Dealing With Regulatory Arbitrage Michael Taylor

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?

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

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.”

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.”

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.

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.

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.

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.

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.

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.

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.

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.

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”