Can the Plight of the European Banking Structural Reforms be a Blessing in Disguise?

in European Business Organization Law Review (in press)

One of the problems perceived to be at the heart of the global financial crisis was an amalgamation of various commercial and investment banking activities under one entity, as well as the ... [more ▼]

One of the problems perceived to be at the heart of the global financial crisis was an amalgamation of various commercial and investment banking activities under one entity, as well as the interconnectedness of the banking entities with other financial institutions, investment funds, and the shadow banking system. This paper focuses on various measures that aim to structurally separate the banking entities and their core functions from riskier financial activities such as (proprietary) trading or investments in alternative investment funds. Although banking structural reforms in the EU, UK, and the US have taken different forms, their common denominator is the separation of core banking functions from certain trading or securities market activities. Having reviewed the arguments for and against banking structural reforms and their varieties in major jurisdictions, including the EU, UK, US, France, and Germany, the paper argues that a more nuanced approach to introducing such measures at the EU level is warranted. Given the different market structures across the Atlantic and the lack of conclusive evidence on the beneficial impact of banking structural reforms, the paper concludes that the withdrawal of the banking structural reforms proposal by the European Commission has been a prudent move. It seems that in the absence of concrete evidence, experimenting with structural reforms at the Member-State level would be less costly and would provide for opportunities for learning from smaller mistakes that could pave the way for a more optimal approach to introducing banking structural reforms at the European level in the future. [less ▲]

Central Banks and Regulation of Cryptocurrencies

in Review of Banking and Financial Law (2020), 39(2)(Spring 2020), 1003-1104

This paper explores the interface between central banks and cryptocurrencies. Focusing on the European Central Bank (ECB), it identifies the potential threats that the rise of cryptocurrencies would pose ... [more ▼]

This paper explores the interface between central banks and cryptocurrencies. Focusing on the European Central Bank (ECB), it identifies the potential threats that the rise of cryptocurrencies would pose to the basic and ancillary tasks of the ECB, in particular, its monetary policy operations and the exercise of its supervisory functions over credit institutions and payment systems. The paper finds that cryptocurrencies can potentially have both direct – through their potential impact on the price stability and monetary policy, and central banks’ monopoly over issuing base money – and indirect effects on central banks, mainly through the institutions and systems that fall under the ECB’s scope of competence. To address the challenges posed by cryptocurrencies, the ECB may take both legal (including supervisory and oversight) measures and non-legal (or technical) measures. With respect to technical measures, the ECB - to the extent falling within the scope of its competence - may focus on improving the efficiency of existing payment systems and addressing the existing frictions in market infrastructures to indirectly affect the cryptocurrency markets. Alternatively, it can venture into issuing Central Bank Digital Currency (CBDC). Regarding legal measures, central banks could envisage regulating cryptocurrencies either directly or indirectly. However, as the most significant potential impact of cryptocurrencies on central banks is likely to be indirect through the impact of cryptocurrencies on the banking and payment systems, and given the limitations on the ECB’s mandate and its regulatory and supervisory tools, it is apposite for the ECB to consider using indirect strategies and tools to influence cryptocurrency markets. This indirect approach can be implemented through the ECB’s existing supervisory and oversight powers over the banking and payment systems. This paper specifies the direct and indirect measures and assesses their merits in addressing the concerns about cryptocurrencies. [less ▲]

The Dark Side of Licensing Cryptocurrency Exchanges as Payment Institutions

in Law and Financial Markets Review (2019), 13(4),

The ultimate objective of cryptocurrencies is to become a payment system substituting, complementing, or competing with the existing conventional fiat-based payment systems. Irrespective of whether such ... [more ▼]

The ultimate objective of cryptocurrencies is to become a payment system substituting, complementing, or competing with the existing conventional fiat-based payment systems. Irrespective of whether such an objective could be accomplished, the functional similarities between certain cryptocurrencies and fiat money has persuaded competent authorities of certain EU Member States to grant payment institution licenses to cryptocurrency exchanges. At first blush, granting such an authorization would seem to be a step forward as it would bring otherwise unregulated cryptocurrency exchanges within the scope of the existing payment regulatory framework. However, such authorization not only faces major legal challenges related to the definition of a payment institution but also introduces new lesser-known risks. Aside from the semantic and definitional issues, authorizing cryptocurrency exchanges as payment institutions can bring activities and instruments - with a different risk profile than that of conventional payment instruments - within the scope of payment systems. It appears that such risks embedded in those instruments cannot be fully addressed under the existing payment laws. This paper studies two examples of unattended risks under the cryptocurrency-exchange-as-payment institution regime. The first risk concerns the use of untethered, non-convertible, illiquid and volatile settlement assets for settlement purposes in cryptocurrency exchanges. The second risk concerns the risks associated with the finality of settlements arising from the use of probabilistic finality in some of the most popular cryptocurrency blockchains. Given that in the conventional payment institutions central bank money or commercial bank money is primarily used as the settlement asset, such risks have already been addressed or otherwise taken for granted, however, in cryptocurrency exchanges, the risks involved in the settlement of liabilities with an illiquid and volatile asset relying on probabilistically final settlement mechanism cannot be dealt with by the existing applicable regulations. As the risks cannot be addressed within the current European payment regulation framework, an alternative policy option would be granting a special license to cryptocurrency businesses or introducing ring-fencing mechanism to protect the conventional payment systems from the risks of cryptocurrency payments. [less ▲]

Ignorance, Debt and Cryptocurrencies: The Old and the New in the Law and Economics of Concurrent Currencies

in Journal of Financial Regulation (2019), 5(1), 1-35

Cryptocurrencies are expected to have a significant impact on banking, finance, and monetary systems. Due to uncertainty as to the possible future trajectories of the evolving cryptocurrency ecosystem ... [more ▼]

Cryptocurrencies are expected to have a significant impact on banking, finance, and monetary systems. Due to uncertainty as to the possible future trajectories of the evolving cryptocurrency ecosystem, governments have taken a relatively hands-off approach to regulating such currencies. This approach may be justified within the theoretical information-economics framework of this paper, which draws parallels between the information economics of money and quasi-money creation within the current central banking, commercial banking and shadow banking systems with that of the cryptocurrency ecosystem. In particular, drawing lessons from the literature on the role of information in creating ‘safe assets’, this paper finds that by building on symmetric (common) knowledge as to the inner workings of the Bitcoin Blockchain - though in a different way - bitcoin possesses a degree of endogenous information insensitivity typical of safe assets. This endogenous information insensitivity could support bitcoin’s promise of maturing into a viable store of value and a niche medium of exchange. This finding should not be overlooked in the policy discussions for potential future regulatory interventions in the cryptocurrency ecosystem. [less ▲]

Shadow Banking in Europe: Idiosyncrasies and their Implications for Regulation

in European Journal of Risk Regulation (2019)

This paper studies the specificities of the regulation of shadow banking in Europe. It argues that the idiosyncratic features of the EU shadow banking sector call for a different (or indigenized ... [more ▼]

This paper studies the specificities of the regulation of shadow banking in Europe. It argues that the idiosyncratic features of the EU shadow banking sector call for a different (or indigenized) regulatory approach from that of the US. It highlights striking differences between the EU and the US shadow banking sectors based on both market structure and legal micro-infrastructure of the shadow banking sectors in these two jurisdictions. These different institutional and legal infrastructures of the shadow banking activities, instruments, and entities, as well as the different trajectories in the evolution of the banking and shadow banking sectors in terms of business models, size and composition of actors and transactions can be the driving force behind the differential regulatory treatment of shadow banking in the EU and the US. In highlighting the differences between shadow banking across the Atlantic, this paper focuses on the repo markets, as the main instruments and activities that play a significant role in credit intermediation outside the regulatory perimeter of the traditional or regular banking system. It then discusses one specific segment of the shadow banking entities, i.e., Money Market Funds (MMFs), and highlights the fundamental differences in the structure, functioning, and existing regulatory treatment of the MMFs in the US and the EU. The paper concludes that the market structure, business models, as well as legacy legal and regulatory frameworks of shadow banking (as well as banking) display substantial differences in the US and the EU. The findings in this paper rally against one-size-fits-all approaches to addressing the problems of the shadow banking system worldwide and recommends differentiated and more nuanced regulatory approaches to regulating shadow banking across the Atlantic. By implication, any adoption of the US regulatory framework or recommendations of international fora for the shadow banking sector by the EU regulatory authorities should not overlook these differences. [less ▲]

Repo Markets Across the Atlantic: Similar but Unalike

in European Business Law Review (2018)

This paper sketches the key differences in the EU and the U.S. repo markets to inform the policy recommendations for harmonization and standardization of rules governing repo contracts put forward by the ... [more ▼]

This paper sketches the key differences in the EU and the U.S. repo markets to inform the policy recommendations for harmonization and standardization of rules governing repo contracts put forward by the international financial fora and standard setters. In so doing, it examines three main aspects of the repo markets. First, it highlights the differences in the legal framework governing repo markets, such as legal construction of repo contracts, special insolvency treatment, and legal treatment of the reuse of collateral. Second, it discusses the composition, structure, and organization of the repo markets, such as differences in the composition of repo participants, the maturity of repos and the composition of the underlying collateral in repo contracts. Finally, it investigates the differences in the issues related to the market infrastructure of repo markets such as differences in the clearing and collateral management stages. The main finding of this paper is that in spite of significant efforts to standardize and harmonize repo markets as well as their applicable legal framework in the past, there remains significant differences across the Atlantic. Such differences in the legal framework, composition, structure, and organization of repo markets and repo markets infrastructure would require differential and more nuanced approach to regulating repo markets than what is pursued by the current international financial standard setters. [less ▲]

Bank Proprietary Trading and Investment in Private Funds: Is the Volcker Rule a Panacea or Yet Another Maginot Line?

in Banking & Finance Law Review (2017), 32(2), 297-341

The Volcker Rule is part of the post-financial-crisis regulatory reforms that partly aim at addressing problems associated with proprietary trading by banking entities and the risks associated with the ... [more ▼]

The Volcker Rule is part of the post-financial-crisis regulatory reforms that partly aim at addressing problems associated with proprietary trading by banking entities and the risks associated with the interconnectedness of private funds (e.g., hedge funds and private equity funds) with Large Complex Financial Institutions (LCFIs). This mission is pursued by introducing provisions that prohibit proprietary trading and banking entities’ investment in and sponsorship of private funds. These prohibitions have three specific objectives: addressing problems arising from the interconnectedness of private funds with LCFIs; preventing cross-subsidization of private funds by depository institutions having access to government explicit and implicit guarantees; and regulation of conflicts of interest in the relationship between banks, their customers, and private funds. Having studied the provisions of the Volcker Rule in light of its objectives, this article highlights the potential problems with the Rule and provides an early assessment as to how successful the Rule is in achieving its objectives. With respect to achieving these objectives, the Volcker Rule can only be partially successful for various reasons. The foremost reason is the numerous built-in exceptions (i.e., ‘permitted activities’) in the Rule included as a result of political compromises. Although the permitted activities under the Rule are backed by sound economic reasoning, there are serious practical problems with these exceptions. The main problem involves distinguishing prohibited activities from permitted activities. Such determinations require regulatory agencies to make subjective and case-by-case evaluations of activities. It is not known what the costs of such determinations would be in practice or how regulators would react if the costs of such determinations exceed their benefits. Regarding concerns about moral hazard, the Volcker Rule strikes a reasonable balance between preventing such an opportunistic behavior (i.e., taking advantage of government subsidies) while not stifling the investment by the banking industry in start-up private funds. However, with regard to mitigation of conflicts of interest, the Volcker Rule only marginally addresses such concerns. This limited regulatory intervention in mitigating conflicts of interest could be partially understood in light of the fact that market forces and private law have been successful in addressing conflict-of-interest concerns originating from the relationships between hedge funds and the banking industry. [less ▲]

A Tale of Regulatory Divergence: Contrasting Transatlantic Policy Responses to the Alleged Role of Alternative Investment Funds in Financial Instability

in Capital Markets Law Journal (2017), 12(1),

This article analyzes the regulatory measures adopted to address the potential contribution of hedge funds to financial instability in the U.S. and the EU in the wake of the Global Financial Crisis. The ... [more ▼]

This article analyzes the regulatory measures adopted to address the potential contribution of hedge funds to financial instability in the U.S. and the EU in the wake of the Global Financial Crisis. The relevant provisions of the Dodd-Frank Act include two sets of direct regulatory measures. The first set of these measures addresses information problems, whereas the second set is intended to address potential too-big-to-fail problems by imposing prudential regulation on systemically important nonbank financial companies. The article then studies the Volcker Rule, as an indirect regulatory measure intended to address the potential systemic risk of hedge funds originating from their interconnectedness with Large Complex Financial Institutions (LCFIs). The second part of this article analyzes the European Directive on Alternative Investment Fund Managers and its attempt to address the potential contribution of hedge funds to financial instability. Despite the common driving forces of hedge fund regulation across the Atlantic, ultimate policy outcomes were significantly divergent. Primarily concerned with creating a single market for Alternative Investment Funds, EU regulators prioritized the EU passport mechanism, which engendered demand for investor protection and more stringent and direct regulatory measures. In contrast, the main concern in the U.S. remained to be addressing potential systemic risk of hedge funds. Such differential regulatory objectives gave birth to indirect regulation of hedge funds with a focus on their interconnectedness with LCFIs. This is mainly embedded in the provisions of the Volcker Rule; a rule whose absence is significantly palpable in the EU regime for regulating hedge funds. [less ▲]

Derivatives in Islamic Finance: Examining the Market Risk Management Framework (Book Review)

in Banking & Finance Law Review (2016), 32(1), 203-207

European Banking and Financial Law Code

Book published by Larcier (2015)