Transparent Financial Innovation in a Post-Crisis Environment

Abstract

The recent stunning failure of financial institutions has put regulatory intervention high on the agenda of governments. Adequate risk monitoring, including by credit rating agencies (CRAs), as well as measurement and management have proven a daunting task, whereas regulation of innovative financial instruments has not brought about adequate disclosure and transparency. Before the recent financial crisis, financial innovation was regarded as inextricably linked with economic growth and aggregate welfare. In the wake of the crisis, criticism as to the utility of financial innovation became more unequivocal. After reviewing the virtues and pitfalls of financial innovation, the article analyses the main transparency initiatives undertaken in the EU and the USA in the aftermath of the crisis to harness various financial innovations that have marked the history of financial markets in the past three decades, including hedge funds, derivatives, and credit ratings. Furthermore, the article critically assesses the likely impact of such regulations on the future of financial innovation. In addition, the article reviews the approach to financial innovation that the General Agreement on Trade in Services (GATS) of the World Trade Organization adopted in the 1990s and assesses the likely impact of the recent financial crisis on this stance. As the perimeter of regulation grows and countries become more suspicious about home-country financial regulation, trade in financial services is unlikely to remain unaffected. Nevertheless, the GATS appears to be running out of analytical tools, a fact that undermines its global role. Within this new landscape, the GATS is bound to adapt. The Author 2013. Published by Oxford University Press. All rights reserved., Oxford University Press.