Anabtawi and Schwarcz have recently examined a very relevant issue in the area of financial regulation – that of the utilization of law as an ex post response to financial failure. They note that financial regulation does not function as a silo, but rather as an interconnected system that exists between the regulatory environment (i.e. the law), markets, and the firms that exist within them. Policies aimed at addressing various financial issues will naturally be affected by the relationships between these actors.

The focus of the paper is the examination of the balance between preventative ex ante regulation and responsive ex post regulation. The examination of responsive regulation, legal approaches, and deterrent strategies is a common theme in the world of regulatory theory. For example, in Adversarial Legalism: The American Way of Law, Kagan notes that regulation in the United States is heavily influenced by a cautious view of governments and businesses. Policymaking is heavily legalistic and emphasizes penalties against offenders as preventative measure against unwanted behaviour. In contrast with this, other countries adopt strategies that use similar penalties only at later stages.

In addition to the type of policymaking environment, it has been widely discussed in regulatory enforcement theory that a balance between voluntary preventative actions that go beyond minimum compliance and deterrent strategies for offenders is crucial. These examples can easily parallel the specific situation examined by Anabtawi and Schwarcz – how can a balance be struck between responsive law and deterrent law, when it comes to financial failures?

As they explain, the realm of financial regulation does not consist of simply imposing a set of norms or rules on markets and firms. It also involves strategies designed to address the evident systemic risks that financial failures pose to the world’s economies. They find that, as with many areas of regulation, a balanced approach between ex ante and ex post regulation should be taken when creating financial policies. Ex post approaches have been criticized in recent years, especially after the financial crisis; a view that Anabtawi and Schwarcz say is not particularly effective. The Dodd-Frank Act illustrates the negative view of ex post measures in several of their provisions which, as it is argued, increases risks to systemically important financial institutions.

Overall, ex post measures need to be in place in conjunction with ex ante approaches when it comes to financial regulation. The risk of not having such measures in place at the beginning of a financial crisis means that regulators will likely end up responding with hastily drafted and poorly-timed regulations that are applied in an ad hoc fashion. Ex post strategies are necessary tools that aid in the containment of the many adverse consequences of a financial crisis.

Reference: Regulating Ex Post: How Law Can Address the Inevitability of Financial Failure