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retail financial services April 30, 2008

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Recent developments in thinking about retail financial services: the Joint Forum published a paper on customer suitability in the retail sale of financial products and services, stating:

concerns about the impact of mis-selling are arguably an area where concerns about system stability and investor protection meet.

And the UK’s FSA published the interim report for its Retail Distribution Review:

The aim of the RDR is for more consumers to have sufficient confidence in the market to want to use its products and services more often. To achieve this, we need an industry that more clearly acts in the best interests of its customers and treats them fairly.

bartle and the politics of regulating games April 29, 2008

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Just after the Commission’s decision to focus on online games, Richard Bartle (writes in the Guardian) suggesting that the political paranoia about computer games is time limited as gamers age:

Gamers vote. Gamers buy newspapers. They won’t vote for you, or buy your newspapers, if you trash their entertainment with your ignorant ravings. Call them social inadequates if you like, but when they have more friends in World of Warcraft than you have in your entire sad little booze-oriented culture of a real life, the most you’ll get from them is pity.

eu commission and on-line games April 25, 2008

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The Commission is concerned about the (lack of) regulation of online video games in the EU:

Overall, the Commission considers that additional efforts are needed with regard to on-line videogames, in order to take account of their specificities: a swift and effective mechanism for age verification is needed, and particular attention should be paid to chat rooms. A pan-European dialogue between all stakeholders would be useful in this respect.
In this context, the EU policy to reinforce public-private cooperation against cyber crime, and in particular against illegal and harmful content on the Internet, may serve as a starting point.

transparency of comments on proposed regulation April 24, 2008

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On reading the LIBA-SIFMA response to the FSA’s January 2008 Discussion Paper on a Review of the Structure of the Listing Regime I thought it would be interesting to see what other organizations had expressed views on the DP and what those views were. If this were a regulatory proposal published by the SEC I’d be able to look on the SEC’s website for comments. For example, here are comments on the recent naked short selling anti-fraud proposal. But the FSA produces response papers analysing the various responses rather than publishing them itself. Trade associations do publish their responses on their own websites, so it is possible to find them, at least in some cases, but relying on commenters to make their comments available produces a less transparent process than if the regulator makes all comments on a particular proposal available in one place.

I often think the FSA makes more effort to consider the interests of financial services consumers than CESR, but here is one example where that is not the case as CESR does itself publish the comments it receives on its own initiatives. In some ways, having the FSA analyse and summarise the responses is helpful (see for example this document on responses relating to private equity) but it would be nice for transparency to have easy and immediate access to comments as they are being made (as is the case with the SEC) as well.

real world, virtual world April 23, 2008

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I have just read a paper by Vili Lehdonvirta which challenges the distinction much mmo/mmorg scholarship makes between real and virtual worlds (the author cites a paper I wrote with Michael Froomkin among the examples of this distinction). It’s a really interesting paper. Lehdonvirta says:

This game-like character of everyday life has not gone unnoticed in MMO studies: Castronova equates society with a large game, although he only sees one game instead of a multiplicity (Castronova, 2006a: 171). At the same time, in some instances MMO gameplay is increasingly resembling work: laborious, tedious and occasionally lucrative (Yee, 2006; Grimes, 2006: 982-985). For all these reasons, I believe it does not do injustice to MMOs to treat them on par with other fields of life, instead of placing them on a separate plane.

I agree with this approach and am working on the ways in which real world financial activity and virtual world financial activity resemble each other – traders on the financial markets may behave as if they are playing a game and some virtual world participants are serious about generating revenue. The trouble is that once we collapse the distinction in the literature between the real and the virtual that has significant implications for the application of legal rules.

For lawyers I think the real/virtual distinction makes sense. Lawyers like to solve problems by defining categories and making distinctions, and we can use up a lot of energy arguing about those distinctions. The rules that apply to different types of tangible and intangible property may be different. And lawyers generally spend a lot of time thinking about jurisdiction: jurisdiction to regulate, jurisdiction to enforce, jursidiction to decide disputes. We tend to think a lot about questions about allocations of power between different geographically defined and hierarchically defined authorities. And there’s a recurrent problem of the extent to which people should be allowed to contract around rules which have a public policy component.

Just because it caught my eye, here’s another example of a real/virtual world distinction in the most recent spiffworld Jonathan Coulton video which is a response to the original here (which uses photographs from flickr) (and which Coulton likes) :

regulators and politics April 18, 2008

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Interesting article by Tom Winsor in today’s FT, commenting on the applicability of the decision in Corner House Research and Campaign Against Arms Trade v Director of the SFO to economic regulators:

Despite the policy perils, and the outright illegality, of submitting to improper political threats, regulators now too often bend the knee. Some blur the distinction between the will of parliament and the will of ministers, insisting that appointed regulators lack the democratic legitimacy of elected politicians. When challenged that his legitimacy comes from the highest democratic authority — parliament and the rule of law — one economic regulator recently said to me that he regarded the supremacy of the rule of law as a “scary concept”. Such a fundamental error may suit control-obsessive ministers, but it does great harm. This decision of the High Court should fortify regulators when next they face interfering ministers. Their eager supplications should end.

Commentary at OurKingdom suggests that the article is “astonishingly muddled”, but I don’t see it in quite the same way. Winsor clearly says that:

Regulators can lose their independence or jurisdiction in two ways. Either parliament legislates, or the regulators, by their behaviour, show that they will give way to improper pressure to act contrary to their statutory duties.

the limits to libor April 17, 2008

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The story that banks may not have been reporting rates accurately for the construction of libor is, as Paul Krugman notes, worrying. Worrying because it suggests that the funding situation for major banks (in the interbank market) is worse than we know. Worrying because some of this problem is caused by a lack of confidence in banks and the financial system generally. Worrying because if it turns out to be true that some of the major banks which are members of the BBA’s contributor panels have been quoting inaccurate rates then confidence will, justifiably, suffer even more than it already has.

The underquoting risk was suggested, for example in an article by Jacob Gyntelberg and Philip Wooldridge in the BIS Quarterly Bulletin:

The widespread use of fixings as reference rates also gives contributing banks an incentive to misquote. The costs of manipulating a given rate might be outweighed by the potential profit from positions based on those rates … For example, market participants with large positions in derivative contracts referencing a rate fixing might seek to move the fixing higher or lower by contributing biased quotes. Alternatively, they might indirectly influence the accuracy of the fixing by choosing not to join the contributor panel.
The scope for such strategic behaviour to influence the fixing can to some extent be limited by trimming, in which biased or extreme quotes are disregarded. However, even trimmed means can be manipulated if contributor banks collude or if a sufficient number change their behaviour.

The description of such underquoting as merely “strategic behaviour” is troubling to me, when the higher rates might suggest a market perception of counterparty risk that might be material to investors in an underquoting bank’s securities. Surely it is more serious, more troubling, than just strategic behaviour? But the idea that it may be acceptable for a borrower to manipulate the appearance of its creditworthiness has surfaced before. Another author, writing in the BIS Quarterly Review in 2006 stated that a utilisation fee for a loan:

enables the borrower to announce a lower spread to the market than what is actually being paid, as the utilisation fee does not always need to be publicised.

Is there a way to rescue BBA libor? The BBA does have the ability to exclude banks from its contributor panels, although deciding whether or not to do so must be a complex problem, particularly given the profiles of the banks in question.The BBA’s US dollar panel is: Bank of America, Bank of Tokyo — Mitsubishi UFJ, Barclays Bank plc, Citibank NA, Credit Suisse, Deutsche Bank AG, HBOS, HSBC, JP Morgan Chase, Lloyds TSB Bank plc, Rabobank, Royal Bank of Canada, The Norinchukin Bank, The Royal Bank of Scotland Group, UBS AG, and West LB AG.

Over the last few months, 3 month libor has often been significantly higher than the effective federal funds rate. So, from the perspective of mortgage borrowers with libor-based mortgage loans, as the WSJ points out, lower rates produced by any underquotes are a good thing.

basel committee and the resilience of the banking system April 16, 2008

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The Basle Committee announced that it was working on a number of steps including:

* Enhancing various aspects of the Basel II Framework, including the capital treatment of complex structured credit products, liquidity facilities to support asset-backed commercial paper (ABCP) conduits, and credit exposures held in the trading book. At the same time, the Committee notes the importance of prompt implementation of the Basel II framework, as this will help address a number of the shortcomings identified by the financial market crisis.
* Strengthening global sound practice standards for liquidity risk management and supervision, which the Committee will issue for public consultation in the coming months.
* Initiating efforts to strengthen banks’ risk management practices and supervision related to stress testing, off-balance sheet management, and valuation practices, among others.
* Enhancing market discipline through better disclosure and valuation practices.

And the UK government plans a scheme to support mortgage loans made before the end of December 2007.

risk and regulation April 15, 2008

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In January Gordon Brown announced the establishment of a Risk and Regulation Advisory Council which was going to take over from the Better Regulation Commission. At the time some commentators suggested that setting up another commission in this area was not the answer and that more aggressive action was necessary (to reduce regulatory burdens). The RRAC doesn’t seem to have done a whole lot in the last couple of months – they don’t even seem to have their own web pages but lurk on the BERR website. Of course, now may not be the best time to be dismantling too many rules : the financial markets are uncertain at best right now.

Meanwhile, other government departments are moving forward on their own risk agendas. The Department for Work and Pensions is steaming ahead with proposals to increase the Pensions Regulator’s powers to issue contribution notices requiring payments to be made into a pension scheme:

The Government therefore proposes that Contribution Notices may be issued where the effect of an act is materially detrimental to a scheme’s ability to pay members’ current and future benefits in order to cover situations such as this. This change would mean that the Regulator would no longer need to prove intent on the part of a party to avoid funding the scheme, but rather that the effect of an act or course of conduct posed a materially detrimental risk to members’ benefits.
The Government recognises that a new power such as this must be defined carefully to give clarity to pension schemes and their sponsors, and to ensure that it may be deployed by the Pensions Regulator where necessary without undue burden. It will therefore consult on the best approach to draft such a power. The Government will ensure that new powers are appropriately targeted on actions which pose risks to pension schemes. For example, it may be appropriate to limit the use of the power to situations in which the prospective recipient of a Contribution Notice is unable to demonstrate that the likely consequences of their actions could not reasonably have been foreseen.
The Government also proposes to remove the existing provision that states that a Contribution Notice may not be issued where a party has acted in good faith, but their actions have had the effect of preventing a debt becoming due. Operational experience has shown that this is an unhelpful hurdle which would prevent the power being used in situations where parties have simply not considered impacts on pension schemes.
These approaches have precedent in tax legislation — but we are consulting widely to avoid legislation with unforeseen side-effects.

The detailed consultation paper is yet to be published although the Government proposes to backdate the effect of the rules to April 14th. The language of the reference to the consultation is unusually frank:

This consultation approach will ensure that everyone gets a chance to influence the way these changes are made.

iif on risk management April 10, 2008

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There’s some very interesting material on risk in the IIF’s Committee on Market Best Practices’ just published Interim Report. For example:

For complex, structured products, a number of product-design issues require risk management examination, and a robust new product approval and monitoring process including oversight from the most senior levels of the firm. For example, the
“triggers”in structured products — ratings, asset-performance or other tests that suddenly require credit enhancement or liquidation of a vehicle — may, in some cases, have been treated as essentially drafting issues, with insufficient analysis of their
potential cumulative effect on the product, holders of interests, or the firm. It is also important to consider the implications of payment “waterfalls”through tranches, both for own account and for investors, and to analyze a firm’s holdings of all tranches of a given deal on a consolidated basis. As a general matter, the various disciplines involved in developing complex transactions (business, legal, compliance, risk, operations, accounting, tax, etc.) may more often than has sometimes been the case need to step back and look at transactions from an integrated, economic point of view over its development from inception to maturity, rather than from a series of specialists’ viewpoints.

There are some implications here in terms of how we should be developing cross-disciplinary education in business, finance and law.