capital based on the alternative method. Pursuant to such method, a broker dealer must maintain at least the greater of US$250,000 or 2 percent of aggregate debit items computed using the Formula for Determination of Reserve Requirements for Brokers and Dealers.11 Minimum capital requirements for broker dealers who do not carry customer accounts are smaller. In Europe, investment firms need to have initial amount of capital in place in order to engage in the business activity. Investment firms that hold client funds or securities are required to have an initial capital of EUR 125,000. Firms that do not carry client funds can operate with an initial capital of EUR 50,000. Additionally, capital requirements rules stipulate the minimum amounts of own financial resources that credit institutions and investment firms must have in order to cover the risks to which they are exposed. The aim is to protect clients and the stability of the financial system.12 The capital requirement rules are currently under review in the EU, to better account in particular for large exposures, securitization exposures, and risks to the trading book.13
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