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Abstract:
The global credit crisis has led to systemic instability, the accrual of massive losses in major US and European banks, and created significant public costs. It has also shown that the current model of national and international banking regulation is inadequate. This paper attempts to answer questions relating to the future shape of national and international financial regulation in light of lessons drawn from this crisis. While most policy proposals for the overhaul of the US, UK, and international financial regulation predominantly deal with issues relating to the containment of a systemic crisis, the paper offers more radical solutions, which deal with the prevention of such a crisis. In this mode, it suggests a pluralistic regime for the licensing and supervision of banking institutions at a domestic level and the establishment of a global multi-tiered licensing and supervisory scheme for transnational investment funds with systemic importance. The supervision of investment funds' compliance with the suggested prudential regime should be assigned to an independent global regulatory authority, which would utilize the market research and surveillance infrastructure of the IMF. The findings of behavioural finance provide solid support for the suggested reforms.

Global Credit Crisis, Behavioural Finance, Banks, Banking Regulation, Bear Sterns, Northern Rock, Hedge Funds, International Financial Regulation, Securitisations, CDOs, Systemic Risk

Abstract:
The EC Directive on Financial Instruments Markets (MiFID) has introduced a number of order and trade publication obligations imposed on organized exchanges, Alternative Trading Systems (ATS), and the class of broker dealers that execute transactions in shares internally. This article investigates the impact of MiFID's trade transparency rules on the trading volume of EU equity markets in a forward-looking mode. The article aims to contribute to the debate among EU policy-makers as to the proper reach of the Directive's transparency rules. Since MiFID has not yet been implemented, a study of its actual impact on the trading volume of EU equity markets is not possible, thus, we must use data extracted from the closest possible precedent. Accordingly, the article uses data describing levels of trading volume before and after the introduction of a central order book in the London Stock Exchange (LSE) on 20 October 1997, when trading in FTSE100 stocks shifted from the quote-driven Stock Exchange Automatic Quotation System (SEAQ) to the order-driven Securities Electronic Trading Service (SETS). This change resulted in significantly increased transparency standards. Trading volume is measured in this article on the basis of three criteria: volume-based turnover, value-based turnover and turnover ratio. No conclusive evidence is found indicating that the introduction of a central order book and attendant higher transparency standards lead per se to higher levels of trading volume, used as one of the indicators of a liquid market. Therefore, the impact of MiFID's transparency rules on trading volume and overall levels of liquidity in EU equity markets should become a matter of further study for EU policy-makers and regulators.

Trading Volume, London Stock Exchange, MiFID, MTFs, Pre-Trade Transparency, Post-Trade Transparency, Regulated Markets, SEAQ, SETS, Structural Time Series Analysis, Systematic Internalisers.

Abstract:
Inadequate disclosure has been at the heart of most policy analysis of the global financial crisis. According to the inadequate disclosure critique, investors had insufficient information regarding the risks involved in structured securities, the flaws of credit ratings, and the impact of excessive executive compensation, all among the main causes of the recent financial market collapse. However, the global financial crisis has also exposed the many limits of disclosure as an effective regulatory tool in the context of financial markets. For instance, many of the risks that led to the creation of the 2008 catastrophe were often fully disclosed but the markets failed to understand what was disclosed and appreciate the implications. The reasons for this failure were product complexity and the impact of socio-psychological factors such as bounded rationality, strategic trade behaviour (herding), and cognitive biases. These findings pose a great challenge to the prevailing rational choice view of disclosure as a regulatory remedy of most market failures. At the same time, the issue of transparent financial markets dominates the global regulatory reform agenda. Accordingly, there is a clear need to devise strategies that make disclosure work under actual (not hypothetical) market conditions and redress the adverse impact of socio-psychological factors. The chapter argues that in specific contexts, such as the field of prudential regulation of banks, disclosure will only work if it is supplemented by protective regulation, e.g., business activity barriers and position limits. It also argues that only through the use of experiments, as a complement to empirical studies, policy-makers and regulators will be able to measure the actual contribution of disclosure to investor protection and devise effective disclosure strategies.

Global Financial Crisis, Subprime lending, Credit Ratings, Disclosure, Financial Regulation, Banking Regulation, Behavioural Decision Theory, Irrational Exuberance, Bounded Rationality, Strategic Trade Behaviour, Basel Capital Adequacy Accord, Experimental Law and Economics

Abstract:
Global financial markets are subject to a complex web of soft law rules and standards called International Financial Regulation. The main rationales/objectives of International Financial Regulation revolve around the protection of investors and depositors and the safeguarding of financial system stability. In recent months International Financial Regulation has come under attack for its lack of proper structures and flawed rules, which have been held to be among the main causes of the global financial crisis. In the aftermath of the Washington Financial Summit of November 2008, significant reforms are under way. In this context, this article argues that International Financial Regulation must undergo a major transformation in terms of means and objectives. The policy objectives of International Financial Regulation must be widened to reflect the impact of financial sector development and access to finance on economic growth and poverty eradication. As part of the transformation of its means (institutional structures and rules) the article proposes the establishment of a global licensing scheme for international investment funds, whereby licensed funds would be obliged to pay a global development tax/fee. It also proposes, as part of the wider effort to reform Basel Capital Adequacy Standards, in the aftermath of the global financial crisis, the introduction of a new asset class for private development finance credits. Implementation of these proposals would enable International Financial Regulation to both strengthen the global financial stability framework and facilitate access to finance in poor and very poor countries fostering economic development and creating a more stable world.

Access to Finance, International Financial Regulation, Basel Capital Adequacy, G20 Summit, Monterey Consensus

Abstract:
Global financial markets are subject to a complex web of soft law rules and standards called International Financial Regulation. The main rationales/objectives of International Financial Regulation revolve around the protection of investors and depositors and the safeguarding of financial system stability. In recent months International Financial Regulation has come under attack for its lack of proper structures and flawed rules, which have been held to be among the main causes of the global credit crisis. As a result, a major reform exercise is under way. This paper argues that, as part of this reform, policy makers and regulators must attempt to widen the objectives of International Financial Regulation so that they become cognizant of the impact of financial sector development and access to finance on economic growth and poverty eradication. In this context, the paper proposes a global licensing scheme for international investment funds and the reform of the Basle Capital Adequacy Standards. Implementation of the proposals would enable International Financial Regulation to both strengthen the global financial stability framework and facilitate access to finance in poor and very poor countries.

International Financial regulation, Systemic Stability, Development, Global Financial Markets, Financial System Stability, Global Credit Crisis, Global Licensing, International Investment Funds, Basle Capital Adequacy Standards

Abstract:
The implementation of the European Union's Action Plan for Financial Services (FSAP) is largely complete, though the transposition of relevant legislation into the Member States' legal orders is still pending. The new legislation has significantly revamped the EU's legal and regulatory framework governing financial markets. The Lamfalussy process has been successfully utilized in debating and enacting the most important pieces of the new EC securities legislation. This article provides a critical analysis of the securities Directives passed under FSAP and critically evaluates their impact on EU capital markets and the EU financial services industry. Furthermore, this article sheds light on the evolution of EC financial market regulation and on the most important and intricate points of the new legislation. It explains the reasons that make the new legislation an agent of profound change for EU financial markets in terms of structure, business planning and trading processes. Finally, the article debates the cost of compliance with and enforcement of the new framework and the supervisory and enforcement loopholes created due to the absence of a single regulator for EU financial markets.

EU Securities Regulation, Lamfalussy Process, FSAP, Market Abuse Directive, MiFID, Prospectus Directive, Transparency Directive, Regulated Markets, MTFs, Regulation of Broker-Dealers, Public Offers of Securities

Abstract:
Based on the findings of cognitive psychology and experimental economics, Behavioural Decision Theory (BDT) has mounted a powerful challenge on the Standard Social Sciences Model of hyper-rationality. In this mode, the notion of fully informed investors making rational choices in order to maximize gains, one of the main theoretical foundations of modern investor protection regulation, has been heavily challenged. Although BDT's findings are not as inconsistent with rational choice theory as initially suggested, this does not mean that public policy-makers and financial market regulators should ignore the least controversial of the findings of BDT. This article provides a number of suggestions for the gradual incorporation of certain of BDT's insights, such as those explaining investors' bounded rationality and the impact of specific cognitive biases, in four areas of investor protection regulation: investment advice, investment promotions, mandatory disclosure, and asset management. Suggested measures include further fragmentation of investor classes for the purposes of protective regulation, pluralism in the prescribed volume of information disclosed to various investor classes, regulatory prescriptions of the structure ('framing') of investment promotions, and the mandatory use of long-term performance targets for fund managers. Although such measures would amount to soft paternalism, they are justified by the distracting effect of certain cognitive biases on investor and market welfare. Furthermore, the use of economic experiments, can facilitate the identification of optimal disclosure formats and assist in the ex ante evaluation of new regulatory measures.

Behavioral Decision theory (BDT), Investor protection regulation, FSA, conduct of business rules, mandatory disclosure, cognitive biases, psychology of choice and judgment, framing effect, behavioural finance, stock market bubbles, experimental economics.

Abstract:
A large body of empirical and experimental literature provides convincing evidence of the complexity of individual and institutional investor behavior in market environments. This complexity raises serious questions regarding the effectiveness of current systems of investor protection regulation, which are largely based on the rational investor model. This chapter considers the whole spectrum of cognitive biases that affect investor decision-making and the impact of investor behavior on market welfare. It also highlights the failure of current systems of investor protection regulation to devise techniques capable to counter the distorting impact of cognitive biases. In order to enhance the credibility of the behavioral critique, the chapter proposes a realistic and workable framework for reform, which, if implemented, would lead to effective debasing.

Behavioral Law and Economics, Financial Markets, Behavioral Finance, Investor Protection Regulation

Abstract:
In September 2008, in the middle of precipitous market price falls and of an impending financial catastrophe most developed market regulators declared a nearly worldwide ban on short sales in financial sector stocks. The ban was in accord with a widespread belief that has long regarded short selling as aggressive speculation that destabilizes financial markets and raises concerns about their economic and moral foundations. However, many empirical studies indicate that short sales are, in fact, a beneficial source of market liquidity and information efficiency. This view is confirmed by studies on the September 2008 ban in the US and the UK, which show that the ban did not yield any concrete welfare benefits, especially in terms of reduction of price volatility. On the contrary, it had an adverse impact on liquidity. The market abuse rationale, offered as the main justification for the September 2008 ban, is also unconvincing. Furthermore, US and European regulatory orders to ban short-sales revealed how disparate are the regimes governing cross-border securities trading in international securities markets including the EU markets. This paper argues that the best way to regulate short sales is through a dual strategy of disclosure and downward price limits, so-called circuit breakers, which lead to a temporary halt in trading rather than a prohibition or an uptick rule. The combination of disclosure and circuit breaker trading halts preserves liquidity enhancing short sales and the valuable information that these trades carry, while it checks downward price pressures, due to market irrationality and herding. Arguably, the FSA's and the SEC's recent proposals to amend their rules on short selling are in the right direction, yet they remain incomplete. In the same mode, IOSCO's draft principles, which are supposed to eliminate inconsistent national regulatory regimes that impede cross-border trading, are so high level that they cannot close the gaps. Therefore, the endorsement of the two prong regulatory strategy proposed in the paper could provide the foundations of a global framework for the regulation of short sales, since its implementation would lead to rather compatible national regulatory regimes.

short selling, 'naked' short sales, regulation of short sales, circuit breaker, uptick rule, SEC, FSA, CESR, IOSCO, Ban of short Sales, Market Abuse, herding, EMH, arbitrage, adaptive markets

Abstract:
International banking regulation comprises, inter alia, transnational quasi-legal standards concerning the capital adequacy of internationally active banks, though their usage is normally much wider. These standards originate from the Basle Committee on banking supervision. The main rationale for their emergence has been the fashioning of national and transnational regulatory systems that are adept at preventing systemic crises and protect bank depositors from bank failures. This chapter suggests that, in addition to systemic stability and depositor protection, international capital adequacy standards may be utilized to facilitate access to finance. The degree of access to finance is a major criterion of financial sector development (FSD). FSD is generally viewed as an essential ingredient of sustained economic growth and thus a very effective means to foster development and fight poverty in developing countries. The first step in utilizing International capital adequacy standards to facilitate access to finance is through the assignment of lower capital requirements to private development finance loans under the Basle framework, in order to reflect their very low default rate. Relevant lending should be facilitated through the intermediation of centralized country schemes or specialized corporate vehicles that on-lend funds to the end lenders, regardless of whether these are mainstream financial institutions or microfinance Institutions. The suggested amendment of the Basle framework would give international banking institutions a clear incentive to be involved in the private development finance business and lend funds at lower interest rates.

Post-Washington Consensus, Capital Adequacy Standards, Banking Regulation, Private Development Finance, Microfinance, Access to Finance

Abstract:
The global financial crisis brought the world banking system to the brink of collapse. The continuing operation of financial markets became possible only after the extensive and costly public rescues of some very big banks. It also brought into sharp focus the inadequacies of the contemporary model of financial regulation both at the national and the global level. This article argues that some of the measures endorsed in the G20 Financial Summit for the revamping of national and global financial regulation, such as increased disclosure and a stronger capital base, and others targeting the enhancement of market discipline will prove less effective than anticipated. The reason for that is that they largely ignore the behavioural elements of the crisis. Instead, what is required is a radical rethinking of the contemporary model of national and international financial regulation. This article suggests a set of far-reaching reforms for the overhaul of the regulatory framework governing the licensing and supervision of banking institutions. It also proposes the establishment of a global licensing and supervisory regime for transnational investment funds with systemic importance, eliminating most shadow banking operators. The catastrophic consequences of the crisis and the findings of behavioural finance provide solid support for these proposals.

Global Financial Crisis, Credit Crunch, Shadow Banking, Behavioural Finance, Banks, Banking Regulation, Hedge Funds, Credit Default Swaps, Global Financial Regulation, Securitisations, CDOs, Systemic Risk

Abstract:
EC securities regulation has been one of the cornerstones of all policy initiatives aiming at the integration of EU financial markets. Yet the development of this body of EC law has been a very lengthy process frequently marred by controversy. Arguably, a marked lack of direction has been its most distinctive characteristic for almost two decades. This was caused by three factors. The first factor was the existence of conflicting national agendas motivated by a desire to protect and preserve domestic investment firms, national securities markets, and local business customs. The second factor was the unwillingness of the global financial services industry to engage in a constructive dialogue and find a common language with EU legislators. The third factor was the inability of EU officials and legislators to fully understand the intricacies of modern financial markets and in particular their global nature and the fast pace of innovation within them. This resulted in the production of legislation that often reflected the reserve, awe, and prejudice with which EC bodies used to view the workings of global finance. A good number of these dysfunctions have been addressed by the European Union's Action Plan for Financial Services (FSAP) and the introduction of the Lamfalussy process. EC legislation passed in the context of FSAP, departs radically from the principle of minimum harmonization and creates self-standing Pan-European regulatory regimes in a number of areas, most notably in the areas of market abuse, investment firm-retail customer relations, operation of licensed financial exchanges and of Alternative Trading Systems (ATS). Furthermore, FSAP legislation upgrades the EC legal framework that governs the regulation and supervision of investment firms and the public offer of securities and their admission to trading on securities exchanges. This article provides a critical overview of FSAP Securities Regulation Directives and highlights the challenges their implementation has created.

Abstract:
The global financial crisis has exposed the many limits of disclosure as an effective regulatory tool in financial markets. First, the famed disciplining power of the market failed to constrain disastrous risk taking by banks. Second, most of the risks that led to the creation of the 2008 catastrophe were often fully disclosed but the markets failed to understand them. In the case of banks, disclosure-based market discipline failed mainly because of the implicit government guarantee. In the case of capital markets, the reasons for disclosure’s failure were product complexity and the impact of socio-psychological factors. Yet much of European Financial Regulation is based on the disclosure paradigm to remedy market failure, discipline market actors, improve investor/consumer choice, and prevent abuse. The EU needs to re-examine the role of disclosure in two contexts: prudential regulation of banks and retail investor protection. EU policy-makers should use empirical and experimental studies before any reform of the investor protection framework. Insertion of default options in a variety of financial contracts may be a necessary supplement to disclosure for retail investors. Furthermore, an independent EU financial products committee would be a better regulatory protection strategy than reliance on investor choice assisted by enhanced disclosure.

EC Banking Regulation, EC Securities Regulation, Mandatory Disclosure, Global Financial Crisis, Subprime lending, Credit Ratings, Behavioural Decision Theory, Irrational Exuberance, Bounded Rationality, Strategic Trade Behaviour, Basel Capital Adequacy Accord, Experimental Law and Economics

Abstract:
One of the fundamental rationales underpinning banking regulation and justifying the costs it entails is the prevention of banking failures and associated depositor runs. This is exactly what the UK regulators could not prevent during the Northern Rock crisis. Apart from the much discussed regulatory failures, the Northern Rock crisis also exposed the absence of an effective legal system dealing with failing banks. The Banking Act 2009 introduces a number of important and far reaching reforms, including a Special Resolution Regime (SRR) for failing banks. The reforms address several of the identified regulatory loopholes. Thus, the Act constitutes a significant improvement over the previous regime. Yet the Act does not seek to reform banking supervision arrangements, even though these have become the subject of considerable criticism. This article argues that, in addition to other reasons, the effective operation of the SRR requires the reform of the institutional structures of the UK system of banking supervision. Otherwise the serious governance challenges and distributional issues the SRR creates may seriously undermine the standing of the SRR authorities, namely, the Treasury, the FSA, and the Bank of England, and have an adverse impact on the effectiveness of the new regime.

Special Resolution Regime for Banks, Banking Supervision, Banking Act 2009, Northern Rock, Global Financial Crisis, Liquidity Regulation

Abstract:
International banking regulation comprises, inter alia, transnational quasi-legal standards concerning the capital adequacy of internationally active banks, though their usage is normally much wider. These standards originate from the Basle Committee on banking supervision. The main rationale for their emergence has been the fashioning of national and transnational regulatory systems that are adept at preventing systemic crises and protect bank depositors from bank failures. This article suggests that, in addition to systemic stability and depositor protection, international capital adequacy standards may be utilized to facilitate access to finance. The degree of access to finance is a major criterion of financial sector development (FSD). FSD is generally viewed as an essential ingredient of sustained economic growth and thus a very effective means to foster development and fight poverty in developing countries. The first step in utilizing international capital adequacy standards to facilitate access to finance is through the assignment of lower capital requirements to private development finance loans under the Basle framework, in order to reflect their very low default rate. Such an amendment of the Basle framework would give international banking institutions a clear incentive to be involved in private development lending lowering interest rates for microfinance and other similar schemes. Relevant lending would be greatly facilitated by the intermediation of centralized country schemes that would on-lend funds to the end lenders.

Access to Finance, Microfinance, International Capital Adequacy Standards, Development Finance

Abstract:
The EU regulatory regime for capital markets undergoes radical changes as a result of the implementation of the Action Plan for Financial Services ('FSAP'). The new EC Directive on Financial Instruments Markets ('FIMD'), which is the successor of the ISD, constitutes the most central component of the Action Plan for Financial Services. FIMD and its 'implementing measures' will provide the 'constitutional' framework for the organisation and operation of the EU financial markets and investment services industry from 2006 and beyond. It marks a radical departure from the previous regime in a number of areas. Through the introduction of a number of provisions regulating the operation of 'regulated markets', Multilateral Trading Facilities ('MTFs') and investment firms and of a new core service in connection with the operation of MTFs the Directive intends to create an integrated capital market in the EU and raise the standards of investor protection. FIMD creates a comprehensive regulatory framework governing the organized execution of investor transactions on exchange, through MTFs or internally by investment firms. It abolishes the 'concentration rule' increasing thus competition between different order execution systems and facilitating cross-border transactions. On the other hand, the implementation of the very voluminous FIMD and of its 'implementing measures' and the increased costs of compliance imposed by the new regime will, arguably, lead to the creation of a highly concentrated and oligopolistic securities industry in the EU reducing competition and restricting consumer choice. In addition, FSAP related legislation, such as the FIMD, the Market Abuse Directive and the Public Offers and Admissions Prospectus Directive, creates a self-standing regime for the regulation of capital markets in the EU whose supervision and enforcement is entrusted to, at least, twenty five competent national authorities. Therefore, the issue of regulatory fragmentation and of the establishment of a single EU securities regulator emerges stronger than ever in the context of the new regime.

MiFID, EU Financial Services Action Plan (FSAP), Lamfalussy Process, MTFs, Regulated Markets, Broker-Dealers, EU Securities Markets, Single EU Seurities Regulator

Abstract:
The rules that regulate investment intermediaries' market conduct and conduct of business have not been comprehensively harmonised in the EU. As a result, cross-border trading in financial products and provisions of other financial services is regulated by largely asymmetrical national rules. Host state regulators are still responsible for the supervision of the compliance of banks and investment firms with national rules of conduct even when they engage in cross-border provision of banking and investment services. However, the advent of the EMU and global trends in the financial services industry have transformed the market landscape. The regulatory challenges that recent market developments pose require a more efficient supervisory regime and a harmonised regulatory environment. These points were focal in the Commission's recent Communication, entitled "Action Plan for Financial Markets". This article examines the current regulatory framework in the area of market conduct and conduct of business in the EU. It argues, with the aid of economic analysis, for the harmonisation of rules of market conduct and for the further harmonisation of conduct of business rules at retail investor level. The proposal for the harmonisation of conduct of business rules goes beyond the Commission's plans and might raise issues of Community competence. However, such harmonisation is dictated by the challenges of investor protection that changing market conditions create. Also, the transaction costs associated with indirect fragmentation inhibit the growth of cross-border trade in this area.