Rethinking Regulation and Oversight to Learn the Lesson from the Crisis

Abstract

During the last few years thousands of pages have been written to describe what happened, even if we need to dig a bit deeper to understand how come in the past four years an increasing number of events have fallen in the tails of our probability distributions, without soliciting any early intervention by the relevant Authorities. Among the main driving forces that have reshaped the financial landscape, the following ones are usually underlined: (a) a pervasive financial integration that has increased interdependence, amplified diversification opportunities and widely dispersed risk; (b) greater interactions between technical progress and financial innovation; (c) the emergence, out of the shadows, of new financial intermediation models and new complex financial products, both relying on sophisticated risk management techniques. Two examples can help in understanding the changes underway, their likely persistence and their possible drawbacks: the Originate to Distribute model and the “mutation” of Exchange Traded Funds (ETF). To address the question on the role of regulation and oversight, we could ask whether we are living in a deterministic world, in which it is possible to learn from our past mistakes to conceive better policy tools, or in a stochastic context in which potentially disruptive extreme events inevitably belong to the tails of probability distributions. As it cannot be excluded that also in the future we will have to face the drawbacks induced by wrong or misaligned macro-economic policies and incomplete rule-books, the Authorities have to reconsider their approach. The need of being more “proactive” than “reactive” is imposed by the complexity, rapidity and pervasiveness accompanying the mutations of the financial landscape. These dynamics inevitably open up the distance between reality on one hand and the regulatory system on the other. That’s why, not to be caught lagging behind it, they need to change their rules and oversight approaches as well. This means less but more effective rules balanced with a more focused oversight and enforcement practices, in a cooperative context. In Europe ESMA is addressing these issues to face, in due time, any possible negative implications on retail investors, as well as on systemic financial stability. In a globally ever more interconnected context, we do need up-dated, state of the art tools to effectively keep under control and manage the growing riskiness surrounding us. The capability of foreseeing market dynamics must be strengthened, to prevent in due time that innovative tools and processes are utilized to trigger, amplify or hide the vicious circle, that during the last decade has very often transformed financial activities from being a tool into a self-fulfilling objective.