The FSA, Integrated Regulation and the Curious Case of OTC Derivatives

Abstract

With a view to better understanding the optimal structure of financial regulation, this paper tests prevailing theoretical hypotheses respecting the efficiency and overall desirability of integrated financial regulation relative to competing institutional models. This test is conducted though the lens of a comparative case study examining the approaches adopted by (fragmented) U.S financial regulators and the (integrated) U.K. Financial Services Authority (FSA) toward the myriad of regulatory challenges posed by the emergence, growth and systemic importance of over-the-counter (OTC) derivatives markets. More specifically, this paper examines why, despite the numerous theoretical advantages of integrated regulation, the FSA adopted a non-interventionist regulatory regime governing OTC derivatives markets which was both functionally equivalent to the fragmented U.S. regime and, arguably, socially sub-optimal. This paper argues that the FSA’s approach toward the regulation of OTC derivatives markets may potentially be explained on the basis of a combination of (1) poor coordination, (2) the FSA’s attempts to balance competing regulatory objectives, (3) incentive problems which arise for national regulators in the context of global financial markets, and (4) the inherent limitations of financial regulation. Each of these potential explanations holds important insights for the ongoing debate respecting the optimal structure of regulation.

Keywords: financial regulation, OTC derivatives, integrated regulation, institutional structure, political economy, financial market complexity, Dodd-Frank Act