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Financial Regulation: Finding the Equilibrium Point

Tobias Maag CFP BrazilBy Tobias Maag, CFP

Equilibrium Point is one of the fundamental concepts in economics, describing the market price of a good or service as being determined by the quantity of both supply and demand for it. In 1890, the English economist Alfred Marshall published his famous work, Principles of Economics. Marshall’s graph displays two lines that cross as an “X” with the declining line representing customer demand and the ascending line supply.

The intersection of the two lines denotes an equilibrium point toward which the market price will move to equalize the supply quantity to exactly match the demand quantity. Any higher price above this equilibrium creates a surplus where sellers would inevitably lower their price to sell more of the product. A lower price creates a shortage where sellers would increase price to earn more profit.

The Equilibrium Point in Other Contexts

Equilibrium may also be defined as a “balance of opposing forces.” In ecological studies these forces are often birth and death, or balance of the proportion of two types as cooperators and defectors. The equilibrium point is the one at which the two opposing forces are perfectly balanced, so that if no outside forces disturb this balance it will remain there indefinitely.

The point of equilibrium can be further classified as either stable or unstable. A stable equilibrium point will tend to return to that value if it is disturbed slightly by outside forces, while an unstable equilibrium point will stray further from the equilibrium if disturbed slightly. No need to mention the possible advantages for those states, corporations and professions which can create the conditions for a stable environment in whatever field it is.

The Search for Equilibrium

Since the beginning of civilization, there have always been antagonist forces and interests, and consequent efforts to somehow find a “point of equilibrium” amongst the different needs and desires. This probably is a “necessary evil” in order to avoid chaos and anarchy, and to find a minimal common ground for all stakeholders. This has nothing to do with getting it right for everyone. Nor does it change the many stories of abuses, manipulation and sufferings.  Nevertheless, in history we have seen many great leaders, wise women and men, who honestly searched for the best possible solutions in their respective time and realities.

Mortimer Adler, a U.S. philosopher said: In Aristotelian terms, the good leader must have ethos, pathos and logos. The ethos is his moral character, the source of his ability to persuade. The pathos is his ability to touch feelings, to move people emotionally. Logos is his ability to give solid reasons for an action, to move people intellectually. Logos requires a framework of beliefs and paradigms, and acceptable/enforceable rules, on which one can construct an irrefutable argumentation, and to which all can refer back to. One example of a great leader, according to this definition is Pericles of Athens.

This brings us to regulations, or, a framework of rules. Rules are designed to control the conduct of those to whom they apply. Regulations are “official” rules, and have to be followed by the community they have been set up for.

The Regulation of Financial Markets

The regulation of financial markets and all related stakeholders gained significant momentum during each of the periods of major financial uncertainties; crashes, market crisis, major fraud schemes and other relevant episodes, where many had to endure severe volatility or losses. The search of equilibrium between the many “temptations” and the possible consequences, also in financial markets, are actively addressed by various types of regulators. Be it the official ones from monetary, fiscal, legislative and other authorities, or by self regulating bodies, associations or corporations.

Such issues probably date back to the beginning of civilization. The economists Carmen Reinhart and Kenneth Rogoff trace inflation (to reduce debt) back to Dionysius of Syracuse, of the 4th century BCE. In their book “This time it is different: eight centuries of financial folly” (2009/Princeton University Press) they bring up instability issues like the debasement of currency which also occurred under the Roman and Byzantine empires. The bursting of the so called “tulip mania” in the Netherlands in 1637, the South Sea (Great Britain) and the Mississippi Bubble (France) 1720 are just a few of the early turmoil’s registered regarding financial markets. 

What Causes Financial Regulation?

The two world wars and the big depression certainly set off new pressure on authorities of various countries and the related regulatory bodies. So did the various burst-bubbles, sovereign defaults, the more recent sub-prime mortgage crisis, and the incompetent or negligent management of countries and corporations.

Schemes like the ones involving Bernie Madoff, Nick Leeson, Jerome Kerviel, the management of Enron, Parmalat and other corporations/larger scale criminal organizations-seem to be just an extension to temptations and risks related to issues like trust, knowledge, greed, character and other only partially controllable aspects, which also directly impact the world of personal financial planning.

The obvious lack of financial literacy, by many, recognized irrationality of investors, behavioral aspects of various players in the field of financial issues, be they personal or corporate, and the often questionable posture by various institutions and professionals, must lead regulators to ask how to protect citizens and institutions in the states best interest?

The Definition of Regulation

One of the central issues is probably how to regulate enough to protect, without being restrictive. Keeping possible conflicts of interest out of such a framework is certainly key. One has to differentiate between protecting and restricting individual choices, needs, and accountability.

Regulating should not become just a “make sure no one can catch or blame me” exercise, nor should it be the curtain hiding special interests, or giving citizens only very selected choices, which might fit other hidden agendas. It should not safeguard the implementing bodies to take on responsibility on issues at least as relevant, like education, supervision and enforcement of already applicable rules. Regulations should not substitute clearly well informed choices, creativity and the offering of alternatives which can contribute to risk diversification, creation, protection and distribution of wealth. Good regulation should support initiative and the development of business, within the ethical and other limitations acceptable to society, respecting cultural issues whenever possible.

As stated by Stavros Thomadakis in the IFAC council seminar in 2007, “Good Regulation serves the public interest through supporting ongoing confidence in processes, such as the market process, in which the public participates and in activities, such as auditing, on which the public relies”. He sees regulation as necessary to support confidence in markets and trust in the reliability of financial reporting and financial services. The key criteria put down by him for assessing if regulation is good, are those related to the necessity, transparency, proportionality, effectiveness and flexibility.  Going into the details of each item would extrapolate the objectives of this article.

Financial Regulation in Brazil

We have seen times when everything looked just fine, or no other way was found in order to accelerate the economy-when regulators leaned back, or maybe were lured in to doing so. Being tough on regulations has probably very seldom earned laurels to candidates running for elective positions…except in times of despair. That’s when the awakening and the so often feared regulatory overshooting happens.

In Brazil financial markets are pretty tightly regulated. Various institutions have their role; the national monetary council (CMN) the central bank (BC), the securities and exchange commission (CVM), self regulating bodies (e.g. ANBIMA), and others. This proven coordination and regulation worked well during turbulences like the ones experienced globally during the sub-prime mortgage crisis, but obviously imposes a heavy burden in other aspects, like global diversification, bureaucracy, giving the sometimes misleading impression of security (since it is “regulated”…), etc…
In general, regulators, not just in financial markets or in Brazil, seem to face major challenges, mainly regarding the criteria of proportionality and flexibility. Regulatory initiatives very often end up being an “all or none”, without taking into consideration any regional or other realities/needs. This leads to the waste of scarce resources, and to more supervision, enforcement and regulation. This regulation process occurs due to the natural tendency of over-regulated parties to search for counterbalancing measures, not always in full compliance with all other rules of a society, in order to find the point of equilibrium!

No Regulation, Yet

Personal Financial Planning is so far, not a regulated profession in Brazil. Professionals acting under this designation must find legitimacy obtaining additional certifications or registration under one or more regulations covering at least part of the individual’s activities. The so called Agente Autonomo, somehow similar to a RIA in the US, is just one of these. IBCPF and the local community of CFP® professionals  is gaining notoriety and credibility, though still very young and small in comparison to the needs and potential of this country. The related community will hopefully find effective ways to contribute so that this profession does not become an overregulated one. Often, with regulation, less is more.

For those who want to claim they provide relevant and consistent personal financial planning service at it’s highest level, IBCPF and its present senior associate ANBIMA, have set very positive and strong signs regarding high standards equivalent to the most demanding ones worldwide for certification, continued education criteria, and through a clear and thorough code of ethics. These standards aim to guarantee that the client’s needs are well served, and that client’s interests come first.

Sources: VetureLine, Wikipedia, Taumoda, Time Magazine, Investorwords, FSA, IFAC

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