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The Nature and Purpose of Financial Regulation

The Nature and Purpose of Financial Regulation. Douglas W. Arner Professor & Head, Department of Law University of Hong Kong. Overview. Finance Evolution of financial regulation Financial stability and economic growth East Asia. The Global Economy.

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The Nature and Purpose of Financial Regulation

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  1. The Nature and Purpose of Financial Regulation Douglas W. Arner Professor & Head, Department of Law University of Hong Kong

  2. Overview • Finance • Evolution of financial regulation • Financial stability and economic growth • East Asia

  3. The Global Economy • 2011 Global GDP (current prices – real exchange rates): US$ 70.16 trillion • 2011 Global GDP (purchasing power parity – PPP): US$ 78.95 trillion • Source: IMF / CIA

  4. Trade in Goods 2011 (Source: WTO) • Exports: US$ 17.779 trillion (20% increase) • Imports: US$ 18 tr (19% decrease) • North America: US$ 2.283 / 3.090 tr • Europe: US$ 6.601 / 6.854 tr • South and Central America: US$ .749 / .727 tr • CIS: US$ .788 / .540 tr • Africa: US$ .597 / .555 tr • Middle East: US$ 1.228 / .665 tr • Asia: US$ 5.534 / 5.568 tr

  5. Trade in Services 2011 (WTO) • Exports: US$ 4.150 tr (11% increase) • Imports: US$ 3.865 tr (10% increase) • North America: US$ .668 / .516 tr • South and Central America: US$ .130 / .163 tr • Europe: US$ 1.964 / 1.605 tr • CIS: US$ .096 / .133 tr • Africa: US$ .085 / .149 tr • Middle East: US$ .111 / .210 tr • Asia: US$ 1.096 / 1.091 tr

  6. Foreign Direct Investment 2011(Source: UNCTAD) • Inflows: US$ 1.524 tr • Outflows: US$ 1.694 tr • Stock: In – US$ 20.438 tr / Out – US$ 21.168 tr • Developed • Inflows: US$ .748 tr • Outflows: US$ 1.237 tr • Stock: In – US$ 13.065 tr / Out – US$ 17.056 tr • Developing / transition • Inflows: US$ .684 • Outflows: US$ .384 • Stock: In – US$ 6.625 tr / Out – US$ 3.705 tr

  7. Global Financial System, 2010 (Source: FSB) • Global financial system: approx. US$ 240 trillion • Shadow banking system: approx. US$ 60 trillion

  8. Currency and Derivatives (Source: BIS) • Daily global foreign exchange turnover (including spot, forwards, swaps, options and other products): US$ 4 tr, 65% cross-border (Apr. 2010) • Over-the-counter (OTC) derivatives (end-2011) • Notional value: US$ 648 tr • Replacement: US$ 27.3 tr

  9. Purpose of Financial Markets • Pricing / allocation of financial resources • Efficient pricing / allocation = financial development • Financial development = economic growth • Economic growth = development • But: financial crisis = high costs • Overall: confidence – key

  10. Globalisation of Finance 1870-1914 “Golden Age” 1914-1944 Interwar 1944-1973 Bretton Woods 1973-1982 Oil Crises 1982-1993 Internationalisation 1993-2007 Globalisation 2007 to present Global financial crises

  11. Market failures, Intermediation and Indirect Finance • Irrational behaviour • Imperfect competition • Transaction costs • Asymmetric information • Adverse selection • Moral hazard • Externalities: systemic risk

  12. “Infrastructure”: Law, Regulation, Institutions • Market functioning / efficiency / development • Systems: exchange, payment, clearance, settlement, custody • Rules: competition, behaviour, transactions costs, information • Information: data, research, ratings, compliance • Fairness • Macroeconomic / monetary policy / development • Systemic risk / financial stability • Overall: Confidence – key

  13. Elements: Prevention • Financial infrastructure: payment / settlement – plumbing (OTC derivatives) • Well-managed financial institutions: licensing, risk management, corporate governance, market discipline • Information • Financial institution safety and soundness: prudential regulation

  14. Elements: Addressing crises • Liquidity provider of last resort: central bank • Financial institution resolution mechanisms, including insolvency • Consumer protection: deposit insurance etc

  15. Systemic Risk and Financial Stability • Systemic risk: • The risk that an event will trigger a loss of economic value or confidence in, and attendant increases in uncertainty about, a substantial portion of the financial system that is serious enough to quite probably have significant adverse effect on the economy. • The adverse real economic effect are generally seen as arising from disruptions to the payment systems, to credit flows, and from the destruction of asset values. • Financial stability • Positive • Negative

  16. Global finance and crises: Analytical framework • Crises • Currency • Banking / financial • Debt • Liquidity / solvency • Private / sovereign

  17. East Asia: Development models • Competitive experimentation • Japanese developmental state model: exports + administrative direction of finance • Financial liberalization • AFC: limitations

  18. AFC to GFC • Export-led growth • Reserve accumulation • Financial reform • Regional cooperation

  19. Asian regional financial integration: Rationale • Crisis imperative • Economic imperative: trade / investment / integration • Development imperative: Asian resources • Political imperative: counterbalance to EU/euro, US/US$ • Context and approaches • Domestic / regional / external • Supply / demand

  20. Asian finance post-GFC • Trade • Investment • Capital • Financial services • Post-crisis regulatory agenda • Liberalization? • The role of China

  21. Financial reform • Post-GFC debate: what model? • Crisis lessons • Financial stability • Domestic / regional economic / financial conditions • Access to finance: underdeveloped rural / urban areas • Risk management tools: derivatives • Innovation: Shadow banking

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