Question

What is the rationale behind mandatory financial disclosure? What determines the level of

resources that countries are willing to devote to regulating their capital markets?

Answer 1

In the financial world, disclosure refers to the timely release of all information about a company that may influence an investor's decision. It reveals both positive and negative news, data, and operational details that impact its business.

Similar to disclosure in the law, the concept is that all parties should have equal access to the same set of facts in the interest of fairness. The Securities and Exchange Commission (SEC) develops and enforces disclosure requirements for all firms incorporated in the U.S. Companies that are listed on the major U.S. stock exchanges must follow the SEC's regulations.

• Federal regulations require the disclosure of all relevant financial information by publicly-listed companies.
• In addition to financial data, companies are required to reveal their analysis of their strengths, weaknesses, opportunities, and threats.
• Substantive changes to their financial outlooks must be released in a timely fashion

Federal government-mandated disclosure came into being in the U.S. with the passage of the Securities Act of 1933 and the Securities Exchange Act of 1934. Both laws were responses to the stock market crash of 1929 and the Great Depression that followed.

The public and politicians alike blamed a lack of transparency in corporate operations for intensifying if not outright causing the financial crisis.

Sarbanes-Oxley

Since then, additional legislation such as the Sarbanes-Oxley Act of 2002 extended public-company disclosure requirements and government oversight of them.

As mandated by the SEC, disclosures include those related to a company's financial condition, operating results, and management compensation.

Insider Information

The SEC requires specific disclosures because the selective release of information places individual shareholders at a disadvantage. For example, insiders can use material nonpublic information for personal gain at the expense of the general investing public. Clearly outlined disclosure requirements ensure companies adequately disseminate information so that all investors are on an even playing field.

Companies are not the only entities subject to strict disclosure regulations. Brokerage firms, investment managers, and analysts must also disclose any information that might influence and affect investors. To limit conflict-of-interest issues, analysts and money managers must disclose any equities they personally own.

SEC-Required Disclosure Documents

The SEC requires all publicly-traded companies to prepare and issue two disclosure-related annual reports, one for the SEC itself and one for the company's shareholders. These reports are filed as documents called 10-Ks and must be updated by the company as events change substantially.

Any company seeking to go public must disclose information as part of a two-part registration that includes a prospectus and a second document that contains other material information. That information includes the company's own strengths, weaknesses, opportunities, and threats (SWOT) analysis of the competitive environment it operates within.

The SEC imposes stricter disclosure requirements for firms in the securities industry. For example, company officers of investment banks must make personal disclosures regarding the investments they own and investments owned by their family members.

The relevance of these policy takeaways varies by economy, and some of them fall outside direct central bank control. Nevertheless, they impact the vibrancy of capital markets and central banks’ ability to meet their objectives. The broad range of drivers identified also suggests that comprehensive initiatives that take into account the range of dimensions identified are likely to prove more successful in developing viable capital markets. First, greater market autonomy would enhance capital market pricing and funding allocations. In particular, policymakers need to address vestiges of financially repressive policies and fix market failures. These include policies that create preferential financing terms for the public sector as well as paternalistic policies that override private allocations. In many cases, repressive measures exacerbate market volatility by reducing investor diversity and suppressing securities issuance. Second, capital market development can be placed on firmer foundations by strengthening legal and judicial systems for investor protection. Policies that ease access to legal recourse lower the cost of private contract enforcement and sanctioning breaches of duty. In addition, raising the efficiency, consistency and fairness of legal proceedings, eg through the creation of specialised financial courts, could usefully boost investor protection, as would policies that raise the predictability and efficiency of insolvency procedures. Third, enhancing regulatory independence and effectiveness is a key factor in striking a balance between investor protection and issuer costs. Clear and well focused objectives and strong governance frameworks for regulators strengthen operational autonomy, thereby protecting against unwarranted influence. Enhancing investigative powers as well as ensuring the adequacy of resources would facilitate effective enforcement of regulations and timely diagnosis of market failures and vulnerabilities. Regulators can also strengthen investor protection by raising accounting and disclosure standards, and promoting best practices in corporate governance. In addition, authorities can supplement regulatory efforts byencouraging the private sector to develop standards and codes that may help market practices keep pace with evolving market innovations. Fourth, many economies have scope to increase the depth and diversity of the domestic institutional investor base. Policies to promote greater penetration on the part of institutional investors such as pension funds and insurance companies can dampen volatility as well as create a domestic constituency that raises corporate governance standards and the broader efficiency of capital markets. Achieving greater financialisation of household savings by facilitating cost-effective, transparent and well regulated collective investment products and fostering greater financial literacy would further boost capital market development. Fifth, a broad and bi-directional opening of capital markets can exert a general positive influence on domestic capital market development. But to reap the benefits, policymakers need to actively engage with potential market entrants and prepare for spillover risks. Calibrating the pace and sequencing of opening and creating macro policy buffers can help contain the associated risks and provide margins for coping with volatility. Finally, enhancing market ecosystems by developing deep complementary markets for derivative, repo and securities lending requires a coordinated effort along multiple dimensions. These include a supportive legal and regulatory environment, regulatory coordination to broaden the investor base in these markets, and robust and efficient market infrastructures such as central counterparties and trade repositories to manage potential financial stability risks.