Stefano Pagliano: "A Global Financial Governance?"

Regulating Finance in the Public Interest Regulatory Capture and Mitigating

Strategies

Dr. Stefano Pagliari [email protected]

“Is it possible at all to create an international regime that prevents regulatory capture?” George Stigler (1971) & the motor trucking industry

Mattli and Woods (2009): capture as “the control of the regulatory process by those whom it is supposed to regulate or by a narrow subset of those affected by regulation, with the consequence that regulatory outcomes favor the narrow `few’ at the expense of society as a whole”

Material incentives vs. ideas (cognitive capture)

Popular concept to explain flaws in rule-making, implementation, supervision but weak empirical standards

When is Regulatory Capture More Likely to Occur?

3 Factors

Demand: Balance of Stakeholders

Pro regulatio

n

Against regulatio

n

AFME

EACT

AIMA

Finance Watch

Allianz

When is Regulatory Capture More Likely to Occur?

3 Factors

Demand: Balance of Stakeholders

Supply: Institutional Design of Regulatory Agencies

Pro regulatio

n

Against regulatio

n

AFME

EACT

AIMA

Finance Watch

Allianz

When is Regulatory Capture More Likely to Occur?

3 Factors

Demand: Balance of Stakeholders

Supply: Institutional Design of Regulatory Agencies

The Broader Political-Economic context

Pro regulatio

n

Against regulatio

n

AFME

EACT

AIMA

Finance Watch

Allianz

Pro regulatio

n

Against regulatio

n

AFME

EACT

AIMA

Finance Watch

Allianz

Asymmetry among stakeholders competing for regulatory influence

Financial Resources

Technical Expertise and Information Asymmetries

Collective Action Problems for deposit holders, investors, and consumers

Congressional Lobbying from Securities Firms

(Data” Centre for Responsive Politics)

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

$0

$20,000,000

$40,000,000

$60,000,000

$80,000,000

$100,000,000

$120,000,000

$1.4 million spent daily by financial industry lobbies during the financial crisis to lobby Congress

Demand Side: Balance of Stakeholders

Balance of stakeholders

Pro regulatio

n

Against regulatio

n

AFME

EACT

AIMA

Finance Watch

Allianz

Heavy bias towards business

Since the crisis: Greater diversity of

stakeholders Greater diversity within the

business community

Source: Pagliari and Young 2013

Pre-Crisis

Post-Crisis

% Difference

Finance (target) 75.1% 60.3% -19.8%

Non-financial business groups

16.4% 24.2% +47.5%

NGOs / Cons. / Trade Unions / Research

8.4% 15.5% +83.8%

USA EU UK

Financial business groups

66.6% 70,6% 59.6%

Non-financial business groups

23.2% 18.9% 28.1%

NGOs / Cons. / Trade Unions / Research

10.2% 10.5% 12.2%

CRD IV (2010)

Banks 43.7%

Non-bank financial groups 33%

Non-financial business groups 19.6%

NGOs / Cons. / Trade Unions / Research

3.6%

Balance of stakeholders

Pro regulatio

n

Against regulatio

n

AFME

EACT

AIMA

Finance Watch

Allianz

Heavy bias towards business

Since the crisis: Greater diversity of

stakeholders Greater diversity within the

business community

Differences between rule-making and implementation

Supply Side: Institutional Design of Reg. Agencies

Pro regulatio

n

Against regulatio

n

AFME

EACT

AIMA

Finance Watch

Allianz

Formal Independence

Consultative Processes

Transparency

Supply Side: Institutional Design of Reg. Agencies

Pro regulatio

n

Against regulatio

n

AFME

EACT

AIMA

Finance Watch

Allianz

Mandate

Funding

Hiring (Revolving Doors) Inter-temporal conflict of

interests Preferential Access & Inside

Knowledge Socialization, Psychological

Biases, & intellectual capture US vs. Europe

SEC Staff

Shares traded in US

1939 1,700 260 mln

2001 2,900 2 bln.

2009 3,584 5.4 bln.

The Broader Economic and Political Context

Pro regulatio

n

Against regulatio

n

AFME

EACT

AIMA

Finance Watch

Allianz

Capture through the political process Electoral weight of Financial industry Finance and the Real economy Banks as primary sovereign-debt

holders

Cyclical Nature of Capture

SlumpSlump

Crisis Crisis

Boom

Boom

Pressures on regulators not to ‘remove the

punchbowl from the party’

Electoral pressures to re-regulate Pressures on

regulators not to forestall economic recovery

What can we do about it?

Paradox of financial regulation: Interaction between regulators and regulated firms…

… is necessary to design regulatory policies … open the policymaking process to the risk of

regulatory capture

Some degree of regulatory capture is inevitable

Channel participation of stakeholders through safeguards & mitigating strategies

1. Promoting Greater Balance & Diversity of StakeholdersBreaking up large banks (Johnson)

Creation of Participatory Mechanisms: “fair, transparent, accessible, open” (Mattli & Woods)

Tripartitism

Proxy Advocates (Consumer Panels; Finance Watch)

Altering incentives of financial firms lobbying E.g. Insurance industry and car safety standards Promoting long-termism and diversity within financial industry

(compensation rules, fiduciary duties of boards, whistleblowers)

2. Getting the institutional design right

Mandate: danger of conflicting/ambiguous mandates

Internal decision-making processes Rotation requirements, internal

audit, devils’ advocates; IMF’s IEO: ‘strengthen the

incentives to “speak truth to power”’ and ‘create internal advisory boards ‘to challenge and think the unthinkable’

2. Getting the institutional design right

Hiring practices: Mitigating strategies: e.g.

disclosure, cooling off periods, complement “revolvers” and career supervisors

Promote diversity of experiences and training (e.g. IMF)

Funding Level Sources (government vs. levies

from fin. industry)

Limits of existing checks Board of Directors; Parliament; Press.

Transparency Sunshine clauses requiring US regulators to

publish details of meeting with industry representatives

3. External Checks & Balances

Public Interest Review Bodies “The Sentinel” (Barth Caprio and

Levine 2012)

Reciprocal oversight from other domestic regulators

Macroprudential regulators; Consumer protection bodies;

Reciprocal oversight from foreign regulators

Financial Stability Board’s peer review,

Colleges of Supervisors, IMF’s surveillance (FSAP and ROSC)

3. External Checks & Balances

Conclusion

Paradox of financial regulation: Interaction between regulators and regulated firms/stakeholders….

… is necessary to design regulatory policies

… open the policymaking process to the risk of regulatory capture

Some degree of capture is inevitable

Channel participation of stakeholders through safeguards & mitigating strategies

Thank you for your attention