Regulating the Financial Innovation Process: Theory and Application

48 Pages Posted: 15 May 2010 Last revised: 28 Jul 2010

Zachary James Gubler

Arizona State University (ASU) - Sandra Day O'Connor College of Law

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Date Written: April 1, 2010

Abstract

What is “financial innovation” and why should we care about it? This question has become increasingly important in the wake of the recent financial crisis, yet the nature of financial innovation remains poorly understood. Drawing on the “New Institutional Economics” literature, this Article contends that financial innovation should be understood first and foremost as a process of change, a change in the type and variety of available financial products to be sure, but also a change in financial intermediaries (such as banks) and in markets themselves. It argues that this reframing has important policy implications for the economics of regulating the financial innovation process and for understanding the dynamics of modern financial markets in general. As an illustration of these ideas, the Article undertakes a critical analysis of a current policy proposal: the requirement that banks that deal in over-the-counter derivatives transfer the management of certain risks associated with these instruments to a highly regulated third-party called a centralized clearing party. The Article argues that this proposal is properly viewed as an attempt to regulate the process of financial innovation itself and that, when viewed in this light, the proposal is neither as modest nor as obviously superior to the status quo as its proponents claim. Finally, the Article sketches two alternatives to the proposed rule that seek to navigate the trade-offs of what the Article refers to as the “new” economics of financial regulation.

Keywords: Financial Innovation, OTC Derivatives, Clearinghouse, New Institutional Economics, Financial Regulation, Financial Crisis

Suggested Citation

Gubler, Zachary James, Regulating the Financial Innovation Process: Theory and Application (April 1, 2010). Delaware Journal of Corporate Law, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1608409

Zachary James Gubler (Contact Author)

Arizona State University (ASU) - Sandra Day O'Connor College of Law ( email )

Box 877906
Tempe, AZ 85287-7906
United States

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