P. M. Vasudev

Credit Derivatives and the Dodd Frank Act – Is the Regulatory Response Appropriate?

Credit derivatives played an important role in the Credit Crisis of 2008-09. The US Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 as a comprehensive response to the Credit Crisis. Collateralized Debt Obligations (CDO) and Credit Default Swaps (CDS), which are among the major credit derivatives developed by the financial industry in the recent decades, are among the subjects covered in the lengthy Dodd-Frank legislation. Regulation seeks to streamline trade in derivatives and promote smooth clearing and settlement of transactions. There is little effort either to identify the systemic risk in credit derivatives or to address the issue of risk. In this paper, I review the measures proposed in the Dodd-Frank Act for regulating credit derivatives and question their adequacy. The Dodd-Frank Act merely attempts to improve the procedures or mechanics governing the trade in credit derivatives and promote prudential standards for the entities dealing in swaps. These are obviously inspired by experience – namely, freezing of the market during the Credit Crisis and companies such as AIG issuing Credit Default Swaps without serious concern about their ability to honor the obligations assumed under the contracts. The issue is whether the regulatory response is adequate from a systemic perspective. This question is important if the goal is to prevent a recurrence of events like the Credit Crisis and the events that led up to the Crisis. In considering this question, a major issue with the Dodd-Frank Act is its failure to sufficiently address the character of the swap instruments, in particular the credit derivatives as they were developed in the market and the risk potential that is engineered in them. I present a proposal in the paper for a screening procedure before the launch of financial instruments. Screening can help generate an informed and reasonably disinterested debate on the planned instruments, and this can lead to a better understanding of their characteristics and risk potential. The procedure would not seriously interfere with the freedom of the market to innovate and devise new financial products, but at the same time it can instill elements of caution and deliberation in the process. The paper also deals with other issues such as the transaction cost of the screening process, any intellectual property rights in the new products and a more basic constitutional issue – the liberty of contract.

Corporate Governance after the Financial Crisis

The Financial Crisis of 2008–09 raises questions about the assumptions that underpin corporate governance. Shareholder value and private ordering may not in fact be the best means of promoting efficiency and corporate responsibility, and the mechanisms that have been traditionally used to ensure management accountability may not be effective. “Corporate Governance after the Financial Crisis” (Edward Elgar, 2012) is a volume that brings together experts from around the world to draw on the experience of the Financial Crisis to explore topical issues in corporate governance. These range from shareholder primacy and the corporate objective to the stakeholder principle, business ethics, and convergence in, or globalization of, corporate governance principles.This paper is the introduction to the volume, provided by its editors. The introduction begins with an overview of the developments in corporate governance in the recent decades, from shareholder value and private ordering in the era of deregulation, and the proclamation of “end of history” in corporate law, moving on to the events after Enron, WorldCom et al, and more recently the Financial Crisis of 2008-09. This is followed by outlines of the chapters included in the volume, which covers a range of jurisdictions – namely, US, UK, Canada, New Zealand, Malaysia and Taiwan.A goal of the volume is to underscore the reality that our understanding of fundamental questions of corporate governance is still developing, and to demonstrate that the corporate governance debate is far from over. In doing so, the volume deals with a diverse set of subjects such as emerging ideas about shareholder primacy (US), public-private models of regulation to promote corporate responsibility (US), business ethics (New Zealand) and the nature of directors’ powers (UK).

Corporate governance in banks – A view through the LIBOR lens

Misreporting of borrowing rates by large banks and the resulting manipulation of London Interbank Offered Rate (LIBOR) has been the subject of headlines news recently. Confronted with charges from regulators, several banks, such as Barclays, UBS (originally Union Bank of Switzerland) and the Royal Bank of Scotland, have paid huge fines and settled the matter to avoid criminal prosecution. The scandal raises serious questions of corporate governance, and this article examines the issue from the governance perspective, using Barclays as a case study. Internal failures occurred at several levels in Barclays’ reporting of rates. Misreporting was mainly of two varieties – misreporting for personal gain and misreporting encouraged by senior managers, ostensibly in the corporate interests. The article argues that corporate governance systems and structures are powerless in dealing with such fraud or lack of judgment. Misreporting for personal benefit was clearly a breach of the fiduciary duty of loyalty of the managers involved. But misreporting, ostensibly to protect corporate interests, is more probably a breach of the emerging fiduciary duty of good faith. The article also points out that the misdeeds occurred in the banks during an era of financial liberalization and permissiveness. In particular, it highlights that the loose structure of interest derivatives and the potential they offered for speculation were important factors in the practices at the banks involved in the LIBOR episode. The article concludes with an analysis of the implications of the LIBOR episode and its consequences for corporate responsibility and accountability as well as public regulation and its efficacy.