Regulatory Competition in Global Financial Markets

Wolf-Georg Ringe is Professor of International Commercial Law at Copenhagen Business School and at the University of Oxford. This post is based on an article authored by Professor Ringe.

The decades-long discussion on the merits of regulatory competition appears in a new light on the global financial market. There are a number of strategies that market participants use to avoid the reach of regulation, in particular by virtue of shifting trading abroad or else relocating activities or operations of financial institutions to other jurisdictions. Where this happens, such arbitrage can trigger regulatory competition between jurisdictions that may respond to the relocation of financial services (or threats to relocate) by moderating regulatory standards. Both arbitrage and regulatory competition are a reality in today’s global financial market, and the financial sector is different from their traditional fields of application: the ease of arbitrage, the fragility of banking and the risks involved are exceptional. Most importantly, regulatory arbitrage does not or only rarely occurs by actually relocating the financial institution itself abroad: rather, banking groups tend to shift trading to foreign affiliates.

In a new paper, entitled Arbitrage and Competition in Global Financial Regulation—The Case for a Special Resolution Regime, I develop a framework for the assessment of both regulatory arbitrage and regulatory competition in the context of financial regulation and assess their merits. I argue that the dynamics of regulatory competition have many advantages over alternative global approaches to financial regulation (notably, international harmonization), by offering a process for the discovery of efficient regulatory standards. However, financial regulation does not operate in the vacuum of a single economy. Relaxing regulatory standards in one jurisdiction bears the risk of imposing externalities on the worldwide financial market—by undermining financial stability as a global public good. A certain competition between financial centers competing to be “light-touch” was arguably part of the pre-crisis problem. Post-crisis policymakers worldwide are now experimenting with remedies to respond to this phenomenon in attempts to redesign a global financial regulation.

A successful regulatory strategy must thus address this latter problem while maintaining the beneficial effects and avoiding stifling harmonization. Regulators and academics have pursued or proposed a range of strategies to curb potentially negative externalities generated by regulatory competition. The natural reaction of promoting international coordination and harmonization is usually difficult to achieve and may be undesirable.

Instead, the paper introduces special resolution regimes for financial institutions into the discussion. I argue that, within limits, a credible, worldwide resolution scheme can effectively contribute to reducing the dilemma. Its main benefit would be to tackle the problem of financial stability caused by SIFIs’ excessive risk-taking. If such risk-taking were to be judged by market discipline instead of posing a risk to global financial stability, the main downside of regulatory competition could be restrained. Within the boundaries of such a system, competition could then operate and contribute to a market-led design of global financial regulation.

The full paper is available for download here.

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