Dealing With Regulatory Arbitrage

1. Dealing With Regulatory Arbitrage Michael Taylor

2. Outline of Presentation • What is regulatory arbitrage and what is wrong with it? • Two regulatory principles. • Techniques for dealing with arbitrage. • Is unified supervision the answer?

3. Objectives Of Unified Regulation • Supervision of financial conglomerates. • Regulatory efficiency. • Regulatory flexibility. • Developing a body of professional staff. • Eliminating arbitrage opportunities.

4. Regulatory Arbitrage • Definition: “The booking of a particular financial service or product in an entity with the intention of reducing regulatory costs and/or oversight.”

5. What’s Wrong With Regulatory Arbitrage? • Financial conglomerates able to “game” the system and avoid proper oversight. • Example: Capital serving “double duty”, used to support risks in more than one entity. • Example: Large exposures “hidden” in other group entities. • Regulators encouraged to compete – may allow regulation to be weakened in a search for “clients.”

6. Not All Regulatory Arbitrage Is Bad • Competition between regulators may be healthy and reduce tendency to over-regulation. • Complete neutrality should not be the aim of regulation. Regulatory objectives are diverse. • E.g. some firms require more intensive monitoring because the costs of their failure would be much greater than others.

7. Two Regulatory Principles • Prudential regulation should differ between types of firm to the extent that they engage in different activities and incur different risks. • Consumer regulation should ensure an equivalent level of consumer protection irrespective of the entity which offers the product.

8. Prudential Regulation • Reducing the scope for regulatory arbitrage requires proper consolidated supervision. • All firms in a conglomerate group should have same reporting date and be audited by single firm of accountants. • Need for a “lead” regulator to co-ordinate and produce group-wide risk assessment.

9. Consumer Regulation • Basic principle: same product = same disclosure standards irrespective of product provider. • “Product Regulation” • A collective savings scheme should have same disclosure requirements whether offered by bank or insurance company. • Securities regulator regulates the sales practices of all collective investment schemes irrespective of which firm offers them.

10. Structure of Regulation • Prudential regulation must be based on institutions. • Arbitrage opportunities are reduced by proper consolidated supervision. • Consumer regulation may be based either by product or by institution. • Product regulation reduces arbitrage opportunities.

11. Structure of Regulation • If prudential regulation is institutionally-based and consumer regulation is product-based some firms will have more than one regulator. • This requires close coordination and cooperation between regulators. • Could lead to firms complaining about their regulatory burden.

12. Unified Supervision • Putting all regulation inside a single organization is a way of dealing with coordination problems. • Can provide firm with single point of contact. • But within the unified regulator the distinctions between institutional v product and prudential v consumer regulation will remain.

13. Single Authorisation Regime • An important objective of FSAMA was to create a single authorisation regime for financial services. • In theory a single firm would be able to move seamlessly from providing one type of financial service to another – markets made more contestable. • In practice more difficult to deliver.

14. Australian Comparison • Financial Services Reform Act 2001 • Aims to achieve some similar objectives to FSAMA to the extent that it: • Establishes a new harmonised regime for the regulation of the provision of financial services in respect of a wide range of financial products • Creates the “Australian Financial Services Licence”