Ninth Symposium on Building the Financial System of the 21st Century China Development Reform Foundation Harvard Program on International Financial Systems Beijing, China, September 14-16, 2012 Topic 2: Financial Regulation and Financial Innovation Panel Remarks By Andrew Sheng 1 President Fung Global Institute I am very honoured to be invited by Lu Mai and Hal Scott to join for my first time, the US-China Symposium on Building the Financial System of the 21st century, a subject of a major research study of the Fung Global Institute. Some of you may be aware that Anthony Neoh (one of the founders of this Forum), Laura Cha and I are amongst the first people from outside China to be invited to work inside the Chinese bureaucracy. What we have learnt is that there is still considerable gap in understanding the complexities of China and explaining them to a non-Chinese audience. Winston Churchill famously said that the English people and the American people are divided by the same language. Similarly, those of us who speak Chinese find that understanding China is not easy unless you understand its history and complex culture, including the nuances in use of language and its syntax. As former Chairman of the Hong Kong Securities and Futures Commission, I relied very much on Harvard regulatory Professor Malcolm Sparrow’s maxim on the regulatory craft: “Pick Important Problems, Fix Them and Tell Everyone”. After working in China, I learnt that the Chinese approach to regulation is to use Chairman Mao’s dictum, “Identify the Principal Contradiction, Understand that Contradiction, and Deal with it.”
Why is global and national regulation in contradiction? We talk about global imbalances, but these imbalances are fundamentally major contradictions between benefits and risks. Our rapporteur has identified that there is need for a balance between financial regulation and financial innovation, between market efficiency versus market stability, between principles-based regulation and rules-based regulation and so on. These are all contradictions that require 1
This is an adapted note of views expressed at the Symposium. The views expressed here are entirely personal to the author and not necessarily those of the Fung Global Institute.
trade-offs that are more in the realm of politics than pure technical, professional issues.
This inherent contradiction in global finance is best illustrated by Bank of England Governor Mervyn King’s dictum that “Banking is Global in Life, but National in Death”, meaning that regulation is largely enforced nationally, but financial institutions roam the world as their market, but if they fail, losses are settled nationally. But national regulators had not realized that these nationalbased banks have large leverage recorded off-balance sheet (below the line) and off-shore (in tax free specialized investment vehicles). They still cannot deal with this without some form of enforceable global regulatory structure.
There is general consensus that the primary cause of all financial crises, including the most recent one, is over-consumption financed by over-leverage. On global imbalance is surely over regulation and under-enforcement. This was the criticism of Asian financial regulation before the Asian crisis, but this seems to be the trend for advanced financial markets as well. Regulation is best enforced through tough enforcement on simple rules/principles that are easy to understand, easy to implement and comply, and easy to enforce. The present solutions and reforms have added complexity to complexity 2. The new rules are difficult to understand, costly to implement and it is still unclear whether they serve to reduce systemic risks.
One theme that was brought up was the growing complexity of regulation and that market abuses arose because products and institutions became too complex to understand, manage and regulate. In fact, when thing get too complex, crises simplify things through...
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