Communication is key in penny regulation

SOMETIMES, the free market fails to reflect the actual value of securities traded on it by a wide margin. Investment guru Benjamin Graham used the allegory of a manic-depressive "Mr Market", divorced from reality, whose mood swings influence the prices he is willing to buy and sell at. Yale University professor Robert Shiller, one of this year's winners of the Nobel Prize in economics, warned in his 2000 book Irrational Exuberance that bubbles in real estate and the stock market can build up as people imitate one another's buying decisions. Prof Shiller said policy interventions to protect societal interests are justified in the event of a market bubble.

But when powerful regulatory forces intervene in the functioning of free markets, they can do more harm than good by introducing distortions and inefficiencies. To handle potentially delicate situations, regulators have resorted to using verbal signals and threats instead of actually taking action. Since markets operate on expectations, the mere suggestion of potential action from a credible authority can reassure markets or cool them down. Excessive market volatility resulting from traders second-guessing market authorities can thus be avoided. Hence the US Federal Reserve tries to regularly communicate its intentions on interest rates. European Central Bank president Mario Draghi calmed the European bond markets last year by saying he would do "whatever it takes" to save the euro, together with a programme of potentially unlimited bond-buying that was never actually used. With a properly executed communication strategy, regulators can cool febrile markets without using more sledgehammer-like distortionary policies.

Similar lessons in communication can be learnt from the recent penny stock fiasco, where three stocks - Blumont Group, Asiasons Capital and LionGold Corp - had a spectacular run-up in price over the past year before crashing down to earth earlier this month. The Singapore Exchange (SGX) had used all three tools available to it in querying, designating, or suspending a security. But questions remain about how it could have done these in a more timely and pertinent fashion.