Regulation in a post-COVID world: What does the Global Financial Crisis tell us about what we can expect?
As governments around the globe start to pivot from a primary focus on the control of health risks posed by COVID-19, there has been much debate about the broader public policy settings needed to shape the future in a post-COVID world. The likely outcome of these policy debates is uncertain. The final policy decisions will depend upon a broad variety of context-specific factors, including the political ideology and priorities of the government of the day, the general state of the economy as well as the relative health of particular sectors in the economy, the strength of opposition and interest groups, and the weight of public opinion.
In contrast, history suggests that there is relative certainty regarding key features of regulation that will be employed to give effect to policy decisions in the aftermath of COVID-19, regardless of the specifics of those policies. Indeed, based on the fall-out from the most recent global crisis – namely, the 2007/2008 Global Financial Crisis (GFC) – there is evidence to indicate that post-COVID regulation is likely to be characterised by the following main features:
more regulation, rather than less;
regulation that reflects systems-based thinking;
structural regulation to restructure at-risk sectors;
trust-based regulation to build and maintain trust among those that are subject to and affected by regulation.
These features are not unique to the GFC. Indeed, one or more of them has also been evident following a range of other global crises and challenges during the past century, including the Great Depression, World War II, the Oil Crises of the 1970s, and the Y2K bug, providing compelling evidence that these features are likely to be an inevitable part of the regulatory landscape in the wake of what is shaping up to be one of the most significant global crises to date – namely, COVID-19.
More regulation, rather than less
All regulation is essentially about controlling risk. In simple terms, risk is the possibility that adverse events or outcomes could occur, causing harm to individuals, businesses and/or society at large, as well as the things that they respectively value. Global crises, like COVID-19, occur when uncertain risks materialise, resulting in a broad range of negative consequences that are felt throughout the world. Regulation typically proliferates after such crises to avoid or more effectively manage risks that are considered to have played a part in precipitating the crisis, or risks that may emerge following the crisis.
This proliferation of regulation was evident following the GFC. The crisis revealed significant weaknesses in global financial markets, banking systems and associated prudential frameworks, which led to excessive and risky lending that was not supported by adequate capital and liquidity buffers. The G20 coordinated an ambitious regulatory reform program, which included a broad range of regulatory measures to enhance the integrity and resilience of global financial markets and banking systems. New rules were enhanced by more intensive oversight and scrutiny by regulators.
No doubt, more regulation will be a key feature in the post-COVID world as governments and their agencies attempt to avoid the unthinkable – another pandemic of a similar scale and consequence as COVID-19. A detailed stock-take of the various direct and indirect risks caused by COVID-19 will provide insights regarding where more intensive regulation is likely to surface. These risks will be diverse including risks to health, financial markets, supply chains, education, employment, trade and privacy. They will affect different sectors and entities which will, in turn, affect the form and substance of regulation used to address them. A complex patchwork of new regulation will inevitably emerge.
Systems-based regulation
Global crises of the past have highlighted the systemic nature of risks facing society and, consequently, the pressing need for a systems approach to regulation. “Systemic risks” are risks that threaten the systems upon which society depends - namely, our health systems, financial systems, educational systems, and transport systems, among others. Systems theory provides a framework to describe and investigate a system, including its resilience, vulnerabilities and possible states. The OECD has indicated that a systems approach to regulation can help the public sector address “wicked” problems. Such problems would include the global crises of the past, as well as COVID-19.
The GFC revealed the systemic nature of global financial risks, given the high degree of complex inter-connections between financial institutions and firms around the globe. A failure of one key player in the financial system – Lehman Brothers – led to cascading failures throughout the entire system. It was widely recognised that GFC reforms needed to account for the whole financial system, rather than merely its component parts and individual risk agents. Reforms around firms that were “too big to fail”, which were aimed at reducing the probability that such firms would fail, were complemented by mechanisms to limit global contagion, including through system-wide oversight.
The systemic characteristics of the risks associated with the COVID-19 are clearly evident. Indeed, a virus that emanated in one city, has led to a cascading array of risks across a multitude of systems in countries throughout the world and brought critical systems to a grinding halt, including systems related to international trade, logistics and transport. The systemic nature of risks that have become apparent from COVID-19 will need to be accounted for when regulating for a post-COVID world; a systems approach will help to identify vulnerabilities in relevant systems and ensure that regulatory intervention is appropriately targeted at those vulnerabilities.
Structural regulation
Regulation can be employed to affect the structure of a sector or industry to reduce the risk of market failure – that is, situations where inefficient, sub-optimal market outcomes are likely to occur in the absence of regulation. Structural reform can also be used to enhance the resilience to “shocks” affecting supply and/or demand and to help drive economic growth. Reform in the form of structural regulation is not uncommon following a crisis, particularly when the crisis unmasks significant structural weaknesses.
Reform to address the consequences of the GFC included structural regulation. In particular, reform initiatives included prohibitions on banks that were considered “too big to fail” from getting involved in risky activities. This was achieved by forcing structural separation of commercial and investment banking businesses.
COVID-19 has already left a trail of devastation and destruction in a broad range of sectors, including international transport, tourism, leisure and entertainment, retail and manufacturing. Unquestionably, structural reform will be on the cards for at least some of these sectors to help them endure the immediate aftermath of COVID-19 and assist them in remaining viable and sustainable in the longer-term.
Trust-based regulation
Global crises are often followed by diminished public trust, largely because of negative personal experiences linked to the health, economic and social implications that may be associated with such crises. Yet, trust is critical to any relationship, including the relationship between a government and its citizens. Indeed, the existence or absence of trust can affect how the public views a government, its agenda and its responses to societal problems. A high level of trust is likely to lead to support, affirmation and co-operation whereas low levels of trust may lead to resistance, opposition and confrontation. The practical implications of a lack of public trust are likely to be particularly profound as governments seek to address the aftermath of major global crises.
The GFC was precipitated, at least in part, by inaction by governments, rating agencies, and regulators to properly oversee and supervise the global financial system. A number of the reforms pursued following the GFC can be characterised as “trust repair strategies” to counter the impression of inaction, including through increased government regulation and scrutiny.
While there is evidence to indicate that the level of public trust in governments that have effectively addressed the health risks caused by COVID-19 has generally been enhanced, this trust will not necessarily endure, particularly as those governments focus less on managing health risks and more on economic risks. Effective and meaningful public engagement can help to actively build trust by accounting for the public’s views and perspectives when designing and implementing regulation. More likely than not, public engagement will feature prominently in the context of COVID-19 regulatory reform programs.
Conclusions
It is important to recognise and take stock of the regulatory features that are likely to prevail in a post-COVID world, even in the face of surrounding policy uncertainty. For governments and their agencies, these features signal growing complexity and workloads associated with the development, implementation and administration of regulation. For business, these features indicate that investment will be needed to adapt to and ensure compliance with an increasingly dynamic regulatory landscape. And for individuals, the perception of growing regulatory burden in the form of “red-tape” is likely to become more pronounced. Nevertheless, these regulatory developments may well be indispensable to help keep society on an even keel, after what have been a turbulent few months.
References
International Monetary Fund (2018) Global Financial Stability Report: A Decade after the Global Financial Crisis: Are We Safer?
Reserve Bank of Australia, The Global Financial Crisis, accessible at: https://www.rba.gov.au/education/resources/explainers/pdf/the-global-financial-crisis.pdf?v=2020-05-18-22-36-48
OECD (2017), Systems Approaches to Public Sector Challenges: Working with Change, OECD Reviews of Risk Management Policies (OECD Publishing, Paris)