The Regulatory Aftermath of the Global Financial Crisis

The following post comes to us from Eilís Ferran, Professor of Company and Securities Law at the University of Cambridge and Niamh Moloney, Professor of Financial Markets Law at the London School of Economics and Political Science.

Some 5 ½ years out from the Autumn 2008 Lehman Brothers collapse, the massive effort by the world’s leading economies to reset the regulation of the financial system is now entering its final stages. The momentum for reform remains strong, particularly with respect to shadow banking. But the main elements of the 2008-2009 G20 regulatory agenda are now in place. In the EU, for example, recent weeks have seen agreement on the Capital Requirements Directive IV, which implements the Basel III agreement and is one of the final elements of the EU’s crisis-era reform programme. Internationally, the regulatory perimeter has extended significantly, new regulatory tools and styles have been developed, and institutional structures have been reformed and replaced. The critical implementation phase is now well underway; the new EU regime has rapidly been intensified by a host of implementing rules; the behemoth US Dodd Frank Act is being subject to similar intensification. The review process is already gathering stream; the EU’s crisis-era short selling regime and its new institutional structure for financial system supervision are both to be reviewed over 2013. It is time to take stock.

In our new book, The Regulatory Aftermath of the Global Financial Crisis we (Eilís Ferran, Niamh Moloney, Jennifer Hill, and John C. Coffee Jr.) examine the forces which have shaped the international regulatory reform process and consider the likely legacy effects of the crisis-era. The book adopts a comparative approach. It examines in detail how the EU and the US – two major world economies heavily affected by the financial crisis – responded to the crisis. But it also considers the Australian experience and probes why the Australian regulatory system and economy proved resilient over the financial crisis and the reforms which it has, nonetheless, experienced. Comparison of these three major economies and how they performed over a period of extreme stress tells us much about the complex regulatory, political and economic ecosystems of which financial markets are a part.

Notwithstanding the influence of the G20 reform agenda on domestic and regional reforms, a major theme of the book is the distinctiveness of local responses to the crisis and the complexity and diversity of the political and market forces which drive change; the EU reform process, for example, as Eilís Ferran explains, has been in part shaped by the eurozone’s sovereign debt crisis which is still producing seismic institutional change through the Banking Union project. As John C. Coffee argues, financial system regulation typically follows a ‘regulatory sine curve’, increasing in intensity after a crisis – which provides reformers with a space within which legislative inertia can be overcome – before falling back. As predicted by the extensive literature on varieties of capitalism, local factors determine the nature of different regimes’ response to crisis and the wider outcomes. Path-dependencies matter. Eilís Ferran’s examination of the factors driving the EU reform process, and of the location of significant sphere of influences, reveals that the tectonic plates which rumble underneath the EU’s longstanding internal market programme, and which periodically generate tensions between Member States supportive of a facilitative Anglo-American capitalism and those of a more market-sceptical bent, collided over the crisis, producing distinct ‘winners’ and ‘losers’ and leading to a redrawing of the boundary between Member State and EU control over the financial system in favour of the EU. In Australia, as Jennifer Hill examines, an array of factors, including in relation to economic conditions, monetary and fiscal policy, the institutional architecture for financial system regulation, and the structure of the financial services industry, notably in relation to banking and superannuation, led to Australia’s greater resilience over the crisis; nonetheless, regulatory reform followed. While, as she explains, many of the factors shaping Australia’s resilience and its regulatory response are locally-driven, her examination of the impact of Australia’s ‘twin peaks’ institutional structure contains lessons for the UK, which, as of April 1 2013, adopted a new institutional model, based in part on a Prudential Regulation Authority and a Financial Conduct Authority.

A second major theme of the book is the dynamism of crisis-driven reform, which can have positive and negative effects. As Niamh Moloney argues in the context of the EU reforms, the wider legacy effects of the reform era have been significant. The financial stability agenda has led to a subsequent re-shaping of consumer protection and securities/market regulation. This reshaping has reflected a distrust of market innovation and of market intensity which has derived from the dominant financial stability agenda. While, as she considers, it may lead to an overdue reconsideration and refreshing of regulation (particularly with respect to the tools for retail market regulation which are being re-designed internationally), the risks are significant, not least given the difficulties in quantifying and capturing optimum levels of intensity and innovation. Dynamism can also lead to hard fought reforms being stymied by interest groups. John C. Coffee illustrates how, as the regulatory sine curve drops away after a crisis, business interests can reshape legislation during the critical implementation stage and thereby erode key reforms. While, as he explains in the context of the crisis-driven Sarbanes Oxley and Dodd Frank Acts, the implementation process can have a valuable self-correcting dynamic, and lead to a refining of over-broad legislation and the removal of errors and inefficiencies, it can also lead to a frustration and downsizing of reforms, notably where the reforms conflict with industry preferences. The Dodd Frank Act, which is characterized by its skeletal structure and heavy reliance on administrative implementation, may, accordingly, risk becoming trivial over time. While this analysis has important implications for the US response to the crisis, it also contains key lessons for the EU. The radical institutional restructuring, and the breadth and depth of the EU reforms, has led to significantly greater reliance on implementing standards and to related strenuous industry efforts to shape these standards. Along with the review clauses which the major EU crisis-era measures all contain, this may lead to an unhelpful instability in the new rule-book.

The book also contains a foreword by Ethiopis Tafara (then Director of International Affairs of the SEC) which outlines his personal reflections on the challenges faced by international efforts to effect regulatory change.

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