Government and Institutions

Statutory regulation vs private regulation

The EU’s second Markets in Financial Instruments Directive (MiFID II) came into force earlier this month. According to the European Securities and Markets Authority (ESMA), its 1.7 million paragraphs will make financial markets more efficient, resilient and transparent.

But will they? Is MiFID II well-designed?

As with any major new regulation, the effects of MiFID II will not be observable for many years, if ever. Nevertheless, it’s a safe bet that MiFID II is poorly designed, for a simple reason: The bureaucrats who made it need not compete for customers. Cars, clothes, medical services and everything else tends to be shoddy when made by people who face no competition. Why should regulations be an exception?

Consider a stock exchange making its own rules, such as reporting requirements for companies listed on it and membership criteria for brokers.

If the rules are too lax, the exchange will be a perilous place for investors and it will lose business to exchanges with stricter rules. Equally, if the rules are too onerous, companies will not list on the exchange and it will lose business to competitors with less onerous rules. Competition makes stock exchanges offer rules that find a good trade-off between the interests of issuers and of investors. Those that don’t will go out of business.

Stock exchanges are not unusual in imposing rules on their customers. It is unavoidable for many private enterprises – banks, insurers, universities and tennis clubs, among others. And, as with stock exchanges, if they do a bad job of designing their rules, they will lose business to competitors who do better.

Contrast such private sector rule-making with governmental rule-making. If MiFID II is a poor set of regulations, ESMA will not go out of business. It is funded from taxation, not from willing customers. And, short of giving up trading in European securities, the firms it regulates cannot “vote with their feet”.

The bureaucrats of ESMA have no financial incentive to improve their regulatory product. Yet I am confident that they will do much work to revise it over the coming years. How else can they justify their ongoing employment? Regulators funded from taxation benefit not from the quality of their rules but from the quantity of them. Rules that require revision are even better than rules that don’t.

If you doubt it, ask yourself why the quantity of regulation grows every year along with the number of people employed in regulatory agencies. Why were the last regulations never quite enough? Why was the first MiFID, which came into force in 2004, 1.7 million paragraphs short of the proper total?

For governmental regulators, failure is success.


Recommended further reading:

Former Director of Research

Jamie Whyte is the former Research Director at the Institute of Economic Affairs. Prior to joining the IEA, Jamie was the leader of ACT New Zealand as well as the Head of Research and Publishing at Oliver Wyman Financial Services. He has previously worked as a management consultant for the Boston Consulting Group, as a philosophy lecturer at Cambridge University and as a foreign currency trader.

2 thoughts on “Statutory regulation vs private regulation”

  1. Posted 16/01/2018 at 15:46 | Permalink

    It’s not a question of competition per se but a question of transparency and power.
    Sometimes markets make things better. Sometimes government regulators are required to make the markets work.
    Financial regulation worked badly for consumers until the consumer protection bureau was there to help the less powerful assert their rights. Otherwise all you had was a market for sharks.

  2. Posted 16/01/2018 at 15:59 | Permalink

    What I think I’m trying to say is that there’s often a prisoners dilemma where even if it’s better for everyone if you act ‘decently’ unless everyone does does it’s sub optimal to do so.
    If you’re part of a well self regulated scheme but it just gets undercut by the dishonest then there’s no benefit to your regulations- think loan sharks, did blue glazing, sub prime mortgages (maybe), dangerous toys, snake oil, etc. The Govt (and its monopoly on violence otherwise known as the police, the courts, etc) can step in and act to allow market coordination for optimal outcomes.
    Perhaps the actual rules don’t matter so much sometimes as the ability to enforce them.

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