Property Rights in Financial Markets

Transcription

1 Property Rights in Financial Markets Larry Harris USC Marshall School of Business Columbia Program on the Law and Economics of Financial Markets May 20, 2008

2 Introduction The identification of important issues is a key object of the Program on the Law and Economics of Capital Markets. I will provide a quick survey of property right issues in the financial markets. These issues all have substantial public policy implications. 2

3 Properties in Financial Markets Most properties contested in financial markets are intellectual properties. Network externalities free rider problems substantially complicate ownership issues for many financial products. 3

4 Common Economic Issues Our main focus today Network externalities Other common economic issues associated with intellectual property Free rider problems Incentives to innovate and copy Monopoly costs 4

5 Today s Topic Agenda Big network externality problems Ownership of futures contracts Market data Other topics Publication of fund portfolio positions Security research and ratings Innovative financial products and processes 5

6 Futures Contracts

7 Contract Monopolies Enforced by exchange clearinghouses Backed by federal laws preventing offboard trading The order flow externality provides extraordinary protection to incumbents. Contrast to the Options Clearing Corp CME-CBOT and CME-NYMEX mergers Competition from OTC derivatives 7

8 Intellectual Property Issues Contract design can be expensive but monopoly can be too. Contrast to patent law 20 years of protection, not forever 8

9 Patents Provide incentive to invest. Create incentives to share inventions to promote further inventions. Not necessary when keeping trade secrets is difficult One-size-fits-all and litigation problems 9

10 A Related Design Issue Who should own the right to write contracts on well-known indices? S&P, Dow, Russell, MSCI, Presently the index manager Should index managers be able to extract the benefits of the network externality? Did you see Titanic? 10

11 Market Data

12 Exchanges Sell Market Data The order flow externality makes the data from the largest exchanges valuable. The data facilitate crossing, internalization, and preferencing. Exchanges and traders both argue that they should own the data because they produce them. Securities and futures market differences 12

13 The Reg NMS Solution The order flow externality arises because an offer to trade is an option. Price the externality! 13

14 Position Reports

15 Mutual Funds Mutual funds must publish their full schedule of portfolio positions within 60 days of the end of each quarter. Forms N-Q and N-CSR Allows interested investors to monitor whether a fund is complying with its stated investment objective Reveals proprietary fund strategy and front-running opportunities 15

16 Other Position Reporting Regs Institutional investment advisors must report aggregate positions within 45 days of the end of each quarter (Form 13F) Actively managed ETFs must report daily In effect, giving up all proprietary research in favor of a market-based distribution system Other actively managed ETF proposals have been stalled at the SEC for at least five years. 16

17 Research

18 The Research Problem Information is easily shared, making it hard to control its distribution. People pay for a first look but not everyone can get a first look. Issuers pay if the consumers will not. Research can lower cost of capital. All sorts of related agency problems 18

19 An Additional Twist By writing regulations that depend on private credit ratings, the SEC Uses rating agency properties Creates markets for the ratings Since the SEC does not own the ratings, it has limited control over them. 19

20 Innovative Financial Products

21 Patents versus Trade Secrets Trade secrets are hard to control with a mobile labor force and little physical capital. Poorly issued patents lead to extortion. Without patents, the regulatory approval process allows slow competitors to catch up to innovators. Examples: Index participations, ETFs, 21

22 Conclusion

23 Property Rights Are Difficult Many disparate governors Patent law Superseding agency jurisdictions Network externalities and free rider problems Many disparate and conflicting interests Among private rent-seekers Among public policy values 23

24 Some Proposed Principles Results should not depend on network externalities and free rider problems. Externalities should be priced, if possible. Regulators should not undercut incentives to innovate A balance between the benefits of innovation and the costs of market power should govern market structure 24

25 Free and Competitive We seek free and competitive markets. Too often people associate the former with the latter. Externalities and free rider problems often make free markets uncompetitive. Free marketers often ignore these problems. Simple is not necessarily good. Benefits and dangers of regulation 25