CE26 - Innovation, travail

How do banks respond to increased regulatory costs?: the case of the derivatives market reform – DERIVREG

How do banks respond to higher regulatory costs?

The case of the derivatives markets reforme

Motivation and objectives

Important mutations are occurring in the structure and geography of derivatives markets. This project sets out to document these mutations; trace their cause to the reform being put in place since 2010; and identify new risks emerging in relation to such mutations. <br /><br />Ten years after the launch of the reform agenda the objectives of this project are to (a) <br />document progress in the implementation of this agenda across signatory countries, (b) explain<br />disparities in the adoption of the reform to date, (c) investigate new risks for financial stability that<br />are created by such disparities as they open room for regulatory arbitrage and (d) draw policy recommendations to mitigate these new risks. <br /><br />The bulk of the recent literature in finance and banking focuses on the causes and the consequences of the 2007-2010 crisis and much less on the policy responses adopted since 2007. More than 10 years have passed since the mortgage-related markets in the US, it is now time to turn to documenting the policy responses to the crisis, to evaluate their effectiveness, and to identify any unintended consequences. <br /><br />Issues of regulatory arbitrage are a major concern for policymakers, as they imply that new regulations do not eliminate risk but merely redistribute it across countries, markets, or sectors. Our research will identify areas where regulators must exercise greater vigilance as new, unchecked, risks emerge.

Our approach is essentially empirical but supported by a theoretical background meant to discipline the empirical exercise and to rationalize the results. We have obtained a rich and previously unexploited dataset from the Federal Reserve Board reporting foreign subsidiaries balance sheet data. In addition, we hand collect detailed regulatory data by country, asset class, financial instrument, and entity. The very disaggregated nature of our data facilitates the identification of causal effects through the inclusion of a full range of fixed effects in our regressions. We further extend our analysis to also include a genuine two-stage instrumental variable setup. This two-stage approach uses initial conditions such as the cost of the 2007-2009 banking crisis and the quality of institutions as exogeneous sources of cross-country variation in regulation. Another approach is to test the robustness of our findings to using 2-quarters or 4-quarters lags of the explanatory variables to limit issues of reverse causality. In light of the observed time it takes for countries to implement new regulations it is however not plausible that regulation could react immediately to cyclical changes in the level of derivative market activity.




The project DERIVREG is an extensive and ambitious research project in the fields of financial economics and banking. While the bulk of the recent finance literature has focused on the causes and consequences of the global financial crisis, this project focuses on the evaluation of policy responses to the crisis. It analyses, more precisely, the reforms undertaken in derivatives markets, a cornerstone of the global financial system reform agenda. In 2009 a G20 summit laid out the agenda for a sweeping overhaul of derivatives markets, with the primary objectives to increase the resilience and transparency of the over-the-counter (OTC) segment of the market and to curb systemic risk. About ten years later, this project will be the first to thoroughly evaluate the intended and unintended consequences of this agenda.
The project will empirically address several key questions with far reaching policy implications: Why was the 2009 reform agenda unevenly implemented in the signatory countries? What opportunities did such disparities across nations create for banks to game the rules? Did banks manage to increase financial risk-taking abroad and at home to compensate for the higher transaction costs at home? Did banks move activity to less regulated countries? How did the structure and geography of the global derivative market change since 2009? Did new and unchecked vulnerabilities in the financial system emerge because of banks actively gaming the new rules? What are the lessons learned ten years later and what policy recommendations can be drawn on the optimal timing and sequencing of reforms and the need to complement market reforms with tighter micro-prudential regulations and supervision of banks?
The DERIVREG project team is an international team comprising four researchers from France, Switzerland and Belgium and one research assistant financed by the project. The project team is well balanced in terms of both seniority and gender and comprises experts in empirical methods and experts in theoretical banking and macro-finance. The DERIVREG project encompasses three sub-projects. Each sub-project is supported by a theoretical background meant to discipline the empirical exercise and to rationalize the results. Our line of research is motivated by the current policy debates in financial regulation and supported by abundant anecdotal evidence reported in the financial press. Sub-project 1 aims at documenting the progress in the implementation of the reform globally and at identifying the factors that explain the heterogeneous timing of its adoption across countries. We are interested, in particular, in distinguishing between cyclical factors and secular or structural factors, to determine whether disparities are likely to persist over time and thus to contribute to the regulatory race to the bottom. Sub-project 2 will test the hypothesis of geographical regulatory arbitrage: Did banks move activity into less regulated jurisdictions through foreign affiliates as regulation at home tightened? To address these questions we have obtained a rich and previously unexploited dataset from the Federal Reserve Board covering all US banks’ foreign affiliates at a quarterly frequency since 2010. The derivatives market is particularly prone to such form of regulatory arbitrage because it is a global market. Sub-project 3 will address the question: Does the swap market reform lead banks to increase financial risk at home and abroad to compensate for higher reform-induced transaction costs? If so, the concern is that the reform, aimed primarily at curbing systemic risk, redistributes risk but does not actually eliminate it.
The cooperation between the French team led by Ouarda Merrouche and the Swiss team led by Steven Ongena is motivated by important synergies and complementarities between the DERIVREG project and ongoing and past research carried out at the University of Zurich.

Project coordination

Ouarda Merrouche (EconomiX)

The author of this summary is the project coordinator, who is responsible for the content of this summary. The ANR declines any responsibility as for its contents.


EconomiX - U-Paris X EconomiX
Université de Zurich / Institut of Banking and Finance
KU Leuven / Department of Finance

Help of the ANR 51,840 euros
Beginning and duration of the scientific project: September 2019 - 36 Months

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