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What is a regulated market?

Continue reading about regulatory market

Are you looking for a regulated market definition? A regulated market, also known as a controlled market, is one in which the government or another public authority exercises some degree of oversight. This supervision can be very detailed, including the effective management of the market by public officials, or at relatively arm’s length, with the authorities establishing a basic set of rules and little more. In some cases, public relation may rely largely on taxes and other charges to ensure compliance. Regulated markets are found in, among other activities, financial services, the utilities and transport.

Where have you heard about regulated markets?

As an investor, you will be aware of the regulated nature of financial markets, with the 2008 crisis having prompted increased supervision in such areas as market abuse regulation. Also, your portfolio may contain shares in regulated businesses such as water, gas and electricity companies. Their dealings, and occasional disagreements with, their respective regulators can move share prices, so you will keep abreast of such developments. Their annual reports will give details of their relationship with their regulators.

What you need to know about regulated markets…

Governments or legislators may choose to establish a controlled market for a number of reasons. One is that the activity being regulated is so important that market participants cannot simply be left to their own devices. This is obviously the case in banking and financial services. Even if wrong doing was unknown in the financial industry, the consequences of error or misjudgement, in terms of triggering a financial panic or crash or other system-wide disaster, are too great for the authorities to stand back.

A watchful eye on the banks

For that reason, banks and other institutions face detailed prescriptions as to the level of capital that they are required to hold and the manner in which they conduct themselves in dealings with their customers.

Also in the financial services field is a quite different justification for regulation, which is that the market participants enjoy access to much greater and more accurate information than do their customers. So, regulation is needed both to redress this balance and to ensure that this ‘information asymmetry’, as it is known, is not abused to mis-sell investments to the public or otherwise take advantage of ordinary investors.

A final justification for detailed regulation of the market participants in financial services forms a distinct branch of market abuse regulation, and relates to the potential for the financial system to be mis-used for purposes such as money laundering and financing crime and terrorism. This type of regulation has expanded greatly in recent years as globalisation and technology have made much easier the very rapid movement of money and other assets round the world.

Regulation on tap for the utilities

In the wake of the financial crisis, retail banks – as opposed to their more exotic investment-banking brethren – were frequently described as ‘utility banks’, the point being that they were as much a part of the infrastructure of everyday life as those companies whose pipes and wires are connected to our homes, and should be similarly regulated.

Gas, water, electricity, postal, cable and telephone services each constitutes a controlled market, with a number of justifications for the detailed public oversight of utilities.

One is that the service concerned either constitutes a natural monopoly, or that, in the absence of regulation, a monopoly would be likely to appear. A controlled marketis therefore essential to prevent real or actual misuse of monopoly power to extract higher prices while delivering poor services.

Thus regulators frequently lay down both price controls and minimum service standards. This can be seen as a type of market abuse regulation.

However, the definition of what constitutes a natural monopoly changes over time, in line with technical and other developments.

For example, telephone services had been assumed for years to be natural monopolies, there being little point or prospect of a second operator digging up the roads and laying its own wires to houses and businesses.

It is still true that the physical link to the system is usually owned by just one company, but regulatory change in many countries allows rival operators access to this network, providing the sort of price competition that was impossible in the past.

Furthermore, control over fixed-line telephony is far less valuable today, in the age of mobile phones, than it was when, for example, America’s AT&T group was ordered by regulators in 1982 to surrender its monopoly.

Other reasons for regulating markets

Not all markets come under regulatory oversight to prevent financial panics, mis-selling and abuse of a dominant market position. There are a number of other reasons why an industry and the market in which it operates may come under public control.

One is environmental. There may be no monopoly in running power stations or nuclear reactors, but few would advocate a free-for-all in this area.

Another relates to labour standards and wages. Some countries apply a minimum wage across the board, others have rates set for specific industries in which employees are thought especially vulnerable to exploitation – agricultural work being one example.

Professional services markets – such as those for legal and accountancy services – are regulated not because of fears of legal and accounting monopolies but because of the vital need for high standards in these areas. In a sense, professional regulation is prompted by the same concerns about system integrity and ‘information asymmetry’ that play a large part in the case for regulating banking and other financial markets.

Changing perspectives in regulated markets

Finally, we should remember that attitudes towards market regulation change over time, and not simply as a result of technological change. For example, in the US, for many decades, inter-state road haulage and rail services were strictly controlled, as were airlines and inter-state bus services.

Most of these restrictions were swept away in the Seventies and Eighties. At about the same time in Britain, regulation of long-distance coach travel and the supply of telephone answering machines was greatly reduced, and the Government got out of the business of road haulage, in which it had been a sizeable operator.

By contrast, previously-unregulated markets in a number of countries, including the UK, were progressively subjected to increasing controls, not least the provision of financial advice and the marketing and sale of real estate, where the traditional principle of ‘let the buyer beware’ was replaced by a compliance culture.

Also, markets that had traditionally regulated themselves – such as stock exchanges or over-the-counter financial markets – increasingly found themselves brought within the scope of formal regulation, especially after the financial crisis.

Find out more about regulated markets…

There is plenty in our glossary about many of the terms in this article, including market abuse, monopoly and globalisation.

The trading and markets division of the US regulator, the Securities and Exchange Commission, provides details about its functions here.

Britain’s regulator, the Financial Conduct Authority, maintains a list of regulated financial markets here.

The European Commission writes about its efforts to ensure the integrity of securities markets here.

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