Dealing With Regulatory Arbitrage

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Dealing With Regulatory Arbitrage

• Michael Taylor

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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?

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Objectives Of Unified Regulation

• Supervision of financial conglomerates.
• Regulatory efficiency.
• Regulatory flexibility.
• Developing a body of professional staff.
• Eliminating arbitrage opportunities.

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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.

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Whats 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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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