Why a new approach to regulation may be required

  • 29 November 2021
  • Blog | Regulation & Compliance | Blog

When a financial crisis or scandal hits the headlines, an understandable question from the press and the public is ‘why didn’t the regulators know about it, and stop it?’. 

The recent collapse of London-based finance firm Greensill Capital, one of the world’s biggest providers of supply-chain finance, garnered more headlines than most – largely due to the involvement of former UK Prime Minister David Cameron. 

This time, the calls were not just for an inquiry into Cameron’s involvement or how the crisis was allowed to evolve within the regulatory framework in place. In fact, on this occasion, questions were raised about whether a whole new regulatory framework should be brought in for the shadow banking sector. 

As Dan Awrey, Professor of Law, Cornell Law School, and a former Oxford University Professor who specialises in the banking and finance sector, pointed out in the summer issue of Chartered Banker, the issue here is that regulators have limited resources and, “for every case such as Greensill, there will be another 10 that don’t have problems but would still need to be regulated”. 

The UK is a hub for financial innovation and, with limited resources, keeping up with the volume of activity is a tough challenge,” Awrey argued. 

However, Awrey believes there is actually a far more fundamental issue around regulation of such practices. 

“There is a fundamental mismatch between the nature of finance and current approaches to financial regulation,” he says, setting out the core message of a paper he has co-authored with Columbia Law School’s Kathryn Judge, titled ‘Why Financial Regulation Keeps Falling Short’

He argues that today’s financial system is such a dynamic and complex ecosystem, that policymakers and market actors “regularly have only a fraction of the information that may be pertinent to decisions they are making. 

“The processes governing financial regulation, however, implicitly assume a high degree of knowability, stability, and predictability,” he says. 

“The procedural rules meant to promote accountability and legitimacy often fail to further either end,” he adds. “They result instead in excessive expenditures before new rules are adopted, counterproductive efforts to perfect ever more detailed rules, and too little re-evaluation of existing rules in light of new information or changed circumstances.” 

Awrey adds that, despite the calls for further regulation of some parts of the financial services sector, “the mismatch between the nature of finance and how finance is regulated helps to explain why financial regulation has failed in the past and why it will likely fail again”. 

In response, he suggests the need for a new approach to financial regulation, one that acknowledges the limits of what can be known given the realities of today’s complex and constantly evolving financial ecosystem. 

Read more from Dan Awrey in our ‘The grey areas of shadow banking’ article on pages 24-26 of the summer 2021 issue of Chartered Banker magazine.