Financial Markets, SME Financing and Emerging Economies by Giusy Chesini Elisa Giaretta & Andrea Paltrinieri

Author:Giusy Chesini, Elisa Giaretta & Andrea Paltrinieri
Language: eng
Format: epub
Publisher: Springer International Publishing, Cham

5.4 Review of Theories Associated with Regulatory Arbitrage

Beyond how regulatory arbitrage is defined, research theoretically explains why it exists. We define theory broadly as knowledge on why regulatory arbitrage exists (or why it does not). This distinction is delimited specifically to a theoretical understanding of regulatory arbitrage and does not refer to theories associated with other theories used in other contexts even though the study focuses on regulatory arbitrage applied in another context. Furthermore, we distinguish between theories and hypotheses based on analytical settings. Theories explain behaviours and motives determining why regulatory arbitrage may or may not occur, whereas hypotheses identify sources, determinants or motives for studying the presence of regulatory arbitrage . Theories are consequently required to understand contextual knowledge beyond the existence of determinants of regulatory arbitrage .

In the sample, 31 studies present motivations for contextual knowledge on regulatory arbitrage (vague theoretical discussions or presentations are included in this value). Sixteen of these studies present a clear and direct theoretical explanation, and four studies refer to regulatory arbitrage as a theoretical concept (regulatory arbitrage theory). The remaining 11 studies implicitly explain the theoretical relevance of the analyses conducted. This implies that the remaining 60 articles present nothing on the theoretical value of regulatory arbitrage. Although this is not an indication of theoretical understandings of regulatory arbitrage , a general picture emerges regarding the non-reflective understanding of regulatory arbitrage in analytical terms in line with a prior observation (VanHoose 2007). This picture becomes even clearer when we acknowledge that 22 of the studies present some type of hypothesis on regulatory arbitrage, of which 16 do not present any theories. Consequently, 44 of the studies do not present theories or hypotheses related to regulatory arbitrage.

Cardone-Riportella et al. (2010) present a common reason for theoretical development. The assumption that regulatory arbitrage is utilised whenever such opportunities can be observed: ‘If the regulatory capital arbitrage hypothesis holds true, then a financial entity that holds less regulatory capital will have a greater incentive to securitise its assets’ (Cardone-Riportella et al. 2010). Consequently, a general approach involves assuming that an identified regulatory arbitrage is also used by all actors capable of using it. Partnoy (1997) suggests that the understanding of arbitrage is the choice of a party to select among a variety of strategies to achieve the same economically equivalent position. In such a context, a regulatory cost to one possible position implies a utilisation of other types of transactions. This can, for instance, be related to regulatory inequalities (by different taxes, accounting requirements, investment restrictions and government subsidies) on non-derivative transactions and its derivative counterparty (e.g. when regulatory restrictions require parties to pay higher prices (including all transactions costs) than for a derivative counterpart).

When it is present in the articles, this form of theoretical irrelevance leads to opportunity cost reasoning, the generation of a regulatory arbitrage hypothesis or simply the conclusion that there are opportunities/risks of regulatory arbitrage . Another way of expressing similar trade-offs involves arguing for the opposite perspective that regulatory arbitrage opportunities will not take place in the event that a theoretical explanation is given.

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