August 23, 2006
Paper on Intermational financial regulation
I am posting a short paper of mine summarizing recent financial reforms in the UK and Germany in the market for financial services (insurance, securities and banking). When I first started on work on this, I thought Germany would have gone much further than the UK, but it has not. The UK has adopted a single regulator model for the all of these services.
I: INTRODUCTION: While trade in goods and services across countries has exhibited robust expansion in recent years, cross-border flows of capital (including foreign direct investment and portfolio capital) have grown much more rapidly. Illustrative figures for trends in growth in trade, capital flows and some other key measures of global integration (such as international tourist travel) can be found by examining figures reported by various United Nations agencies, such as the UNCTAD.
Just as trade flows (in response to shifts in production and cost patterns occasioned by specialization) promote global (and in most cases, national) welfare, free capital movements are commonly believed to allocate the available fund of aggregate savings to their most productive uses and destinations. Unimpeded capital flows are not only “efficient” in an allocative sense in the short term, but may have a permanent and dynamic benefit as well. In times of domestic financial shortfalls, capital inflows or borrowing from abroad may permit smoothing of domestic consumption and external financing of needed domestic investment. Prudentially utilized, similar to any other form of leveraged investment, external finance can well pave the way to more rapid domestic growth than reliance on domestically-generated savings alone.
In the early euphoric days of the Reagan-Thatcher privatizations followed by the dissolution of the former Soviet Union in early 1991, both domestic and external account liberalization in rapid order was actively promoted by both academics and international organizations. Little attention was paid to the differing consequences of trade liberalization versus capital account or domestic financial sector liberalization until a series of financial crises in the closing years of the twentieth century. Scholars have documented several instances of financial “meltdowns”, such as the Mexican peso crisis of 1994-95, the Asian “contagion” (which lead to precipitous declines in economic activity almost simultaneously in several southeastern Asian countries and the bond defaults in Argentina Russia
Not surprisingly, the international financial community, including governments, non-state actors and inter-governmental organizations retreated from their initial enthusiasm for early external financial sector liberalization. A new literature on prudential financial regulation and sequencing of reforms rapidly developed. At the same time, a number of advisory standards proposing a new and more transparent international financial architecture were drawn up by several bodies, including the International Monetary Fund, OECD, IOSCO (International Organization of Securities Commissions). A series of Basle
In what follows, I briefly discuss and compare recent legislative and administrative financial reforms in the United Kingdom Germany
IIA: FINANICAL REFORMS IN THE UNITED KINGDOM United Kingdom Britain UK US London
By itself the FSMA is only a blueprint with the details of implementation to be filled in by the body over time with accumulated experience. In fact, preparations for the FSMA had been ongoing in Britain
As constituted, the FSA, much like the Securities and Exchange Commission in the US US UK
Consistent with the unitary single regulator model, the reach of the FMSA, both with respect to activities and territory is very broad. Specifically, the FSMA applies to any “regulated” activity in the UK UK UK UK
The FMA is ultimately accountable to the British Treasury (and Parliament) with respect to its general activities and broad polices. Unlike the US US
Finally and unlike the US in which judicial review is liberally available, FSA actions can in principle be challenged in the courts but early indications are that such review is likely to be extremely deferential. Initial review can be obtained by an administrative court (similar to an Article I court in the US UK
IIB: FINANCIAL REFORMS IN GERMANY: Germany began its financial reforms somewhat earlier than the UK by successively enacting four acts in 1990, 1997, 1998 and 2002 respectively, but they have been more limited in scope. In contrast to the UK UK
The new executive body (BaFin) does have a separate legal personality but is subject to close and continuing oversight by the Federal Ministry of Finance and the Bundestag (through appropriate committees). In addition, it is required to cooperate closely with the Bundesbank (German Central Bank) regarding regulations and ordinances affecting adequacy of capital reserves of banks. Consistent with the strong cultural tradition of German constitutionalism and administrative powers, judicial oversight is far more limited than in common law countries such as the UK
Insurance against unforeseen losses has always been a feature of the German no-fault legal regime and it is not surprising that the insurance industry was the first to be regulated in 1901. In
Unlike the detailed supervision of insurance, German banking is principally concerned with the overall health of historically sound German banking system. Supervision of individual banks is not the primary goal of the Federal Banking Act and BaFin is under no obligation to apprise the public at large of its findings regarding solvency of individual banks.
Securities regulation has been the latecomer in Germany
Like the British FMA, the German agency BaFin does not have criminal enforcement powers which are left to public prosecutors. It may however, demand documents, conduct searches for documents of a concerned entity during business hours, levy fines and in extreme case, revoke licenses. As with other national authorities in the European Union, criminal prosecution of financial market participants can only be brought by public prosecutors for offenses committed in Germany or committed by German nationals abroad concerning securities that are traded in the EU or EEA. However, the FSA has negotiated a number of bilateral agreements with various foreign securities commissions in several OECD countries, such as the SEC, to facilitate the exchange of information and cross-border cooperation.
In conclusion, while the German financial landscape has undergone sweeping change in the last decade, these have been only organizational in nature and have not involved the creation of a single unified legal regime as in the UK
III: COMPETITION OR HARMONIZATION: In this Section, I briefly discuss the arguments for or against increased regulatory competition for financial services. In the area of banking services and at least within the OECD countries, a significant degree of harmonization and convergence has taken place via the Basle Core Principles and the Basle US US Delaware US
Why might a global regulatory regime offering investors a choice of regimes be superior to a single regulator or a cartel model? Various arguments are commonly adduced. One suggestion is drawn from political economy and is based upon political accountability. While national regulators are not elected, they are appointed by elected officials in the executive branch and to that extent, may be responsive to the discipline of voters’ preferences. However, international regulators (or international lawmakers) do not stand for election (with the limited exception of EU Parliament delegates) and may be more apt to rent-seeking behavior because of “capture” by narrowly drawn interest groups. Secondly, with the existence of regulatory competition, if firms and investors are able to choose the national regulatory regime they prefer, national regulators will be less likely to engage in wasteful wealth-transfer activities by favoring selected sectors or industries. Next, regulatory competition is more likely to foster innovation and improvement because of the possibility of inter-jurisdictional flight of security issuers and capital. All of these and other arguments too numerous to detail here may be expected to lower issuance costs for underwriters and hence, the cost of capital. In turn, lowered capital costs might be expected to stimulate investment and growth. Correspondingly, the establishment of a single, unified regulatory global or regional regime, if pursued, may not be a desirable objective.
 In particular, see the HANDBOOK OF STATISTICS 2005 (UNCTAD Geneva , Switzerland
 Some writers repeatedly warned against undue enthusiasm for external capital account liberalization in advance of domestic financial “deepening” and reforms. See for example, Jagdish Bhagwati, The Capital Myth: The Difference Between Trade in Widgets and Dollars FOREIGN AFFAIRS (May/June 1998).
 The Mexican peso crisis occurred in 1994-95, coming shortly after the entry into force of the NAFTA accords. Imprudent government spending coupled with a lax banking system “connected lending” lead to a precipitous decline in external value of the peso as investors engaged in massive capital flight from Mexico Washington DC 1997 in Thailand Malaysia Indonesia Korea Argentina Brazil Russia Argentina
 There is very considerable literature (both in development economics and in law and development) on the “sequencing” of reforms, with most mainstream economists (and legal policy makers) recommending trade or current account liberalization first, followed by domestic financial reform (including the domestic banking system) and only then, external capital account liberalization. Current account liberalization refers both to the reduction of tariffs, as well as, the elimination of restrictions on payments for current account transactions. Domestic financial reform includes elimination of “financial repression” (repressive regulations that inhibit free competition), “crony capitalism” (the practice of permitting or requiring state-influenced banks make loans of dubious quality to uncreditworthy cronies of government bureaucrats) and the maintenance of adequate capital reserves against outstanding loans. Capital account restrictions are those that implicitly or explicitly tax or limit outflows or inflows of capital and are not prohibited under the IMF Articles of Agreement. See IMF Articles of Agreement, Art. VI (3) (stating “Members may exercise such controls as are necessary to regulate international capital movements, but no member may exercise these controls in a manner which will restrict payments for current transactions.”). Id.
 The IMF Code of Good Practices and Fiscal Transparency is at http://www.imf.org/external/np/fad/trans/code.htm. The OECD documents may be found at http://www.fatf-gafi.org/pages/0,2987,en_32250379_32235720_1_1_1_1_1,00.html, while the IOSCO principles may be found at the web site of the IOSCO at http://www.iosco.org/library/index.cfm?section=pubdocs.
 The various Basle Basle
 Financial Services and Market Act of 2000 (effective December 2001). Even before the enactment or implementation of the FSMA, some supervisory functions such as regulation of banking had been transferred from the the Bank of England
 Ferran at note 1 supra.
 An important rationale for the unified regulatory model was the necessity of coping with the reality oversight over multi-service financial conglomerates. Financial innovation in derivatives and securitization of an ever-increasing array of financial instruments had come to mean that a single company might well be potentially subject to multiple regulators.
 See notes 5 and 6 supra. Some of the stated objectives in the FSMA relate to consumer protection, improving public accountability and to exposing wrongdoing. Notably, there is no reference to promotion of competition among financial institutions in the UK Oxford University
 Enforcement powers of the FMSA are specified in Part VII of the Act.
 Criminal prosecution of serious cases such as insider trading can be sought by the FSA by referral to prosecutors. See FMSA section 130.
 The definition of “market abuse” under the FSMA is contained in Section 118. A
 Although not specified in the statute or in any published decisions, it is reasonable to assume that electronic access in the UK
 By contrast, merger and takeover activity in the UK
 Some semi-autonomous bodies in the US US
 These are the respective Financial Market Promotion Acts. For further details see, Rainer Grote, The Liberalization of Financial Markets: The Regulatory Response in Germany in RAINER GROTE AND THILO MARAUHN (eds.), THE REGULATION OF INTERNATIONAL FINANCIAL MARKETS (Cambridge University Press, 2006).
 The three regulatory regimes for these sectors are the Gezetz über Kreditweden (Banking Act), Gezetz über Versicherungaufsicht (Insurance Companies) and Wertpapierhandelgezetz (Securities Trading Act). Legal innovation in these regulatory regimes, to the extent that it has occurred, has taken place through periodic amendments to the existing separate laws.
 See for example, M. Singh, GERMAN ADMINISTRATIVE LAW IN COMMON LAW PERSPECTIVE (2d ed. Springer 2002). The German Constitution as interpreted by the
 Federal regulators in the US
 Some of the new securities regulation was included in the portions of the Financial Market Promotion Acts mentioned at note 17 supra.
 See the German Criminal Code, Section 7(2). The application of criminal jurisdiction over German nationals abroad is based upon the nationality principle. It is noteworthy that automatic criminal jurisdiction does not extend to German nationals committing securities offenses with respect to securities traded only in the US, for instance.
 See Roberta Romano, Empowering Investors: A Market Approach to Securities Regulation 107 YALE L.J. 2359 (1998) and The Need for Competition in International Securities Regulation (Research Paper 258, Yale Law School
 See Paul Stephan, The Futility of Uniformity and Harmonization in International Commercial Law 39 VA. J. INT’L. L 743 (1998).
 The regulatory regime in the US UK Germany US Frankfurt
 An example, is the loss of substantial Swiss banking business in secret accounts to Luxembourg, the Grand Cayman Islands and other jurisdictions as Swiss banking secrecy laws began to be relaxed in response to heavy international pressure.
August 22, 2006
Judge Posner on Warrants and Oversight
Today's Wall Street Journal has a brief but pithy column by Judge Posner (available here) on the recent decision by Judge Anna Diggs Taylor (available here) finding the National Security Administration's program of warrantless wiretaps to be unconstitutional.
Judge Posner speaks eloquently for himself. I simply want to frame the question that he poses in a slightly different manner. Antiterroism presents new and vexing challenges for law enforcement officials. Society would be better served, for instance, by deterring terrorists from committing their heinous crimes than by finding, prosecuting, and punishing them after they have done so. This would, of course, be true of all crimes but, in view of the horror of the contemplated crimes of terrorists, is particularly true of crimes designed to sow terror. But this emphasis on prior knowledge of terrorist intentions runs up against the strong interest that we all have in living our lives free from excessive government interference. We typically balance legitimate concerns about freedom from that interference and social desire to deter wrongful acts by requiring law enforcement officials to seek a warrant for interference on the basis of probable cause that the object of the warrant will commit a crime. But it may be particularly difficult to bring "probable cause" and seeking warrants to bear on terrorists. And, as Judge Posner notes, the Fourth Amendment forbids general warrants that might serve to allow the broad interference in individual liberty that the NSA program trod close to or on.
That being so, Judge Posner proposes an alternative -- an ex post method of regulating the NSA and similar agencies in their quest to discover terrorist plans and persons. He suggests an executive or legislative branch oversight committee to which the NSA (or its equivalent) would report periodcially. The reports would document who had been surveilled, when, for how long, what was discovered, and what "reasonable" ground or grounds existed for that surveillance. The oversight committee would have the power to impose large, significant fines on officials who had abused this discretion.
I'm not sure whether Judge Posner's oversight committee with its ex post punishment powers would work. I can think of some reasons that the committee might not serve its contemplated function well. It might, for example, be deeply influenced by political considerations in a way that judges on the Foreign Intelligence Surveillance Court are not. And I wonder about the effectiveness of fining individuals for the acts of surveillance that they authorized. Will, as my colleague Andy Leipold asks, the agencies indemnify them against that liability so that they can persuade talented people to lead the agency? Nor am I aware of any changes in the ex ante method of seeking and approving warrants that we might consider and whether those changes are practicable and more or less efficient than the proposed oversight committee. Is it really so difficult and time-consuming to get a broad warrant from the FISC?
But, as always, Judge Posner has given us clear cause for thinking. Incidentally, he and Professor Gary Becker discuss some of these same matters at the Becker-Posner Blog, available here.
August 2, 2006
Teaching and scholarship
The Empirical Legal Studies blog (here) is having a one-day forum today about Professor Ben Barton's (Tennessee) recent empirical paper, which claims that there is no correlation between being an effective or popular teacher (two very different things) and a productive scholar. Professor Jeff Stake of Indiana responds to Professor Barton.
August 1, 2006
"How's My Driving?" and Wikipedia
Late last week the IPLE (Illinois Program in Law and Economics) Summer Reading Group met here in Champaign to discuss Professor Lior Strahilevitz's "'How's My Driving?' for Everyone (and Everything)." We all liked the article, forthcoming in the N.Y.U. Law Review and available from SSRN here, very much. Strahilevitz notes that commercial fleets that used the "How's My Driving?" stickers on their trucks had a demonstrable reduction in accident losses. Not that many people called in to the numbers on the stickers, but apparently truck drivers who knew that people might do so were thereby induced to drive more cautiously than they otherwise might have.
Strahilevitz proposes that if HMD campaigns work to improve safety for commercial fleets of truck, then they will probably do the same for all the rest of us. So, he explores (and ultimately endorses) a HMDFE ("'How's My Driving?' for Everyone") campaign.
We liked the idea but were skeptical of its practicability. (We also joked about a "How's My Professoring?" program.) One of the factual issues that we thought might bear on the administrability of the HMDFE program was how well such free-form information-aggregation programs as Wikipedia work. None of us knew the answer to that inquiry, but shortly after our luncheon, the most recent New Yorker magazine arrived with a marvelous article about Wikipedia. That article, available here, should, I believe, make one skeptical about the usefulness of HMDFE.
Incidentally, I looked up the entry for "Law and economics" in Wikipedia. It needs some extensive work.