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Dan Awrey is an Associate Professor of Law and Finance. Dan’s teaching and research interests reside in the area of financial regulation and, more specifically, the regulation of banks, non-bank financial intermediaries, collective investment schemes, derivatives markets, and financial market infrastructure. Before entering academia, Dan served as legal counsel to a global investment management firm and, prior to that, as an associate practicing corporate finance and securities law with a major Canadian law firm. Dan holds degrees from Queen’s University (B.A., LL.B.), the University of Toronto (LL.M.) and Oxford University (D.Phil.).
He was also an Adjunct Researcher with the NUS Centre for Banking & Finance Law between 11 August 2014 to 10 August 2015.
1. Law and Liquidity in the Shadow Payment System
Banking, derivatives, and structured finance may attract the lion’s share of accolades and approbation in global finance – but payment systems are where the money is. Historically, payment systems in most jurisdictions have been legally and operationally intertwined with the conventional banking system. The stability of these payment systems has thus benefitted from the prudential regulatory strategies governing deposit-taking banks. These strategies include deposit guarantee schemes, emergency liquidity assistance, and special resolution regimes. Importantly, these strategies have the practical effect of relaxing the strict application of corporate insolvency law, thereby enabling banks – and the payment systems embedded within them – to continue to perform payment and other functions even under severe institutional stress.
Recent years have witnessed the emergence of a vibrant shadow payment system. This system includes peer-to-peer payment systems such as PayPal, mobile money platforms such as M-Pesa, and crypto-currency exchanges such as Mt. Gox. The defining feature of these shadow payment systems is that they perform many of the same payment functions as conventional banks, but without benefiting from the prudential regulatory strategies which ensure that bank-based payment systems can continue to function during periods of institutional stress. This paper examines the potential risks to shadow payment system customers generated by this functional gap, along with the effectiveness of various strategies which these systems might employ to address these risks.
2. The Euromoney Problem
This project examines the Euromoney problem. The Euromoney is in fact two intertwined problems. The first problem is the conventional ‘money problem’ stemming from the ability of private financial institutions to create deposit liabilities and other money claims. The second problem stems from the loss of monetary sovereignty that occurs when financial institutions in one jurisdiction issue money claims denominated in the currency of another jurisdiction. Together, these problems create risks for the financial institutions that issue these money claims, for the jurisdictions that underwrite the relevant currencies, and, ultimately, for global financial stability.
Having examined the Euromoney problem, this project also examines various strategies for minimizing its harmful effects. These strategies range from a prohibition against the issuance of money claims by foreign financial institutions, to the creation of a global central bank and settlement asset. In between these extremes reside a number of strategies envisioning the incremental reform of existing institutional arrangements such as the central bank swap lines used to provide US dollar liquidity to foreign banks during the global financial crisis.
3. The Limits of Private Ordering Within Modern Financial Markets
From standardized financial contracts, to stock exchanges and alternative trading platforms, to benchmark interest and exchange rates, private market structures play a number of important roles within modern financial markets. These market structures hold out a number of benefits. By harnessing the incentives of market participants, these structures can help lower information, agency, and other transaction costs; enhance price discovery, and promote greater liquidity. Simultaneously, however, successful market structures are the source of significant market distortions stemming from positive network externalities, path dependency, and market power. These distortions can erect substantial barriers to entry, insulate incumbents from competition, and undermine the emergence of new and potentially more desirable market structures. Using Libor and the ISDA determination committee mechanism as case studies, this project seeks to better understand these distortions. It also explores how relatively modest changes to the public regulatory regimes governing these market structures could yield significant improvements.
4. The Shadow Payment System
Payment systems are an essential component of modern economies. Historically, most payment systems have centred around deposit-taking banks. Banks accept deposits from savers and direct these savings into longer term investments. The resulting credit, liquidity, and maturity mismatches render these institutions susceptible to destabilizing depositor runs. To minimize this risk, many jurisdictions have introduced deposit guarantee schemes and liquidity backstops. To address the resulting moral hazard problems, banks are then subject to prudential regulation and supervision.
More recently, firms such as mobile phone companies have started to provide savings and payment services similar to those provided by banks. This trend has been most pronounced in emerging market jurisdictions where citizens have limited access to conventional financial services. This project explores the development of this emerging shadow payment system with a view to examining three questions. First, does this shadow payment system perform the same economic functions as conventional ‘bank-centred’ payment systems? Second, does this system manifest the same risks? Third, do existing regulatory regimes governing the firms at the heart of the shadow payment system effectively respond to these risks?