The Road to Precautionary Review of Financial Products

Abstract

Financial innovation introduces new and complex products into the financial system, providing market participants with more bespoke ways to manage their risk, return and liquidity. However, by increasing the complexity of the financial system, financial innovation also compromises financial stability. Faced with the rapid pace of financial innovation, regulators have two options. One is to seek to meet the complexity of the industry with complex regulation, in an arms race that under-resourced regulators are bound to lose. The less explored (and more controversial) path is for regulators to try to reduce the complexity of the financial system by limiting financial innovation through a pre-approval process for new financial products. This Essay surveys and adds to the proposals that have been advanced for such precautionary pre-approval of new financial products, focusing on the political and technical challenges that such proposals face.