Because financial trading is often seen as a zero-sum-game, quite often the need arises for a supervising body to ensure that parties do not take unfair advantage of the uninitiated. This is a fact of history that goes back as far as Edwardian England, when the first recorded instance of financial regulation had the king force money brokers to be licensed by the government.
Three hundred years later, former Dutch East India Trading Company officials prompted a market crash by short-selling company stocks, which led to the first known instance of market regulation – a ban on short-selling; and when the Tulips market collapsed owing to unfulfilled obligations, the government banned the trading of futures contracts.
In different countries, different regulatory activities are undertaken by different bodies. In Japan and most European countries, one regulator regulates all financial sectors, with the European Securities & Marketing Authority (ESMA) serving as an umbrella organisation for all EU regulators.
In the UK, on the other hand, the Prudential Regulation Authority supervises banks, credit unions, insurers, major investment houses and building societies. The bank of England regulates banks and insurance companies. The Financial Conduct Authority regulates financial services.
And in the US, the Securities Exchange Commission originally supervised investment banks while the Federal Reserve was responsible for commercial ones. Today, the SEC is the administrative regulator for the entire financial sector and the FED – the monetary one.
Financial regulators supervise:
Companies listing themselves on the stock exchange to ensure transparency and prevent fraud
Exchanges to ensure transparent pricing and proper trade execution
Investment managers and brokers to ensure transparency and best-practices vis-à-vis their clients
Banks and financial services companies to ensure smooth functioning of the systems in place and prevent abuse by the banking industry
Soon after the EU’s 1992 founding of its Monetary Union (EMU) in the Dutch town of Maastricht, the Union’s stewards began to understand that a monetary union meant little with no unified financial plan. State institutions were disparate and there was little joint strategy underlined by an agreed-upon policy.
Thus, in 2004, the Committee of European Securities Regulators – formed in 2001 as part of the Lamfalussy Process aimed at developing a unified financial services industry – issued its first set of directives (MiFID-1), aimed at increasing competition between financial services companies, lowering costs and increasing investor protection.
Four years later, the financial world collapsed and the CESR began work on its 2nd set of directives, which were laid on ESMA’s table in 2014 (ESMA having replaced the CESR in 2011). This time, wary of what had befallen in the interim, MiFID required a painstaking recording process of each financial transaction and communication undertaken by an agent of any sort in the name of a client to prevent fraud – a clear playground tilting in the direction of online companies who had the technology in place to undertake such a daunting task (some traditional institutions still rely on paper-bound ledgers).
MiFID-2 also institutionalises the levels of leverage appropriate for different levels of investors, institutes negative balance protection and more – all to protect retail investors from some of the more blatant pitfalls of financial trading. It also dictates appropriateness tests to ascertain that an individual can afford to trade – both financially and with regards to his/her knowledge of financial markets.