Journal 36: Global Finance and Regulation

This issue of the Capco Journal of Financial Transformation has a number of papers that deal with the problems of finance in a “bigger picture” context. We feature articles with high-level critiques of how the financial system is organized and operates; critiques on whole paradigms that are employed by a large part of the industry, such as econometrics; articles that explore the relationship between business models and regulation, the relevance of risk management techniques in systemically important banks, and the systemic role of credit rating agencies; and further contributions that examine general fractal and multi-fractal properties of time series, or offer an analysis of instruments that are directly related to banks’ capital policies, namely CoCo bonds.

Even as we write, the consistent global regulation of financial markets remains a utopia, or dystopia, depending on one’s perspective.

We have witnessed the evolution of finance into a global tool that transcends sovereignty, geography and local legislation, to the point that regulation is struggling to fulfill its very purpose – to effectively regulate global financial markets. Previous issues of The Journal of Financial Transformation have presented many and different views on this topic. Are the Basel Committee recommendations that are being considered by European banks, recommendations coming from a country that is not part of the European monetary union, going to be consistent with the Dodd Frank act in the US? What of regulation in Asia and emerging markets in South America? These recurring questions will surely keep us busy for quite some time to come.

Finance employs tools and products that easily cross borders and continents, and whose risks, in a number of cases, cannot easily – if at all – be analyzed separately. The outstanding notional of derivatives in 2011 was US$708 trillion, as opposed to the planet GDP that then totaled around US$79 trillion. While the notional contains much double counting, it is staggering to see this size for derivatives markets in 2011, slightly less than ten times the gross domestic product of the planet. Let us not forget that derivatives markets, often referencing global risks, represent only a small portion of innumerate and often highly complex financial instruments.

According to the Tax Justice Network, largely reported in the mainstream press, the “global wealthy elite” has leveraged gaps in cross-border tax rules to hide US$21 trillion of wealth offshore – the same as the US and Japanese GDP combined. It therefore goes without saying that regulation too, to be effective, should be global. On the other hand, if regulation is poor or ineffective, making it global would not be ideal, and the Basel framework has been criticized several times for providing a false sense of security to the market.

Journal Articles