Posted by: Nicholas Davis | May 23, 2009

Future Summit notes: The regulation pendulum

By way of context, I’m currently whiling the time (“while” – who thought of using THAT as a verb?) in the Etihad lounge at Abu Dhabi, mid-way through a mammoth layover that is entirely due to my own stupidity.

Given that I’m on may way back to Geneva from what was a really excellent Future Summit in Melbourne, I thought I’d post my notes from the main session on which I was a panellist on Tuesday morning: “The Regulatory Pendulum – Getting the Post-Crisis Regulatory Environment Right”. I spoke alongside Cally Jordan from Melbourne Uni, Mitch Craig from KPMG, Saul Eslate from ANZ and the new ASIC Commissioner, Gred Medcraft. I was really privileged to be up there alongside these guys and it was an excellent session with lots of questions from and dialogue with the audience. Due to time pressures, not all the points came out below, some were challenged and others expanded upon in interesting ways. We even got a few laughs.

I put down some earlier thoughts on this panel in my previous post, so it’s interesting (to me, at least) to see how my thinking changed over the last days before the summit.

There were other great moments from the Future Summit that I want to collect and post – I hope the Summit report from the ADC goes online soon!


PART 1: Where do we see the pendulum swinging on a macro scale?

  • Four scenarios for the global regulatory environment:

    • Re-engineered Western Centrism sees us going back to business as usual, with some tinkering of existing risk models and stress tests, and the great forgetting beginning again. The pendulum swings back towards markets quickly.

    • Financial regionalism sees an ideological battle emerging over global regulation – with three blocs, Asia, Europe and the US, competing to prove that their approach works the best. Australia has to play diplomatic games through its regulation.

    • Fragmented protectionism sees the specter of trade and capital controls returning us to a post WWII-like world. The pendulum swings far and stays therefor most countries.

    • Balanced Multilateralism sees the G20 process and beyond provide us with internationally coordinated financial regulation with a supranational regulator to complement the global financial system. The pendulum swings considerably, but is primarily coordinated on a global level.

    • None of these are true – but all are completely plausible and it is impossible to assign probabilities.

  • Who will drive future regulation? – Peter Weinberg and Sameer

    • US behind the curve – US Treasury understaffed, Europe more gung ho

    • Asia influencing regulation in the medium-term

    • What does this mean?

      • Focus on alternative investments

      • Substance, not form: “if it looks like a bank and quacks like a bank, we have to regulate it like a bank” Adair Turner, FSA

      • Potentially less of an appetite for govt guarantees and ownership positions to exit

PART 2: More radical ideas that might be needed and could draw attention

  • Might we see some radical suggestions adopted?

    • Size limits for banks – riskiness and moral hazard

    • Return to a clear separation of function – Return of glass-steagal – firewalls

    • Restrictions on complex products to classes of investors – snake oil

    • New incentives for regulators – pay them bonuses linked to the size of the fines they can levy on financial institutions – balanced incentives for supervisors

    • Use of alternative currencies as a stabilizing factor – e.g. the WIR – UBS research institute – counter-cyclical measures in the micro-economy

    • Fundamental re-assessment of risk management that rejects neoclassical assumptions and explicitly builds in both behavioural psychology and complexity theory to explain crises – acceptance that current statistical approaches, both VAR and stress testing, are inadequate in the face of uncertainty

PART 3: Potential dangers

  • Could regulation be a red herring? Makridakis etc

    • Sure, we need it, but don’t let it lull us into a false sense of security. One thing we underestimated from the last 10 years was the capacity of markets to outsmart even the regulation that was there.

    • We can’t let ourselves think we’ve got the problems nailed – we’re always regulating for the last crisis, and we cannot predict the next

    • The behaviour of biased actors in the system means that most major bubbles are explained away by “new paradigms” of efficiency, risk management – in a system that hides its own complexity, regulation cannot keep up.

  • Could coordinated regulation and more transparency increase systemic risk – Niall Ferguson

    • Common regulations and more open information increases homogeneity and could increase contagion if there weren’t other natural barriers to stop correlations driving to 1 in the case of trouble

  • Is the pendulum a useful metaphor?

    • The interplay between regulation and markets is complex, dynamic, and I think would benefit from a less polarized conceptualization. If you’d like, I’m happy to expound offline two potential competing metaphors that were borne in the airport lounge in Abu Dhabi – regulation souffle and regulation bumper-bowling.

  • Will the public understand what governments and the financial sector do?

    • Meaningful reforms cannot be put over by an advisory and administrative elite that is itself the architect of the existing situation. Unless the public understands the reason for change they will not accept its cost; understanding is the foundation of legitimacy for reform.” – Hyman Minsky, 1986


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