RECONCEPTUALISING GLOBAL FINANCE AND ITS REGULATION (& LAWS)

EXECUTIVE (LAW PRACTICE) SEMINAR

The University of Hong Kong

Saturday, 14 December 2013.

I. HUMAN RIGHTS (& SOCIAL RESPONSIBILITY) Compliance in Finance:

MULTILEVEL Activities, there is wide POLICY (regulatory) framework at International scale:

United Nations (UN) Global Compact (UNGC);

Organization for Economic Cooperation and Development (OECD);

International Labor Organization (ILO);

International Finance Corporation (IFC);

International Chamber of Commerce (ICC);

IFC, ICC & Private Institutions;

ISO 26000;

These frameworks can be compelling or (in most cases) voluntary (ie. self-regulation)

schemes.

They may also APPLY TO THE VARIOUS FIELDS of the Finance sector:

Retail & Private Banking;

Corporate & Investment Banking;

Asset & Wealth Management;

Project (& Trade) Finance, Public-Private Partnerships (PPP’s);

According to the nature of each field, risk and Due Diligence (DD) issues may vary.

THREE FACTORS are crucial in the Practical implementation of these frameworks:

1. Thun Group on Banks & Human Rights;

2. UN Guiding Principles;

3. Human, Material & Business Resources.

Ethical issues in Banking have become relevant in recent years; the Finance sector has to

become SOCIALLY RESPONSIBLE (to be held accountable to its stakeholders within the

many communities to which it serves)!

Another CRITICAL issue to address in this regard, is the global reach and diversification in

the modus operandi and resources of the INTERNATIONAL CRIME:

Same within areas where the need of prevention is patent, such as Money Laundering, or

Terrorism Financing; and

Grey areas, such as Human Trafficking, Drugs, Extortion, Arms Dealing, etc…

…Not to mention that (corporate culture) ETHICS & VALUES IMPACT the Financial

MARKETS (well, better said, the Human behavior influences markets);

Also the Legal aspect is equally important to be covered, however the problem in Legal

standards may be less evident, as they may be subjective and relative (ie. matters such as

loopholes, mainly in Domestic frameworks; and jurisdiction shopping, the latter in the case of

International Law and Conflict issues).

However, LEGAL RULES are not really enough to promote Social Responsibility in the

Finance sector. MARKETS’ ACTIVITY and regulation should be oriented too, not only

towards economic gain but also to ETHICAL RESPONSIBILITY;

In the end, ethics and integrity are important to MAINTAIN FINANCIAL STABILITY!

RISK CONTROL and culture (supervisory focus) is equally important…

In this regard, it is very important to become familiar with the concepts of:

AGGREGATE RESPONSIBILITY (Corporate and Leadership Responsibility): this means

that Directors and Officials who do have the authority to do so, are responsible in

PROMOTING ETHICS AND INTEGRITY (values) within the Financial institutions;

INTEGRITY OF THE MARKETS: which means ALL participants in the Financial markets

are responsible.

CULTURAL DRIFT nowadays, RELEVANT REMARKS:

1. We need to revert the idea that Corporate Governance in the Financial Sector cannot be

(or is not) ethical oriented;

2. In China and other East Asian Nations (Japan, Korea & ASEAN Countries), the trend

nowadays is that CONFUCIAN VALUES (such as strong social nuclei) are creating

impact in the way of regulating markets and doing business, as well as crating added

value;

3. ETHICAL JUDGMENT is ESSENTIAL for the integrity of the markets: for practical

matters, it is desirable to preserve the adequate functioning of these (mitigate systemic

risks), OTHERWISE, THE SYSTEM WILL FAIL;

4. Anyway, not loose sight of the notion of keeping “FREE MARKETS”: regulation schemes

should not be excessive or interventionist, while promote HEALTHY COMPETITION,

Financial & Social performance (development) go hand in hand;

5. WIN-WIN situation: in relation to past point 4, as Financial & Social performance go hand

in hand, integrity is important for creating and cultivating TRUST & ADDED VALUE in the

provision of services.

II. “SHADOW BANKING” & Systemic Risk:

First of all, WHAT IS “SHADOW BANKING”?

Shadow banking refers to a sub-sector of Finance, under which NON-(formal or “traditional”)

BANKING organizations or activities enter into Financial intermediation (it can be associated,

or not, to peer-to-peer (P2P) lending);

Shadow banking comes when Financial institutions require “safe assets” in order to secure

operations (anyway, what can be considered a safe asset, in this specific regard?);

However… Some institutions and activities of shadow banking can be better secured than

others.

Under normal circumstances (correct functioning of Financial markets), government debt is

considered as safe asset (ie. cash, treasury bonds, etc.)…

Shadow banking has caught the attention of Central Banks in recent years:

WHAT SHOULD GOVERNMENTS DO? In this regard, there are TWO CRUCIAL ISSUES TO

ADDRESS:

1. HOW TO PRODUCE safe assets, subject to the activity of shadow banking?;

2. HOW TO REGULATE safe assets, under which shadow banking activities are to be

undertaken…

The main reasons for which shadow banking activities are required and services demanded

are:

The need to create SAFETY (sub) markets in the Finance sector (on a wider sense);

Shadow banking activities (necessarily) operate with LIQUID assets;

Operate under (regulatory and or tax) EXEMPTIONS on certain assets;

How much Government INTERVENTION is there over operational assets? (in many

jurisdictions, they are not heavily regulated)…

Shadow banking can be either:

1. PART OF COMMERCIAL BANKING (Asset & Wealth Mgmt, Trust Schemes);

2. RESULT OF FINANCIAL DEPRESSION (Private, P2P Lending).

In the short-medium term (at least within an East Asian context), we may find as MAIN

DRIVING FACTORS, the following:

Financial (gradual) LIBERATION and de-regulation in Mainland CHINA;

Regulatory ARBITRAGE;

TECHNOLOGY development.

On the other hand, in the long-run, we may find as driving forces, the following:

More DYNAMIC networks and COOPERATION SCHEMES between Central and local

governments;

DUAL financial REGULATORY systems, not only in the traditional banking sector (in

general), but also in the sub-sector of Trust Services and Schemes;

Technology & TECHNIQUE: P2P Lending, online services…

Within a Global perspective, shadow banking has tended to become increasingly common

and strongly marketable in emerging economies and developing countries, especially since

FUNDING COMES FROM THE GENERAL PUBLIC;

As before mentioned, in several jurisdictions (for instance, within Africa and LatinAmerica) it

remains as a deregulated sub-sector… However, it is still nowadays a relatively small activity.

So, AT WHAT EXTENT SHOULD SHADOW-BANKING BE REGULATED? For instance,

there is no single way to address this question, and solutions may not be definite, especially

since WE ALREADY HAVE A SAFE ASSET CIRCULATING WORLDWIDE: MONEY (CASH)!

In addition, shadow-banking can also serve as an instrument of economy in emerging

markets, in order to promote socio-economic development. Shadow banking (especially in its

form of P2P Lending) is accessible to individuals who see it harder to enter the formal

commercial and traditional (banking) channels… In this specific regard, it is also worth to be

noted that here comes another related ISSUE: that one of CREDIBILITY on the formal Credit

System, which DERIVED FROM THE FINANCIAL CRISIS OF 2008…

Is it convenient and feasible to REGULATE (on a Centralized basis) and INTEGRATE (by

securitizing) the Private Lending schemes that exist besides the formal Credit System? At

what extent?

…This is a question that will remain in the air, at least within the foreseeable future!

III. TRANSNATIONALIZATION OF COMPLIANCE Frameworks in Finance:

FIRST ISSUE: the Financial Crisis that rose in 2008 (as it is usual of any Financial crises, be

them Domestic or abroad), came from a PROBLEM OF COORDINATION on Investment

patterns and Financial markets…

EXPECTATIONS come in this regard, as a KEY ISSUE!

KEY QUESTIONS TO ADDRESS:

1. HOW MUCH should markets be regulated?;

2. HOW TO SOLVE, or at least, address the COORDINATION issue?...

In relation to the second question before mentioned, it is important to remark that coordination

(in Financial supervisory frameworks and markets) should be effective enough to PREVENT

CONFLICT (or competition)!

Conflict comes when market players adopt AGGRESSIVE STRATEGIES: zero-sum games,

hawk-dove, “chicken” playing (the bottomline is: the dilemma for investors and participants in

the market, especially among those who are competitors is “should I SWERVE, concede, or

not?”);

After the Financial Crisis of 2008, the new paradigm of participating has been “it is preferable

to lose than to die”…

To address the question of “HOW MUCH should markets be regulated?” we should bear in

mind the issue of SALIENCE in networks (FOUR FACTORS):

1. Familiarity;

2. Visibility;

3. Singularity;

4. Authority;

The we can say that the LIMITS OF NETWORKS may vary according to these factors;

…Furthermore, other questions arise, deriving from the issue of salience:

THE MORE relevant and International that Financial institutions tend to become, the

tighter they should be regulated? (Most probably, YES);

HOW (AND WHY) should we enhance, or promote, the salience of networks?;

Again, also comes out the issue of LAW VS. ETHICS (or also LEGAL VS. REGULATORY

bonding): are Compliance schemes meant to be implemented and enforced for FEAR OR

RESPECT?... Does compliance with Law suffice, in order to ensure coordination in

Financial networks and markets? What is the PURPOSE OF THE LAW?

IV. LEX MERCATORIA in Finance:

Lex Mercatoria is historically known (since the Middle Ages) as legal guidelines under which

TRADE ACTIVITIES WERE MEANT TO BE UNIFORMLY REGULATED (on an International

basis), seeking to settle commercial disputes in the most expedite and equitable manner as

possible, according to the customs and practices of merchants in a given time (or region).

The concept of Lex Mercatoria HAS NOW BECOME BASIS of International Trade Law and

Finance, and even to their regulations, increasingly on a Global scale…

In the field of Finance, Lex Mercatoria comprises TWO ASPECTS of Law and regulation:

1. Principal guidelines (Global regulations and sources of Private International Law);

2. Financial standards (such as GAAP, or practices and customs);

The main sources of Financial Law and Regulations, at global scale, come from International

Organizations and their published guidelines from time to time:

International Monetary Fund (IMF);

OECD;

World Bank;

Financial Action Task Force on Money Laundering (FATF);

Basel Committee on Banking Supervision (Basel: I, II, III), among others;

However, the problem with International Legal (and even Regulatory) GUIDELINES is that

they may VARY ACCORDING TO MANY FACTORS:

IDEOLOGY (theory underlying the spirit of the guidelines);

INTERESTS (politics);

FOCUS (in seeking to protecting stakeholders);

Perspective or SCOPE (time and special applicability);

ENFORCEABILITY (is it compulsory or not?);

In other words, guidelines ARE NOT COMPREHENSIVE!

However, what brings standards together: is it the GAMING SYSTEM of Financial networks

and markets?

On the other hand, Legal Systems may vary on their features and ways of dealing with

conflicts, WE HAVE TWO PRINCIPAL MODELS:

COMMON LAW (oral, expedite, accusatorial trial system), operational in UK, USA &

Commonwealth Nations and former British Colonies, etc.;

CIVIL LAW (written, procedural, inquisitorial trial system), operational in EU and other

Continental Europe Nations, Latin America, Mainland China, etc.;

And we also have HYBRIDS AND OTHER, SIMPLIFIED (and even self-regulatory)

MODELS (ie. Bloomberg, ICC & IFC, Basel, etc.);

Then, the PURPOSE and the main ROLE OF LEX MERCATORIA in Finance is to UNIFY

CUSTOMS and practices in Legal and Regulatory frameworks that regulate trade and

financing operations, across different jurisdictions and systems, in order to simplify and drive

more smoothly the relations and practices in trade and financing operations, even in the

means of solving disputes.

Lex Mercatoria is now EVOLVING in the sector of Finance, towards the creation of a NEW

VARIANT which we may call LEX FINANCERIA; however, nobody can agree on what game

is being played (if compulsory or self-regulation, in which the latter case, salience is relevant).

Also, we should keep on sight that MARKETS ARE SENSIBLE TO REGULATORY

UPDATES AND MODIFICATIONS.

Even though various elements can be taken from both Legal systems Civil and Common Law,

the DIFFERENT FEATURES of each system have STRENGTHS & WEAKNESSES which

need to be addressed on a case-by-case basis, in order to implement and consolidate the

very ample frameworks of Lex Financeria.

(Just to mention an example, considering that oral covenants under the Common Law system

are valid for closing deals, these may prove reliable thanks to the intimacy and immediacy of

human voice, helping to create mutual trust among parties in a contract; however, the

problem with human voice is that it is not accurate, and it is a very casual, or informal, means

to follow the closing of a deal, reason for which the Civil Law system prefers to formalize

negotiations in writing.)

Until recently, it could be argued that the US (which belongs to the Common Law system) is

the “leading market”, or example to follow on Financial regulatory schemes…

In the case of ASIA, relevant regulatory and market changes are about to come with the

Finance and banking LIBERALIZATION which has been gradually taking place IN CHINA (a

regional market which represents more than 20% OF THE OVERALL FINANCIAL SERVICES

MARKET in the World, and belongs to the family of Civil Law, at least in the theory).

In this last regard, among the leading players in the Global Financial arena, it is yet to be

seen which path shall China and other East Asian countries follow, in the foreseeable future

(even there is little certainty whether China will be willing to integrate and actively participate

in the consolidation of the Global networks of Lex Financeria)…

What is sure at this moment, is that the implementation of major legal and regulatory

REFORMS KEY AREAS OF PUBLIC POLICY (Finance & Economy, Foreign Direct

Investment (FDI), and even in fields like Security, etc.), in China and other Southeast Asian

countries (emerging markets) will help to provide MORE CERTAINTY TO PLAYERS AND

INVESTORS.