The Harm of Regulatory Disharmony

LONDON – In the alphabet soup of institutions involved in the regulation of global financial markets, the FMLC – the Financial Markets Law Committee – is not very prominent. Given that it is based only in London, having grown out of an initiative by the Bank of England 20 years ago, and that most of its members are lawyers, most banks have not even heard of it (though some of them are represented on its Council). But the services provided by the FMLC have never been more necessary.

The FMLC’s mission is to identify and propose solutions to issues of legal uncertainty in financial markets that might create risks in the future. As a recent FMLC paper showed, the wave of new regulations implemented since the global financial crisis – many of which were poorly planned or inconsistent across countries – has left a jumbled landscape of legal uncertainties.

Consider banks’ capital requirements. The Basel 3 Accord, adherence to which increased the liquidity of all banks and decreased their leverage, is viewed as a firm standard in some parts of the world. But, in others, it is regarded as a minimum to which additional rules may be added. Such “super-equivalence” or, more colloquially, “gold-plating” creates inconsistencies across jurisdictions, thereby facilitating regulatory arbitrage.

Likewise, the European Union, in contrast to the United States, regards the leverage ratio as a supervisory optional extra, known as a “Pillar 2 measure” (which permits supervisors to add additional capital buffers to address a particular bank’s idiosyncratic risks). And, though both the US and the EU prohibit proprietary trading, they each define it differently.