The history of financial markets and finance are united by continuous fluctuations between economic cycles from bull markets to bear markets or bubbles to recessionsSeeAlsoSeeAlsoFinancial Crisis as well as crises usually caused by structures that enable opportunism and moral gambling. Every crisis contains the seeds of a change, but also risks for regulative overreactions, as well as drastic market reactions. One example is the Great Depression of the US in 1929, which was caused by virtually free speculative trading of stocks and derivatives to the general public and the loss of trust through separation of ownership, as explained by Berle & Means in The Modern Corporation and Private Property in 1932. Another and more modern example is the subprime crisis that began in 2007, which was caused by securitization of speculative mortgages and secondary markets related thereto, which at first stage caused widespread credibility gap between banks (i.e. credit crunch), and then later spread across the financial markets as a whole. This latter crisis gradually grew into a worldwide financial crisis eventually leading to the European sovereign debt crisis when several European countries experienced the collapse of major financial institutions, bankrupts of numerous of the countries’ biggest companies, high government debt, and rapidly rising bond yield spreads in government securities (Bradley 2013; Chambers and Dimson 2016).
The European sovereign debt crisis also heavily influenced later changes to functioning of and initiatives taken by the European Central Bank (ECB) such as (i) the long-term refinancing operation (LTRO), which is an enhanced credit support measure to support bank lending and liquidity in the euro area announced in 2011, (ii) the targeted longer-term refinancing operations (TLTROs), which are euro system operations that provide financing to credit institutions announced 2014, 2016, and 2019, respectively, and (iii) the asset purchase programme (APP), which is part of a package of non-standard monetary policy measures that also includes targeted longer-term refinancing operations initiated in mid-2014 including corporate sector purchase programme (CSPP), public sector purchase programme (PSPP), asset-backed securities purchase programme (ABSPP), and third covered bond purchase programme (CBPP3). The aim of the ECB with abovementioned programmes was on the one hand to offer banks long-term funding at attractive conditions in order to preserve favourable borrowing conditions for banks
and stimulate bank lending to the real economy and on the other to support the monetary policy transmission mechanism and provide the amount of policy accommodation needed to ensure price stability (European Central Bank 2020). In addition, the crisis acted as a catalyst to a still persisting zero-level (or even negative) interest rate environment in Europe.
The former (i.e. Great Depression) led to the implementation of two important acts in the US. First, the Banking Act (i.e. the Glass–Steagall Act), which prohibited any one bank from both accepting deposits and underwriting securities, in order to ensure that if a bank made significant losses underwriting securities, deposits would not be adversely affected. And, second, the extremely tight Securities Act of 1933, representing the first major federal legislation to regulate the offer and sale of securities in the US in order to ensure that buyers of securities receive complete and accurate information before they invest in securities, which is still in force in the US with only some relief from the original statute (Cassis 2017; Mitchener 2005). Both Acts restricted banks’ business opportunities largely for the benefit of the general public and society as a whole.
The latter caused tightening of bank regulation, such as risk-weighted capital requirements, market condition, and investor protection, in the global financial markets (especially in the US
and Europe) (Chambers and Dimson 2016, pp. 193–194). The enactment of the Dodd–Frank Act in the US was a response to the subprime crisis and brought about the most significant changes to financial regulation in the US since the 1930s preventing the US government from bailing out failing banks with taxpayers’ money and imposing short-selling restrictions. In Europe, similar legislative changes were implemented and, with enactments of, among others, the Capital Requirements Directive IV (CRD IV) and the Markets in Financial Instruments Directive II (MIFID II), many restrictions were imposed on banks’ businesses. Actions taken both in the US
and Europe have heavily impaired banks’ business opportunities, by way of, among others, tying their capital to much higher ratios than before the crisis, preventing or even restricting the use and leverage of their balance sheets as well as increasing regulatory compliance and wider conduct requirements (Zestos 2016).
This restrictive trend, as described, has been particularly strong in Europe, with the result that especially the financing of small and medium-sized enterprises (SMEs) has become more challenging. This has been counterbalanced by large-scale EU-wide financing and guarantee arrangements, whose long-term effects are still unknown. In future, we shall learn whether this partial “socialization” of credit risk to the taxpayers was an effective means to counterbalance the tightening regulation. Examples of these approaches, include a corporate bond purchase programmes started by the ECB (as referred above) and the setting up the European Fund for Strategic Investments, which is an EU budget guarantee that provides a shield for the European Investment Bank covering most risky part of the projects it has funded. In authors’ view, once these instruments have been introduced to the markets, it may be hard to withdraw them even in the bull market leading into a long-term partial socialization of SME credit risk to taxpayers.
Like other forms of financing, crowdfunding always works within a particular jurisdiction. The provisions laid down in the regulation, in particular the mandatory ones, must be taken into account when utilizing all forms of financing. Besides understanding the history and functioning of global financial markets, it is always necessary to place the activity within the given operating environment and regulations related thereto (Drake and Fabozzi 2010). At the same time social institutions, such as governments, central banks, market supervisors, and supranational institutions, strive to promote trading to maintain economic growth while contrary to this goal also control the markets and operations therein in order to prevent the emergence and spread of systemic risks. Financial law includes acts, which in many cases point to opposite ways aiming at enabling efficient exchange to support investment, economic growth, and employment, and, at the same time, to prevent actions threatening the basic operation of national economies through avoiding emergence of systemic crises. The goal of financial market legislation is simple: trying to optimize the functioning of the financial market. Efficiency in the financial markets does not mean extreme liberalism. On the contrary, the financial market regulation should be limited to what is necessary so that overall confidence in the financial system remains (Drake and Fabozzi 2010).
Every statute increases complexity of the legal system in a non-linear manner. New regulation may lead to artificial market practices and efficiency losses for all market players. Hence, regulation should, from a market liberal economic perspective, focus on ensuring the functioning of key market mechanisms with minimal interruption. In Confusion de Confusiones Joseph de la Vega well stated in 1688 that financial system is at the same time “the fairest and most deceitful business … the noblest and the most infamous in the world, the finest and most vulgar on earth”. Things have not changed so much after de la Vega. The aim for the regulator is to incentivize the fairness and nobleness and de-incentivize the deceitfulness and vulgarness.
Efforts to maximize the interests of different stakeholders in the financial markets, and competition among them, create incentives for moral gambling, which lawmakers seek to counter by creating and imposing counter-incentives as well as effective control and enforcement systems. Financial market regulation always affects competitiveness of stakeholders in the financial markets, and regulation that is too burdensome can be seen detrimental to the whole financial market system. On the other hand, legislation can also help speed up market disruption (PWC 2017). Delays are a challenge for the legislator: decision delay, legislative delay, and implementation delay cause problems for effective and well-functioning legislation. The longer the delays the legislator is facing are, the easier it is for crises to emerge and the deeper they can become.
Similarly, the faster the new forms of financing, innovations, and practices are emerging in the financial markets, the more challenging is the role of the financial market supervisor and the legislator. However, as the legislator and market supervisor seek to control systemic risk by observing and regulating existing phenomena, new forms or models and other financial innovations are evolving at an ever-increasing pace in the financial markets. Of these, crowdfunding is an illustrative example. A considerable amount of new financial regulation has come into effect during the last years affecting those operating in the financial markets by increased costs and complexity. This emphasises the ongoing struggle between the stakeholders operating in the financial markets and the broad, ever-increasing, and multi-level regulation shaping the fundaments of financial ecosystem (Kallio and Vuola 2018).