While Christine Lagarde, managing director of the International Monetary Fund (IMF), was in London last month, she heavily criticized the ‘fierce industry pushback’ that was manifesting itself in delays to financial sector reforms. This is not necessarily news to most who follow the developments in financial sector reform and regulation, but it is an important statement that needs to be reiterated. Ms. Lagarde’s sentiments were summed up by her statement that the, “… industry still prizes short-term profit over long-term prudence.”

This is often painfully true as exhibited by prominent attempts to slow or even inhibit the introduction of stricter rules and regulations in financial services. There have also been what seems to be an endless stream of front page cases of financial misconduct – from money laundering to the benchmark manipulation (for example, the manipulation of Libor).

Former Bank of Canada governor Mark Carney, currently serving as the governor of the Bank of England, echoed Ms. Lagarde’s sentiments along with many other policymakers and regulators.

Jamie Dimon, the current CEO of JPMorgan Chase, is one of the industry’s loudest voices when it comes to speaking out against tougher regulation. Some of his prime arguments are that, at the end of the day, customers would have to pay more for harsher regulation and that tougher rules are anti-American.

But that is not to say that all of those in the industry feel the same way as Mr. Dimon. There are those who consider, this writer included, a balanced regulatory approach to be absolutely crucial to not only the safety and soundness of the financial system but also to the stability of financial institutions. Progress has certainly been made with regards to capital, liquidity, and risk management, but there are certainly holes that need to be filled to properly safeguard the system. This is where a well thought out regulatory framework needs to be put into place. Such a framework would utilize a variety of enforcement mechanisms to ensure that new rules are actually adhered to rather than scoffed at. Another measure that desperately needs to be addressed is the notion that a financial institutions can be too big to fail (TBTF). These designations seemingly give select institutions a free pass that, even in the instance of non-compliance, they will not be allowed to fail as an organization.

Overall, it is clear that, despite industry pushback from key players, increased regulation is here to stay for the foreseeable future. Time will tell if policymakers and regulators find a balanced approach that gains traction and buy-in from the industry.

The consumer credit industry is quickly expanding in the United Kingdom and is therefore under the microscope of regulators, namely the Financial Conduct Authority (FCA). One of the most prominent among these growing ranks is that of the payday lender and, in correlation, the FCA is going to be closely monitoring these lenders for unfair practices.

The business model of the payday lender is fairly straightforward – in exchange for loans from these businesses, consumers must accept both high costs and short terms. It is not particularly surprising that the potential for unfair practices is ripe under these conditions. As such, the FCA will be cracking down on these consumer credit providers starting in April of 2014, when the responsibility of regulating the industry transfers from the Office of Fair Trading (OFT) to to the FCA. At that time, approximately 50,000 firms will be required to comply with new consumer protection regulations. These new rules and guidance will revolve around the core principle of transparency. More specifically, they will address misleading advertising along with the provision of advice. There will also be limitations on the use of continuous payment authorities. This proposal entails that payday lenders will be limited in the amount of times they can access payments from a customer’s bank account. This will help to alleviate the degree of control they hold over customers’ finances while enabling customers to maintain some independence and flexibility.

Overall, the Chancellor of the Exchequer has gone on to insist that a cap be placed on the exorbitant costs and burdens incurred by the borrower in such transactions. Ideally, the new oversight powers and rules for the FCA will equip it with effective enforcement tools and mechanisms to ensure the protection of consumer interests.

Source: Financial Conduct Authority – Consumer Credit

The topic of bitcoin and digital currencies is permeating not only discussions among regulators but also those of politicians. Most recently, United States Congressman Jared Polis wrote a letter to Treasury Secretary Jack Lew, Federal Reserve Chairwoman Janet Yellen, Comptroller of Currency Thomas Curry, Acting CFTC Chairman Mark Wetjen, FDIC Chairman Martin Gruenberg, and SEC Chairwoman Mary Jo White. In it he uses a satirical tone to address the greenback by levying similar criticisms against paper currencies that have been laid against digital currencies. Here are some excerpts from Mr. Polis’s letter:

“I write today to express my concerns about United States dollar bills. The exchange of dollar bills, including high denomination bills, is currently unregulated and has allowed users to participate in illicit activity, while also being highly subject to forgery, theft, and loss … I urge regulators to take immediate and appropriate action to limit the use of dollar bills.”

“Printed pieces of paper can fit in a person’s pocket and can be given to another person without any government oversight. Dollar bills are not only a store of value but also a method for transferring that value. This also means that dollar bills allow for anonymous and irreversible transactions.”

While Mr. Polis clearly took a humorous approach to pointing out the flaw in the logic of some of the arguments against bitcoin, he still raises the overall valid point that not even established forms of currency are infallible. It is clearly important that as technology continues to progress, we remain open-minded and prepared to address emerging developments to ensure the safety and stability of the financial system.

Source: Polis Calls for Ban of U.S. Dollar Bills in Response to Manchin Letter Calling for BitCoin Ban

Here is a quick news update to complement Banfield’s last post:

The Law Library of Congress has recently released a report entitled the Regulation of Bitcoin in Selected Jurisdictions. This report outlines the current regulatory environment surrounding bitcoin and other digital currencies around the world. As one reads through the report, it is clear that the approach by all countries is not consistent. Some, like Canada, are more receptive to bitcoin while others, like China, are very forthright in their cautioning about the dangers of digital currencies.

Earlier this month the Wall Street Journal reported that, according to a Canadian official from the Department of Finance, bitcoin is not considered to be legal tender in Canada. This is not particularly surprising considering that the term ‘legal tender’ is described in the Currency Act (R.S.C., 1985, c. C-52) as:

8. (1) Subject to this section, a tender of payment of money is a legal tender if it is made

(b) in notes issued by the Bank of Canada pursuant to the Bank of Canada Act intended for circulation in Canada.

Along with section 7 of the Act, which describes the Royal Canadian Mint as the current authority to issue coins in Canada, it is clear that legal tender is a state-centric term. More specifically, the two authorities described in the Act that are allowed to issue ‘legal tender’ currency are the Mint and the central bank. Therefore, it can be argued that this is an issue of semantics in that ‘legal tender’ is a descriptor of state-backed currency which is, at the end of the day, fiat money.

With this in mind as the qualifier of ‘legal tender,’ it seems that bitcoin would not necessarily be considered as automatically ‘illegal.’ In fact, the Canada Revenue Agency (CRA), Canada’s taxation authority, has a fact sheet on its website addressing digital currencies. The fact sheet clearly acknowledges that digital currencies can be used as legitimate forms of payment. More specifically, they state that:

Digital currency is virtual money that can be used to buy and sell goods or services on the Internet. Bitcoins are an example of digital currency. Bitcoins are not controlled by central banks or any country, and can be traded anonymously. Bitcoins can be bought and sold in return for traditional currency, and can also be transferred from one person to another.

Therefore, it can be seen that, regardless of whether bitcoin is ‘legal tender’ in Canada, it is considered to be a legitimate form of money by agencies such as the CRA. In fact, Canada has embraced digital currencies more than some of its Western counterparts, with the country now host to a growing number of bitcoin exchanges and ATMs. Given that digital currency is being utilized by an increasing number of Canadians, it is important to consider its regulatory implications. While the relative volume of alternative currencies such as bitcoin is quite low in comparison to traditional currency, there is still a degree of risk that it might pose to the financial system. As such, authorities, such as the Bank of Canada, have a careful watch on the realm of digital currencies and seem well-positioned to lead the charge on monitoring and regulating them to ensure that safety and stability are maintained.

It is very easy for consumers to overlook the payments process when they are at a point of sale. Technology has allowed us to swipe a card, insert a chip, or wave some plastic and be on our way. However, there is a complex and well-oiled machine running behind all of these payments. Aside from this, there are several actors involved in the processing of transactions, one of which is the third party processor.

These third parties often work as an intermediary between a business/retailer and financial institutions. They can provide various payments services for financial institutions and also serve as a connection to the payment system.

So, from a financial regulation perspective, how should these intermediaries be addressed? After all, they impact a financial institution’s risk-based strategy with regards to monitoring and supervising identified risks. More specifically, financial institutions need to be able to conduct appropriate due diligence on their customers and partners. For example, they need to be aware if a third party processor that they use conducts appropriate monitoring of suspicious activities.

Overall, financial institutions need to have effective risk-based management in place when it comes to relationships with such processors. This can be achieved through, among other things, thorough due diligence and know your customer (KYC) procedures when signing an agreement with a processor in addition to monitoring for changes in its activities, operations, or customer relationships.

Reference: Federal Reserve Bank of Atlanta, Securing All the Links in the Chain: Third-Party Payment Processors

It is clear that, in a post-crisis world, strong and comprehensive financial regulation has become pervasive. The road to a safe and sound financial future that is transparent is paved with acts, rules, guidelines, and frameworks. While it is necessary to have such regulation in place, it is often viewed with great apprehension and dread by many financial institutions. This is often due to the fact that regulation leads to a regulatory burden. Specifically, we are talking about the resource costs to meet regulatory requirements (i.e. financial, human, and time).

Meeting these requirements can be particularly challenging for smaller institutions that have been trying to grow in a post-crisis world. To challenge well-established institutions by simultaneously growing operations and meeting increasing compliance needs is a difficult task, to say the least.

To address this issue, some experts are of the opinion that it is time to consider compliance as a shared service within markets. What this means is that institutions should be able to utilize a shared service that collectively provides a platform for smaller institutions to meet their respective requirements. Overall, the goal would be to improve efficiency through economies of scale.

Overall, the major point to get across is that compliance is something that is here to stay. Whether such a shared service centre for institutions will ever come to fruition in Canada is not the primary issue in this post. The focus is rather on institutions, big or small, finding cost-effective ways to meet their regulatory requirements. A shared compliance service is just one of many innovative ways to do so.

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