Financial regulation today confronts a particularly challenging landscape. Three decades of intense innovation radically transformed markets, calling on regulators to develop new competencies and expertise about the architectures of the marketplace.
Recent events suggest, however, that regulators may not have developed the type of skills that are necessary for securing the stability of a highly technological and interconnected marketplace. As an illustration, consider the 2015 legal case brought by the Securities and Exchange Commission against UBS ATS. UBS was accused of violating rule 612 of Regulation National Market System by providing some of the platform's users the ability to submit sub-penny orders to the platform's matching engine. As the legal scholar James Angel noted, the importance of this case isn't necessarily the allegations against UBS but rather the tardiness in the SEC's reaction: Although it was informed about the technicalities of UBS ATS six years earlier, the SEC only intervened in 2015.
This is not the only instance of belated regulatory action. To this we might add other cases of technology-related events where regulators' interventions were considerably lagged with respect to the event. Think, for instance, of the relatively unsatisfactory report by the SEC on the 2010 'flash crash', or the CFTC's quite delayed prosecution of Navinder Sarao for market manipulating. If anything, the recent controversies around technology in financial markets have reinforced a public image of regulators as reactive responders rather than proactive engineers.
What explains this apparent sluggishness? In this article, I explore the reasons why one regulator, the Securities and Exchange Commission, may be structurally unable to deal with rapid technological innovations in the marketplace. This analysis matters for two practical reasons.
Firstly, in an age of great uncertainty, understanding the constraints of regulatory action is important for designing novel strategies that secure the stability, fairness and efficiency of the market. Ours is not a time to reduce regulation on ideological grounds but rather a historical moment to rethink how regulatory institutions might guarantee the long-term sustainability of the marketplace, particularly in the context of a fast pace of innovation.
Secondly, financial markets are considerably more complex now than when current regulatory institutions were established. This is in part due to changes in the architecture and design of markets such as the proliferation of trading venues, changes in market participants and the development of new trading strategies. Yet, regulators have not adequately focused on these changes but instead prioritized corporate governance. Were regulators better able to keep up with those essential changes in markets, participants could have greater confidence in both the markets and those that police them.
The argument I present in this article is the following: Regulators have faced such relative complications dealing with innovation because of how regulatory organizations were constituted historically. In particular, financial regulators are disproportionately populated by lawyers and accountants who share a specific understanding of what matters for regulating markets (namely compliance, disclosure, and enforcement). This leads to a limited perspective that regulators have for dealing with changes in the technological fabric of the marketplace, as well as delays in how they respond to surprises. In this study, I analyze seven decades of commissioner speeches to identify the matters of concern and areas of focus that drew most of the SEC's attention in the markets it regulates.