What Is Regulatory Arbitrage?

There is currently no unified definition of "regulatory arbitrage" at home and abroad. It is generally believed that when the economy meets the following two conditions, there will be opportunities for regulatory arbitrage, and rational market entities will choose the optimal trading strategy to maximize their own utility: (1) one economic purpose can pass multiple trading strategies to realise. (2) Regarding the above-mentioned substantially the same but different forms of trading strategies, the supervisory system has different treatment methods. The difference in the way the regulatory system treats it stems from the inherent incompleteness of the system, which cannot give a sufficiently precise definition of the economic substance of transactions.

Regulatory arbitrage

"Regulatory arbitrage" borrows the term "arbitrage" in finance. According to the definition of the New Palgrave Dictionary of Monetary and Finance, "arbitrage" is an investment strategy that guarantees positive returns in certain circumstances without the possibility of negative returns and without the need for net investment. Its main characteristics are no risk, no net investment, or positive returns. Similar to arbitrage, regulatory arbitrage captures the imbalance in the market. The key factor that determines the attractiveness of arbitrage opportunities is the transaction cost of the arbitrage strategy. However, there is currently no unified definition of "regulatory arbitrage" at home and abroad.

Donahoo & Shaffer (1991) ^[1]

In the article "Regulatory Arbitrage: The Main Mode of Financial Arbitrage in China" (Shen Qingyu, Humanities Magazine, 2010, 05: 80-85) ^[4]

Supervision is essentially a compulsory contract. Many characteristics of the contract, such as information asymmetry and incompleteness of the contract itself, are also applicable to supervision. As with many problems in the general contract in contract theory, regulatory arbitrage is an inevitable result based on the inherent characteristics of the aforementioned regulatory contract itself ^[5]

The principle of regulatory arbitrage lies in the "LawofOneNetRegulatoryBurden". The net regulatory burden is the difference between the costs and benefits that regulation brings to market players. An economic purpose can be achieved through multiple trading strategies, and the regulatory regimes corresponding to each trading strategy are

,

,

,

, The net regulatory burden corresponding to each trading strategy is

,

,

,

. If in the regulatory system

versus

The cost of converting between

, Then, for any two regulatory regimes

versus

,in

At that time, there will be a shift from a trading strategy with a high net regulatory burden to a trading strategy with a low net regulatory burden. If there are no transaction fees in the market, that is

= 0, the market entity will choose the trading strategy with the lowest net regulatory burden, that is, choose trading strategy i, so that for any trading strategy j, there are

. Other regulatory systems will be meaningless, and the regulatory department will restructure the system to eventually have the same substantial trading strategies. The net regulatory burden must be equal, that is, for any i, j, there are

, That is, the "one price law of net regulatory costs."

Is regulatory arbitrage legal or illegal? In jurisprudence, it belongs to "legal circumvention" and is also called "off-law." Its legal characteristics are that the form is legal and the substance is illegal. Legal circumvention originates from international justice, which means that the purpose of breaking the law is achieved through a legal form. For this meaning, Han Depei (1997) believes that: "Legal circumvention means that the parties to a foreign civil legal relationship deliberately create a certain connection point in order to use a conflicting norm In order to avoid the law that should be applied, so that the law that is in your favor can be applied to escape or escape. "Xiao Yongping (2002) defines the circumvention of the law as:" The parties deliberately create some kind of connection point. A constituent element in order to avoid a law that would be applicable against it, so that a law that is in your favor can be applied to escape or escape. " Although there are still some differences in the views of scholars, to sum up, they all emphasize that legal circumvention is a way for parties to avoid the unfavorable laws applicable to them by some means, so that the laws in their favor can be applied. behavior. Regulatory arbitrage is the possibility for market entities to use the principles of private law autonomy and contract freedom to form legal forms. Without reasonable grounds, they choose a legal form that is different from the conventional form of economic transactions, and achieve the same Economic results, while avoiding the legal form requirements that are commonly used, and reducing or eliminating regulatory burdens. There is huge controversy in the academic field about its legal effect.

Validity

Some scholars in the common law system believe that since the conflict of laws gives the parties the possibility to choose the law, the parties should not blame the parties when choosing the law of a country in order to achieve their own purpose; if the conflict of laws is to be prevented The use of humans should be regulated by the legislator in the conflict norms. Scholars such as Savigny in Germany believe that if legal circumvention is regarded as illegal, it will prevent unfair laws from being repealed and hinder legal progress and economic and social progress. Since the bilateral conflict norm recognizes that domestic law and foreign law can be applied, in order to establish a legal relationship that cannot be established in accordance with domestic substantive law, domestic people go to a foreign country that allows such a legal relationship to establish a joint point so that It was established, which did not go beyond the scope allowed by the conflict norms, and therefore could not be considered illegal. In practice, some countries have no restrictions on legal evasion. In fact, legal evasion often occurs in real life, and it is already a common phenomenon. However, when the court hears such cases, there is almost no trial practice of deciding the parties to evade the law.

Invalidity

Some scholars in civil law countries believe that in order to maintain the stability of their domestic legal order and defend the majesty of their laws, the circumvention of domestic laws is generally regarded as illegal and this circumvention has no legal effect. Niboyet and others in France believe that if the law is fraudulently used, it should be punished, and the application of the rules of private international law has the opposite effect to the legislative purpose and cannot be recognized. This will make people Don't dare to think differently. Civil law countries generally believe that legal circumvention is a kind of deceptive behavior. Based on the theory that "fraud invalidates everything," in the case of legal circumvention, whether the party evades domestic law or foreign law, the parties should be excluded. I want to apply the law, and apply the law that should have applied. For example, Article 1207 of the Argentine Civil Code stipulates that "a contract concluded abroad to circumvent Argentine law is meaningless, although this contract is valid in accordance with the law of the place where it is concluded"; Article 1208 states "a circumvention of foreign contracts concluded in Argentina The contract of law is invalid. " Article 5 of the 1982 Yugoslav International Conflict Law stipulates that "Foreign law applicable in accordance with the provisions of this Act and other federal laws shall not apply if the foreign law applies to circumvent the laws of the Socialist Federal Republic of Yugoslavia." Such similar provisions are reflected in the Hungarian Private International Law, the Gabon Civil Code and the Senegalese Family Law.

Regulatory arbitrage has both positive and negative economic effects. Positive impacts may include: increasing the leverage of the regulatory authorities' macro-controls, alleviating behavioral distortions caused by irrational regulatory rules, and prompting regulatory authorities to improve the regulatory system; negative impacts may include: increasing systemic risks in the financial system and reducing the effectiveness of the regulatory system Sex ^[6]

Regulatory arbitrage is an important economic concept that can explain many phenomena in essence. The corresponding policy recommendations can include the following aspects:

Optimize the allocation of residual control between regulators and the market

Based on the theory of incomplete contracts, the problem of preventing regulatory arbitrage is the problem of re-allocating residual control. Supervisors have the following two methods to reconfigure residual control: First, adopt individual regulatory measures to promote the completeness of contracts and reduce residual control. After the supervisor finds a regulatory arbitrage that is inconsistent with its purpose, it changes the original system to identify the regulatory arbitrage as illegal. Its advantage is to focus on cracking down. Regulations on arbitrage that are more common and more harmful in practice are regulated through individual clauses, which will not affect legal behavior, and the stability and predictability of the system are not easily damaged. However, its shortcomings are that it is powerless to create regulatory arbitrage, and the regulation is lagging. With the accumulation of individual provisions, the regulatory system is complicated, disorderly, and lacks systematic determination. Second, the general negative rule is used to allocate part of the remaining control to the regulator. The supervisor may provide that regulatory arbitrage is not allowed within a certain scope of supervision, and give the supervisor the right to determine whether it is a regulatory arbitrage. The general negation rule denies various unforeseen regulatory arbitrage behaviors and allocates some remaining control to the regulator. This method helps to avoid the applicability and lag of the regulatory system to the new regulatory arbitrage, but it will threaten the security and predictability of the system. Moreover, because the determination of regulatory arbitrage is inherently ambiguous, it will lead to the abuse of the regulator's discretion. The optimal design of the regulatory contract should be an effective combination of individual regulations and general negative rules, so that the number of remaining control rights and the distribution ratio are in a state that, given the number of remaining control rights, Increasing the marginal cost of the residual control of the supervisory authority is the same as increasing the marginal benefit of the residual control of the supervisory authority; and given the distribution of the residual control of the supervisor and the supervised, the marginal cost of increasing the completeness of the contract and the increase The marginal returns to contractual integrity are equal ^[8] .

Narrow system differences and reduce arbitrage space

The research in this article shows that the existence of regulatory arbitrage originates from the differences within and between institutions. The net regulatory burden is the difference between the costs and benefits that regulation brings to market players. An economic purpose can be achieved through multiple trading strategies. If, for any two types of regulatory systems, the difference between the net regulatory burden is less than the transaction cost of the system conversion, there will be a transition from a trading strategy with a higher net regulatory burden to a trading strategy with a lower net regulatory burden. If there are no transaction costs in the market, market entities will choose the trading strategy with the lowest net regulatory burden, other regulatory systems will lose their meaning, and the regulatory department will restructure the system. In the end, they will have the same substantial trading strategy, and their net regulatory burden will be equal , That is, the "one price law of net regulatory costs." Therefore, by reducing institutional differences, the space for regulatory arbitrage can be reduced.

Appropriately guide arbitrage in line with policy intent

Financial supervision can play a macro-control role for market participants. From a certain perspective, regulatory arbitrage behavior is the feedback behavior of market subjects on regulatory policies. The emergence of regulatory arbitrage in line with the wishes of the regulators is precisely the goal of the regulators to conduct macro-control through financial supervision. Supervision departments should actively guide market entities to carry out regulatory arbitrage in line with their policy intent, and improve their ability to regulate and control policies.