BIS: Can financial products be regulated like drugs? The Bank for International Settlements says they could be overseen the same way, with safe ones widely available, risky ones doled out carefully and new ones subject to rigorous tests. The trouble is, safety can be hard to judge in finance. BIS must also press for better disclosure.
The Basle, Switzerland-based “bank for central banks” thinks an approach modelled on pharmaceutical regulation might help avoid future crises by balancing product innovation with safety. Of course, regulators already try to do this – but they often come to different conclusions.
For example, retail investors are not able to buy securities that aren't registered with regulators or to invest in hedge funds or complex derivatives-based products in the US. But in some other countries, a neophyte can wander into a post office, bank or brokerage house and buy equity derivatives-based products so complex even their developers don’t fully understand them.
IN any event, US rules limiting the purchase of unregistered collateralized debt obligations to institutional investors didn’t spare them – or the retail investors whose money they often managed – from losses.
The difficulty judging an investment’s safety complicates the BIS’s concept. The only laboratory rats are often flawed computer models, while limiting new products to a small group of investor-users, as is done with drugs, ignores potentially critical systemic effects that arise when products are distributed more broadly, and which don’t apply to drugs.
So for regulators to weed out the most perilous products, they probably have to err on the side of caution. That would dampen innovation. Granted, this might not be a bad thing – drug watchdogs try to ensure new products help patients, whereas the benefits of recent financial advances have largely accrued to their sellers, not their buyers.
Moreover pharmaceutical regulators like the US Food and Drug Administration sometimes fail to weed out products that are later found to be toxic, either by themselves or in combination. One way to guard against this is through better disclosure – labelling drugs properly and ensuring doctors have up-to-date performance data.
While financial regulators should think about how to vet investment products, they’d also do well to focus on the clarity and completeness of disclosure. That way investors, sophisticated or otherwise, will stand a better chance of making smart decisions.
