Financial Regulation in a World of Financial

Transcript:Financial Regulation in a World of Financial:
Financial Regulation in a World of Financial Engineering? Shyam Sunder, Yale University Cheng Tsang Man Chair Visiting Professor School of Accountancy Singapore Management University Singapore, January 18, 2013 1/18/2013 1 Sunder: Financial Regulation & Engineering An Overview Great efforts made to write effective regulatory standards—accounting as well as prudential—for financial services industry. Events of the recent decade show that these efforts have largely failed to achieve their stated objectives, both globally as well as in major economies of the world. Why? 1/18/2013 2 Sunder: Financial Regulation & Engineering Overview (Contd.) A root cause of these regulatory weaknesses and failures lies in inability of regulation to deal with the challenge presented by financial engineering. Regulators, constrained by governments, business and profession, take years to write the rules and standards. Their labor of love—carefully drafted regulations—is soon rendered ineffective when financial engineers and lawyers design of new instruments, transactions and organizations to bypass the regulations. No amount of wisdom and hard work by regulators, whether located in Basle, Norwalk, or London, has or can overcome this disadvantage. 1/18/2013 3 Sunder: Financial Regulation & Engineering Overview (Contd.) Modern mathematical finance and financial engineering can bypass just about all written regulations without difficulty. Written regulations, as an instrument of regulating financial services industry, do not work. What are the alternatives, and their pros and cons? No easy solutions. 1/18/2013 4 Sunder: Financial Regulation & Engineering Some Maintained Premises of Regulation 1/18/2013 5 Sunder: Financial Regulation & Engineering 1. General Standards General standards of financial reporting and regulation applied across time, economies, industries and corporate size and organizational forms best serve the society (e.g., Basel, IFRS, FAS). Standardization does save costs and effort, (electrical plugs, clothing, cars, street grids, commercial codes) Becomes counterproductive beyond certain limits when environments to which they are applied are diverse How do we know the limit of standardization? Rhetoric of universal accounting standards and universal language (Esperanto?) 1/18/2013 6 Sunder: Financial Regulation & Engineering 2. Written Standards It is fair and efficient to write down the regulatory standards for everyone to know and comply with (e.g., the Code of Hamurabi). Written standards promote our sense of fair play in a democratic society to avoid arbitrariness and partiality But all contingencies cannot be anticipated and written down. Written standards constrain discretion in enforcement They also serve as “road maps for evasion” and gaming to take advantage of the rules 1/18/2013 7