Posts Tagged ‘conflict of interest’

Who Cares About Regulations?

October 17, 2010 Leave a comment

American journalist Mignon McLaughlin once said that we humans are “…all born brave, trusting and greedy, and most of us remain greedy”. This has some truth to it, even if at certain levels of greed. For the most part though, the majority of individuals have control over their ‘greed’ (for a lack of a better word) by adhering to certain censorship codes, whether be it: religion, morals, ethics, social norms, etc. That doesn’t mean though, that there does not exist individuals who allow greed to consume them, and guide their decisions. With all the dangers surrounding the decisions taken by such individuals, perhaps the most of which, are those that have negative effects on other individuals. If we project such dangers onto the financial industry, then greedy decisions maybe referred to as systematic risk; “the unscrupulous actions of a few market participants could undermine public confidence in the entire financial system” (Levy and Post, p.896, 2005).

Given the potential fragility of financial markets, due to vulnerability from information asymmetry, agency problem, and transaction costs, lies the importance of regulating them. Regulations sometimes are viewed as tools, or deterrents, that “address systemic risk” (Schapiro, 2010). The main issue with financial markets is that incentives are misaligned on the “micro-level;  which [could result] in numerous potential conflicts of interest” (Kumpan, 2009). Regulations of financial markets are especially important in our current times, as when “financial institutions get bigger, markets move faster and investments grow more complex” (Schapiro, 2010), introducing potential cracks that ill-guided individuals may exploit. But one must not latch onto such negative view of regulations, as the main reason they are put there is to bring along with them added benefits to the financial industry; regulations are not closed doors. They attempt to align interests, effectively promoting for more efficient markets. They may also act as springboards in promoting more connected and expanded markets. The net effect is further industry stablility and stronger economies.

In deciding how much regulation should be put in place, one has to understand the reasons behind regulating the financial industry, and the implications that may be brought along with it. The benefits have been discussed above; which simply boil down to providing a better market platform that offers stability, efficient movement of capital and potential of growth. Many authors coined the term economic safety in describing such benefits. But “economic safety is more elusive than military safety …. too much safety undermines the very stability that safeguards promise” (Amity, 2010). Issues that should be taken into account when deciding on the level of regulation to be put in place, include:
> Available infrastructure: would a country’s given financial market infrastructure support such regulations? Whether the the answer is a yes or a no, how much will it cost to have such regulations put in place?

> Acceptability of local financial market: do such regulations actually benefit the players in a given financial market? [the point of these regulations in the first place is to benefit such users of the financial market — not burden them with no added benefits]

> Foreign investors: Given the interconnectedness of international financial markets, as a result of globalization trends, any regulation put in place by a specific country’s financial market could bare effects on other international markets. Thus, when drafting such regulations, financial market synergies along with foreign investors must be take into account; else the regulations would solve a specific issue while introducing more problematic issues.

> Market transparency and efficiency: the effect of such regulations on the market’s transparency and efficiency.

> Culture: on a more non-financial level, the regulations have to take into account social and cultural norms. These regulations, and the authorities who issue them, may find themselves in the spotlight, if for example, foreign investors are favoured over what is socially acceptable.

> … and many more issues

The degree of how much regulation should be put in place may seem like an simple task; one can argue that it borrows a page from the it ‘costs versus benefits’ theme. At the end of the day, there must exist certain goals and objectives for a given country’s financial industry; much like the goals and objective of companies. Regulations should promote and facilitate the achievement of such goals. For the most part, this is true, but what is different here is that the both internal and external environment that the financial industry interacts with is ever changing. And this change is a result of many variables, a lot of which are unknown territory for us: for example, our interpretation of the financial industry with advancements in technology, our definition of incentives, our understanding of ethics, etc.

“… it is managements’ job to organise, manage and control their businesses in a way which meets a set of high level principles … to safeguard the interest … and secure the safety and fairness of [financial] markets” (Tiner, 2005). Regulations are there to make sure that happens.

— Youssef Aboul-Naja