Financial Innovation, Derivatives and the UK and US Interest Rate Swap Scandals: Drawing New Boundaries for the Regulation of Financial Innovation

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A number of questions remained unanswered with respect to the regulation of large financial institutions after the global financial crisis (GFC) of 2007–08. Some pressing issues have resurfaced in the context of the recent interest rate swap scandals. These events provided the opportunity to reflect on the wider socio-political agenda that involves the regulation of banks' behaviour vis-à-vis societal stakeholders. In particular, the Interest Rate Swap (IRS) scandals have shown the ability that banks have to first, innovate and customise complex financial products, and second, limit their legal liability when selling them to investors. This has resulted in a highly unfair balance of powers between financial institutions on the one hand and regulators and financial consumers on the other.

The desired behaviour of banks should be enshrined in statutory regulation.
Regulatory changes should enhance the protection of financial consumers.
The power of banks to innovate for speculative aims should be curtailed through more prescriptive regulation; this would inter alia curb the problem of information asymmetry in financial markets.
The balance of powers in financial markets should be reconfigured together with the role of financial institutions in society.
The behaviour of banks should have regard for social priorities ahead of profit-making activities conducted in the interest of banks' shareholders and executives.