Timing the Regulatory Tightrope

Abstract

Regulators face a hard problem. Novel products are developed and launched all the time. At first, regulators have very little information about the product, including its risks and benefits. Moving too quickly to impose regulations is therefore risky. And since the market for a nascent product is generally small, the benefits of regulation may also be small. It therefore makes sense to let the market develop a bit before taking action.

But waiting too long to intervene can also be perilous. Once enough time has passed, and the product becomes established, it can become extremely difficult to intervene. Now there is an entrenched constituency supporting the product; this constituency can be very difficult to overcome, even if regulation—including regulating the product out of existence—is socially valuable.

In short, regulators face a timing problem: Waiting allows regulators to learn, thereby reducing the risk of mistakes. But it can also limit the regulator’s choice set. While this is a generic problem, this chapter explores this issue in the context of new products in the securities market. It does so by considering the introduction of three distinct products: cryptoassets, money market mutual funds, and exchange traded funds.