January 1, 2011

The enhanced regulation of financial markets:

Work in progress or exercise in futility?

Yvan Allaire | Policy Options

To stifle financial speculation and ban the shenanigans that brought on the devastating stock market crash of 1929, the U.S. Congress enacted a series of measures to save a moribund capitalist system. The Glass-Steagall Act of 1934, in barely 53 pages, mandated a new regulatory framework for banks and other financial institutions in the United States.

Under intense popular pressure countervailed by equally intense and effective lobbying, the US Congress finally adopted in July 2010 the Dodd-Frank Act as a putative response to the financial collapse the world experienced in the fall of 2008. In its draft form, the Act ran to some 2,315 pages; in its final official version (in eight-point types), the Dodd-Frank Act takes 848 pages to mandate a new set of rules for the U.S. financial system!

A 53-page Act in 1934 versus an 848-page one in 2010 is a good indicator of the intricacy and complexity of financial markets in our time. But the act is only the tip of a new U.S. regulatory iceberg. The Dodd-Frank Act heaps upon U.S. regulatory agencies dozens of unresolved issues with instructions for them to bring forth policies and rules to cope with these issues at a specified later date. In this manner, the U.S. regulation of the financial system is at best a work in progress with an uncertain final shape.

The Financial Stability Board (FSB), an off-shoot of the G20 set up to give substance to financial reform, coordinate and monitor its implementation, has also issued its own voluminous documentation and multiple recommendations. Indeed, all G20 nations have committed to implement, in a coordinated manner between now and the end of 2012, regulatory or supervisory frameworks along the lines of the FSB recommendations.

The Bank for International Settlements (BIS) and its Basel III Committee for Bank Supervision have also proposed an elaborate set of measures to strengthen the international banking system and improve its resilience and resistance to violent financial storms. The FSB and the BIS have a close working relationship.

The European Union (EU) Commission has also produced an abundance of policy papers and proposals on these issues, which, in several instances, go beyond the recommendations of the FSB. The financial crisis, it seems, provided the EU Commission with an opportunity to take on new powers and to assert its authority over national regulatory bodies.

The International Organization of Securities Commissions (IOSCO) has also issued a number of policy papers on key aspects of the financial system.

Although sound policies and some measure of luck have shielded it from the financial debacle of 2007-2008, Canada, as a member of the G20, as an active participant on the FSB and on the Basel III Committee, must implement in some fashion the policy recommendations and regulations coming out of these bodies.

Of course, Canadian banks, along with all banks in developed economies, will have to abide by the Basel III stipulations, under the watchful supervision of the Office of the Superintendent of Financial Institutions (OSFI).

This article aims at providing an overview of what these long and complex policy documents aim to achieve. It assesses the adequacy of this regulatory response to the causes of the systemic crisis of 2007-2008. […] Read more