Regulating Financial Innovation: A More Principles-Based Alternative?
(2011) 5:2 Brooklyn Journal of Corporate, Financial and Commercial Law 273-315
59 Pages Posted: 5 Nov 2010 Last revised: 10 Jan 2017
Date Written: November 3, 2010
The global financial crisis has exposed the complexity of modern financial markets. One of the primary drivers of this complexity has been financial innovation. From sub-prime mortgages, securitization and credit default swaps to sophisticated quantitative models for measuring and managing risk, the footprints of financial innovation can be found at almost every step along the road to the Great Recession. More broadly, complexity and innovation have combined to generate significant asymmetries of information and expertise between public regulators and private actors, thereby exacerbating the agency problems which pervade financial markets. At the same time, the pace of innovation has left regulators and regulation chronically behind the curve. This paper examines the desirability of ‘more principles-based’ regulation (MPBR) as a response to the challenges stemming from the complexity and innovativeness of modern financial markets. This paper advances the scholarly and public policy debates surrounding the optimal approach toward financial regulation in three ways. First, it re-conceptualizes the theoretical core of MPBR and demonstrates how this core transcends the now stale ‘rules versus principles’ debate within which the debate over MPBR has been historically mired. Second, using over-the-counter derivatives markets as a case study, it illuminates the pervasiveness and significance of asymmetries of information and expertise and agency problems within complex, innovative financial markets and how MPBR manifests the potential to address many of the attendant regulatory challenges. Finally, it moves the debate beyond the structure, perimeter and even substance of regulation and toward the examination of the optimal philosophy of regulation given the complexity and innovation exhibited within modern financial markets.
Keywords: Financial Regulation, Financial Innovation, Principles-Based Regulation, New Governance, Derivatives, Centralized Counterparties, CCPs, Dodd-Frank Act
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