Presentation University of Twente - IEM - Financial Semester 2016 - Martijn Van Andel

Supervision on financial
markets and services

University of Twente September 8th, 2016
Martijn van Andel MSc,
Technical project lead, programme Data Driven Supervision,
The Netherlands Authority for the Financial Markets (AFM)
Introduction
WHO AM I?
Page 2
Thursday, September 8,
2016
| University of Twente
A short history
2013
AFM, Risk analysis and program Data driven Supervision
2011
Hot ITem, Business Intelligence and data warehousing
2009
Tibbe Company (now part of KPMG Plexus), Health care process optimization
2007
University of Twente, Industrial Engineering and Management, Logistics track (master)
Page 3
2016
Lets start with a question
WHAT IS A SUPERVISOR?
VOTE
Page 4
2016
Agenda
PART I
Supervision and a free market
Financial supervision in The Netherlands
How is supervision organised within the
AFM?
PART II
Capital markets
Financial reporting
Page 5
2016
A paradox?
SUPERVISION AND
A FREE MARKET
Page 6
2016
Are financial markets

perfect?
From the perspective of classical economists: market
equilibrium maximizes welfare
From the perspective of neoclassical economists: all
market players are rational and maximize their
utility, based on perfect information
If this is true
how is it that markets produce too much of some
(pollution) and too little of other (innovation)?
why do people bring their savings to an Icelandic bank
that is about to go bankrupt?
why do people buy financial products that promise an
unrealistically high return?
Page 7
2016
All market players are

rational?
Youtube:
Last Week Tonight with John Oliver: Preda
tory Lending (HBO)
: Payday loans
(August 10th, 2014)
Page 8
2016
History of crises: Boom bust

boom
More info: www.boombustclick.com
http://www.2doc.nl/documentaires/series/npo-doc-exclusief/
2015/boom-bust-boom.html
Developed by:
Cardano Investment Management
Page 9
2016
A brief history of financial

crises
The slumps that shaped modern finance
(The Economist)
Page 10
2016
Market imperfections and

failures (1)
Information asymmetry
Moral hazard
Adverse selection
Externalities
Bounded rationality of the consumer
(Market power)
(Public goods)
Page 11
2016
Moral hazard
Page 12
2016
Market imperfections and

failures (2)
Inadequate information on the part of consumers

Problems of asymmetric information
Agency costs
Potential principal-agent problems
Problems of determining quality at the point of
purchase
Imprecise definitions of products and contracts
Inability of retail consumers to assess the safety
and soundness of financial firms
Free-rider problem
Technicality of some financial products
Page 13
2016
Pathology of businesses as a
legal person
https://www.youtube.com/watch?v=s5hEi
ANG4Uk
(The Corporation, 2003)

Page 14
2016
Financial products are

different...
Complex
Intangible
Large impact
Low purchase frequency
Long incubation period
Large externalities
Page 15
2016
Quality is
difficult to
observe,
reputation and
learning effects
do not work
properly
Bounded rationality
House money effect

Snakebite
Trying to break even
Endowment effect
Status quo effect
Disposition effect
Herding
Sunshine effect
Page 16
2016
Regulatory approach of the Netherlands
HOW IS FINANCIAL
SUPERVISION ORGANIZED
IN THE NETHERLANDS?
Page 17
2016
Short history
Pre AFM
1989 Securities Board of The Netherlands
(STE)
1995 Supervision on insider trading and
investment firms
2000 Administrative fine and penalties
2001 Public offerings
Page 18
2016
Short history
Market developments prompted the
overhaul of our supervisory framework
in 2002
Banks and insurance companies have been
merging into financial conglomerates
Introduction of innovative financial products
combining banking, insurance and
investment characteristics
Focusing on the objectives of

supervision
Page 19
2016
Mission statement
The AFM is committed to promoting fair and
transparent financial markets.
1. The AFM promotes the fair and conscientious
provision of financial services
2. The AFM promotes the fair and efficient
operation of the capital markets
3. The AFM contributes to the stability of the
financial system
Twin Peaks
Banks
Insurance
Pension funds
Investment Securities Financial
companies
DNB
AFM
Page 21
firms
brokers
Prudential supervision;
Solidity of financial
enterprises and financial
stability (systemic stability)
Conduct of business supervision;

Behaviour and transparency of all market participants
2016
Evolution of the AFM

600
100
69.7
400
57.4
200
214
271
328
383
456 473 483

435
435
420
526
40
Budget (mln)
20
FTE (left axis)

AFM establised
80
60
38.3 38.4
FTEs
73.1
81
77.5 78.2 77.6 78 80.2
Budget (right axis)

Financial supervision
act (Wft)
Mifid
Supervision on
product
development
Ban on
inducements
Large number of financial institutions under

supervision covers a broad spectrum (2012)
Type of institution
Number
Banks
210
Insurance companies
570
Investment firms
260
Investment funds
120
Pensionfunds
550
(Insurance) intermediaries
TOTAL
9,000
11,000
The AFM approach
HOW IS SUPERVISION
ORGANISED WITHIN THE
AFM?
Page 24
Thursday, September 8, 2016
Supervisory remit of the AFM (1)

Financial Services
Page 25
Capital Markets
Initiated by the AFM

Prospectuses
(Dutch: essentile
beleggingsinformatie)
Financial information leaflet for complex

financial products (Dutch: financile
bijsluiter)
Services documents
(Dutch:
dienstverleningsdocument)
Financial communication and warnings

(i.e. geld lenen kost geld, borrowing money
costs money)
Ban on inducements
Page 26
(Dutch: provisieverbod)
Agenda 2016
Capacity is limited:
Pick the most important problems and fix
them.
1. Product providers put the customers interests
2. The quality of financial service provision has improved
3. The quality of capital accumulation has improved
4. Financial services provided to professional and semi-professional
parties is appropriate
5. Pension providers provide an overview of and insight into the
amount of pension, and the risks to pension
6. The quality of governance, reporting and audits will improve
7. The securities markets operate fairly and efficiently, and the
infrastructure remains robust
8. Conduct supervision contributes to the stability of the financial
system
9. Harmful behaviour and financial crime diminish
10.Supervision of the BES Islands
Page 27
Three views on supervision (1)

Economic view:
The AFM is there to reduce market imperfections
and strives to strengthen the confidence of
consumers and businesses in financial markets
Legal view:
The AFM upholds the law
Psychological view:
The AFM is there to positively influence behaviour
of (persons in) financial institutions
Page 28
Three views on supervision (2)
Good supervision combines the three views:

The economic view gives the basis for financial supervision, the legal view
gives the tools and determines the boundaries of supervision, and the
psychological view gives direction to the implementation of good supervision.
Page 29
Illegal versus harmful
Illegal
behaviour
Page 30
Harmful
behaviour
Effective supervision?
Page 31
Effective influence of behaviour

e ce
rc
fo lian
En mp
co
Re
vok
e
or
sus
pe
nd
the
Fine / penalty
lice
nse
Warning, threaten to
sanction
Persuade, instruct and advice
Page 32
e
ot ss
o m ne
Pr lling
wi
Cooperation and to respond to informal

social control and prevailing standards
Promoting willingness
Page 33
Vote
Page 34
Three hunting questions

Why was the
AFM not
present?
Why didnt the

AFM identify the
problem?
Why didnt the

AFM act?
Page 35
The hunting questions in practice
Page 36
Interest rate derivatives

AFM pointed out conclusions were
drawn too fast
External investigation
Page 37
In depth Part 1
CAPITAL MARKETS
Page 38
Capital markets
The securities markets operate fairly and
efficiently, and the infrastructure remains
robust
Monitoring the markets

Providing transparency
Page 39
Monitoring: Live monitoring

Live monitoring of the Dutch trading
platforms
Spot unexplainable price movements
Positions of insiders
To prevent:
Market manipulation
Insider trading / Foreknowledge
Page 40
If spotted: investigate
Possible market manipulation
In communication
Stop trading?
In techniques
i.e. Algotrading
Page 41
Monitoring: Boiler rooms

https://www.youtube.com/watch?v=TbIR
edOqDwE
Page 42
Securities market: Transparency

Prospectus
(Dutch: Essentile
beleggingsinformatie)
Takeovers and (Initial) Public Offerings

Price sensitive information (Dutch:
Koersgevoelige informatie, KGI)
Disclosures:
Page 43
Short selling
Insider transactions
Issued capital
Price sensitive press releases
Substancial holdings and gross short
In depth Part 2
FINANCIAL REPORTING
Page 44
Financial reporting
Financial reporting
Big cases in the 21st century
Page 46
Financial reporting (2)

Increased need for reliable and
comparable reporting:
Legislation and supervision
Standardisation: IFRS (International
Financial Reporting Standards)
Responsible and credible audit firms
(Dutch: accountants)
Page 47
Standardisation: IFRS
Financial statements present
fairly:
Financial position
Financial performance
Cash flows
The true and fair view requires the

faithful representation of:
Transactions
Other
Page 48
Events
Conditions
IFRS: Material significance

Definition (IAS 1.7)
The omission or misstatement of items is
material if:
Individually or collectively
This could affect the economic decisions of
users that they make on the basis of the
financial statements
Two dimensions of the misstatement are

relevant
Size of the error
Nature
Misstatements that are not material are:

Page 49
September 8, 2016
Not separately Thursday,
presenting
immaterial
items
Re-active vs. Pro-active

A bit more on the programme Data
Driven Supervision
Page 50
Next
COMPANY VISIT
Page 51
Friday, October 14
Visit to AFM
Tour in the Amsterdam Exchange

(Beursplein 5)
Page 52
Questions?
Page 53

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Supervision on financial

markets and services

AFM, Risk analysis and program Data driven Supervision

Hot ITem, Business Intelligence and data warehousing

University of Twente, Industrial Engineering and Management, Logistics track (master)

Lets start with a question

Are financial markets

All market players are

History of crises: Boom bust

A brief history of financial

Market imperfections and

Market imperfections and

Inadequate information on the part of consumers

(The Corporation, 2003)

Financial products are

House money effect

Regulatory approach of the Netherlands

Focusing on the objectives of

Conduct of business supervision;

Evolution of the AFM

456 473 483

FTE (left axis)

Budget (right axis)

Large number of financial institutions under

The AFM approach

Thursday, September 8, 2016

Supervisory remit of the AFM (1)

Thursday, September 8, 2016

Initiated by the AFM

Financial information leaflet for complex

Financial communication and warnings

Thursday, September 8, 2016

Three views on supervision (1)

Thursday, September 8, 2016

Three views on supervision (2)

Good supervision combines the three views:

Thursday, September 8, 2016

Illegal versus harmful

Thursday, September 8, 2016

Thursday, September 8, 2016

Effective influence of behaviour

Persuade, instruct and advice

Thursday, September 8, 2016

Cooperation and to respond to informal

Thursday, September 8, 2016

Thursday, September 8, 2016

Three hunting questions

Why didnt the

Why didnt the

Thursday, September 8, 2016

The hunting questions in practice

Thursday, September 8, 2016

Interest rate derivatives

Thursday, September 8, 2016

Thursday, September 8, 2016

Monitoring the markets

Thursday, September 8, 2016

Monitoring: Live monitoring

Thursday, September 8, 2016

Thursday, September 8, 2016

Monitoring: Boiler rooms

Thursday, September 8, 2016

Securities market: Transparency