Our Lessons have Returned: Insights into Post-Crisis Financial Regulation from Mandatory OTC Derivatives Clearing Policy

Abstract

The global crisis of 2008 associated with the failure of Lehman Brothers revealed the fragility of the financial system. In its aftermath, policy makers created many new rules to address the perceived causes of the crisis and to enhance financial stability. Nearly all of these rules have now been implemented, and regulators’ focus has moved to policy review and revision. This phase of the regulatory cycle offers a golden opportunity to consider how these processes should be conducted, given the volume of rules written and their importance. This paper introduces mandatory clearing of over-the-counter derivatives as a case study of the issues in the review of post-crisis regulation. This example highlights a number of questions which regulatory review should address. These include the goals of the regulation; its proportionality; whether alternative policies could meet the same goal with lower cost, higher benefit, more certainty and/or fewer side effects; the size and allocation of redistributional effects; and the calibration of the policy. Insights from regulatory theory are used to illuminate these issues and to suggest how a thorough review of financial regulation might proceed. In the case of mandatory client clearing, this leads to suggestions both for the design of the policy and for potential improvements in the rule making process.

Keywords: Financial Regulation, Mandatory Clearing, OTC derivatives, Regulatory Review, Regulatory Theory