Structural Regulation as Antidote to Complexity Capture
American Business Law Journal, Vol. 49, Issue 3, Fall 2012
University of Tulsa Legal Studies Research Paper No. 2012-01
71 Pages Posted: 8 Mar 2012 Last revised: 18 Feb 2013
Date Written: March 8, 2012
This article proposes a new way of thinking about the ways in which market complexity threatens the future viability of financial regulation. It examines financial complexity in the context of the ample literature on complexity from the physical and social sciences that has, to date, been underappreciated in law and economics scholarship. According to this physical and social science literature, complexity means something more than “very complicated” or “difficult to understand.”
Regulators, like all agents charged with tasks, are limited by their bounded rationality. But in conditions of complexity, the problem of regulators’ bounded rationality emerges as less of an obstacle to be overcome than a structural impediment to effective policy. To the extent regulators rely on industry itself to provide the information they require to make a good-faith effort at performing their statutory mandates, they risk complexity capture — a soft, hegemonic capture of even virtuous, public-regarding regulators who are resistant to traditional capture efforts by industry.
This article’s contribution to the financial regulatory literature is to investigate financial market complexity in detail, drawing on recent research by complexity scientists. But highlighting the inherent difficulties of regulating complexity is only a diagnostic, preliminary step. This article proposes further a model of structural regulation — as opposed to behavior-based regulation — as an antidote to complexity capture. It is hoped that this article, by developing the notion of complexity capture and demonstrating the problems associated with continued reliance on industry-provided information and/or highly particularized systems of behavioral regulation, also makes a modest contribution to efforts to theorize a regulatory approach to combat the instability that complexity necessarily entails.
Keywords: financial regulation, capital adequacy, administrative law, living wills, resolution, complexity capture, regulatory capture, safety and soundness, banking law, feedback effects, network effects, normal accidents
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