On Leagal Issues Of Regulatory Capital Arbitrage

Regulatory Capital Arbitrage is that the bank takes advantage of the defects in the capital regulatory regime by way of financial innovations or other means to bypass the regulatory constraints with the purpose to arbitrage as an act of the evasion of Economic law.The proliferation of Regulatory Capital Arbitrage is considered to be an important cause of the Financial Crisis. After the Financial Crisis, all set the control of Regulatory Capital Arbitrage as one of their targets in the amendment of Basel Framework, the international cooperation of financial regulation and the legislation improvement of nations.The main objective of Regulatory Capital Arbitrage is to avoid the capital regulation over the banks. In contrast, the core of Prudential Supervision is the capital regulation. This touches the basic framework of today’s financial regulations and the basic concepts of the banking regulations. So it is in great needs of in-depth research and analysis. Meanwhile, the common view is that China’s financial market lacks innovative products and motivation of financial innovations, which is also the direction of how to reform and consummate China’s financial legal system. In fact, the core function of so-called financial innovations, such as securitization, is not limited to the transfer of risk, increasing liquidity and other positive aspects, but reflected in avoiding the regulatory system. So it must adhere to the principle of balancing the capital regulation and the regulation of financial innovations during the construction of China’s financial legal system. For the above reasons, this article will analyze the legal attributes and causes of Regulatory Capital Arbitrage, and review the legal paths and legal consequences of Regulatory Capital Arbitrage retained by the bank in its financial innovations. And further, this article will present advices and opinions on how to improve the regulations upon Regulatory Capital Arbitrage. The structure of this article is set as follows:Chapter One defines and explains the legal definition of Regulatory Capital Arbitrage. It is considered as one of the economic law evasion activities, but still remains in legitimate status.Chapter Two analyzes the legal causes of Regulatory Capital Arbitrage. The defects in capital regulation theory, loopholes in existing rules, and imperfectness of supporting implement mechanism of law all encourage the bank to seek avoidance of supervision. Prudential theory can stimulate the market dynamic, but it leads to bank supervision and regulation away from its original target, thus weakening the control function of Regulatory Capital Arbitrage. The failure of the constraint mechanism of traditional legal liability under virtual economic system is also an important cause.Chapter Three reveals that the legal path of contractual Regulatory Capital Arbitrage is by and through achieving mutual integration with financial innovations of which the legal nature is civil contract. Banks ostensibly set equally agreed terms of rights and obligations in the contract, but unevenly distribute anticipative civil liability to achieve Regulatory Capital Arbitrage, and then transfer all risks to the financial consumers with the effect of avoiding regulatory constraints. Asset Securitization is the one of the typical products of financial innovations and the primary activity of Regulatory Capital Arbitrage, of which all essential legal mechanisms such as true sale, bankruptcy remote, credit enhancement, are having institutional function to avoid capital regulation. The motivations to employ Regulatory Capital Arbitrage are widely spread among China’s banking industry. The common types of Regulatory Capital Arbitrage include financial management products, hybrid capital instruments, and capital supplements of bank supported by sovereign credit, and etc. Chapter Four analyses and reviews the New Basel rules (BaselⅢ), the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the latest legislation of major Western countries on the control of Regulatory Capital Arbitrage. Although these new regulations will help to control the Regulatory Capital Arbitrage, they obviously have the crisis-oriented features and have set redundant restrictions on the micro-finance participants and then undermined the market efficiency. More effective ways on controlling Regulatory Capital Arbitrage include improving bank compliance management based on equally distributed civil liability and conformable rules, and promoting the integration of prudential regulation and the theory of restrictive regulatory, and keeping the objectives of capital regulation to meet with the legal system. In addition, the introspection and reforger of traditional legal liability based on the social background of virtual economy will also help to control the Regulatory Capital Arbitrage. From the perspective of Chinese financial law, the control of Regulatory Capital Arbitrage is conditioned on the establishing of incentive compatible regulatory regime together with the amendment and improvement of regulations on securitized products, derivatives, and financial products in order to realize the balance between capital regulation and financial innovations.However, Regulatory Capital Arbitrage is an inevitable result of the conflicts among financial security, market efficiency, order, and freedom of market, and other values of economic law. It is also the driving force of evolution for“regulation and innovation”, the continuous development of the dynamic equilibrium structure. Therefore, not only in China’s financial market, but also in the world financial markets, Regulatory Capital Arbitrage will continue to exist or even overflow again.