Disclosure system and capital market regulation: institutional efficiency

Introduction to Disclosure Systems

• Legal Framework & Market Efficiency: The legal framework for an efficient capital markets law requires mandatory disclosure rules to provide the market with necessary information on issuers
• Historical Perspective: The importance of mandatory disclosure was recognized as early as 1966 by the Segre Committee
• Harmonized European Capital Market: Disclosure is a necessary prerequisite for the viability of an integrated European capital market
• Regulatory Influence: Inspired by US Securities Regulation, which follows a strong disclosure philosophy

. Economic Justification: The necessity of a mandatory disclosure system can be assessed not only from a legal perspective but also from an economic standpoint

Transparency and Capital Market Efficiency

Mandatory Disclosure acts as an instrument to manage conflicts of interest and is essential for investors to make optimal investment decisions

Economic Perspective: The relationship between disclosure, investor behavior, and capital markets is analyzed under the benchmark of efficiency

Types of Efficiency

Purpose: · Allocational · Institutional · Operational

Allocational Efficiency in Capital Markets

Main function of capital markets as: allocating scarce resources to investment opportunities

Institutional Efficiency in Capital Markets

affecting the functioning of the market (i.e., liquidity, volatility and investor confidence)

Operational Efficiency in Capital Markets

affecting time and trasaction costs (i.e., the higher the circulation of information, the lower the transaction costs)

Allocational Efficiency Concepts

• Informational deficits can cause market failure or inefficiency
• "Market for Lemons if the quality of the product is uncertain, the customer can no longer distinguish between good and bad quality by looking at the price. This leads to adverse selection, where sellers of high-quality products (good cars) cannot obtain a fair price and exit the market
• Efficient Capital Market Hypothesis (ECMH): 3 forms of Informational Efficiency :. Weak, prices reflect historical information; Semi-strong, prices instantly reflect all publicly available relevant information; Strong, prices reflect all public and private (inside) information
• Criticism: ECMH does not guarantee "correct" prices, only that markets quickly respond to new information; after financial crises, some criticized ECMH's role in justifying deregulation

Institutional Efficiency Criteria

• Defines criteria for capital markets to function as markets
• Institutional Efficency is Measured in terms of:
  • Free market access for investors and traders
  • Range of financial products and depth of available capital
• Other consider Investor confidence as the key factor in institutional efficiency
• Primary goal of capital market law: strengthen investor confidence in market integrity and stability
• Institutional efficiency is measured in:
  • Liquidity: Ensuring a sufficient flow of financial assets
  • Volatility: Necessary for market price adjustments to new information

Operational Efficiency and Information Costs

• Focuses on market processes in relation to time and transaction costs
• Insufficient disclosure leads to higher costs for investors and increased difficulty in making informed investment decisions
• Informational efficiency depends on:
  • How much/widely information spreads/diffondono informazioni
  • Lower information costs resulting in better circulation
• Three types of information costs:
  • Cost of Acquisition
  • Verification
  • Processing
• Market efficiency increases when the disclosure reduce the costs for investors to acquire information

Disclosure Provisions and Capital Market Regulation

Economic Point of View tified as any deviation from an allocationally efficient market, that justifies regulatory intervention

Reducing Information Asymmetry

• Legal disclosure obligations ensure that informations are available to the public, reducing inefficiencies caused by private research efforts
• Asymmetric information between issuers and investors creates agency costs
• Signal theory suggests that market participants will only disclose information if they gain economic advantages from it
• Public Good Problem: public goods suffer from the free-rider effect, where market participants gain access at no cost/free way, reducing market incentives for disclosure
• Transaction costs theory: disclosure reduces overall transaction costs, improving market efficiency

Investor Protection and EU Regulations

Investor Protection Ily a response to regulatory concerns, rather than a purely economic model

Pan-European regulations are justified by the need to ensure investor confidence

• Capita markets law promotes autonomous decision-making, avoiding governmental paternalism. ECMH influenced EU regulations, emphasizing mandatory disclosure for better decision-making
• Debate on whether disclosure protects individual investors or ensures market- wide efficiency
• EU laws allow national discretion, and lead to variations in investor protection across countries
• Behavioral finance challenges the rational investor model, showing how bounded rationality and information overload affect decision-making

Sustainable Finance and Disclosure

Instrument to Foster/Promote Sustainable Finance JN 2030 Agenda for Sustainable Development have increased governmental action for sustainability the EU Commission's 2018 Action Plan promotes sustainable finance as a key regulatory focus/objective

• Two key regulatory aspects:
  • EU Taxonomy economic activities - Introduce Classification system for defining sustainable
  • Disclosure obligations ESG factors Companies must report sustainability risks and
• Mandatory disclosure is a tool for regulatory control, influencing market participants' decisions
• The shift towards sustainable investments requires long-term corporate transparency

_Companies must integrate ESG factors into operations, enhancing stakeholder accountability > sustainability disclosure serves serves as an instrument for

Development of a Disclosure System

• Early EU legislation lacked a unified disclosure system
• First directives focused only on securities listed on stock exchanges
• Over time, the EU expanded its regulatory scope, leading to an overall disclosure regime

Categories of Disclosure Obligations

1. Public Offerings - Issuers must publish a prospectus (Prospectus Regulation)
2. Secondary Market Participation – Requires periodic and ad hoc disclosures (Transparency Directive)
3. Major Market Events - Disclosure of inside information, major shareholdings, and corporate control changes

Disclosure System Overview

Disclosure is correlated with market participation: the more an issuer raises capital on the market, the more its disclosure obligations grow

«Sunlight is said to be the best of disinfectants» (L. Brandeis, 1914), but «Excessive sunlight can cause skin cancer» (L. Loss, 1985)

Primary Market Disclosure

Prospectus Regulation

Secondary Market Disclosure

Periodic obligations Transparency Directive Rules on market abuses (e.g. rules on inside information)

Additional Disclosure Obligations

Information on significant/major shareholders Information on exercise of control over a target company

Dissemination Procedure and Regulated Information

• Initially, each directive had separate disclosure requirements
• The Transparency Directive (TD) of 2004 introduced a more unified approach
• TD focuses on:
  • Disclosure procedures
  • Storage of regulated information (all information which the issuer is required to disclose under the TD, including notifications on major holdings; financial reports; inside information, directors' dealings)
• Issuers must disclose information promptly and non-discriminatorily
• Disclosure must be accessible to the widest(più ampio) possible public
• Internet publication is now explicitly allowed, replacing printed newspapers
• The Market Abuse Regulation covers disclosure of inside information and directors' dealings

Disclosure & Storage of Information

Officially Appointed Mechanism (OAM)

• Member States must ensure regulated information is stored centrally in an OAM
• OAMs guarantee data security and easy access for investors
• Only if information disclosed under the MAR is also "regulated information" under TD, that information must be available in an OAM

European Electronic Access Points & European Single Access Point (EEAP & ESAP)

• EEAP connects national OAMs, creating a centralized access point for regulated information
• Due to concerns about cost and complexity, EEAP merged into the broader ESAP initiative, which takes a more comprehensive approach to financial transparency
• ESAP regulation (Regulation (EU) 2023/2859)