Volume 36, Issue 2
Dan Awrey, Split Derivatives: Inside the World’s Most Misunderstood Contract, 36 Yale J. on Reg. 495 (2019). [PDF]
Derivatives are the “bad boys” of modern finance: exciting, dangerous, and fundamentally misunderstood. These misunderstandings stem from the failure of scholars and policymakers to fully appreciate the unique legal and economic structure of derivative contracts, along with the important differences between these contracts and conventional equity and debt securities. This Article seeks to correct these misunderstandings by splitting derivative contracts open, identifying their constituent elements, and observing how these elements interact with one another. These elements include some of the world’s most sophisticated state-contingent contracting, the allocation of property and decision-making rights, and relational mechanisms such as reputation and the expectation of future dealings. The resulting hybridity essentially splits every derivative into two separate contracts: one that governs under normal market conditions, and another that governs under conditions of fundamental uncertainty. In good times, derivative contracts contemplate the almost automatic determination and performance of each counterparty’s obligations. In bad times, these contracts include various mechanisms designed to provide counterparties with the flexibility to incorporate new information, fill contractual gaps, and promote efficient renegotiation.
The process of splitting derivative contracts open yields a number of important policy insights. First, the bundling of contract, property, decisionmaking rights, and relational mechanisms makes derivatives look far more like commercial loans than publicly traded shares or bonds. The regulatory treatment of derivatives as “securities”—and the resulting emphasis on market transparency—is thus somewhat misguided and serves to distract attention from the significant prudential risks posed by the widespread use of derivatives. Second, the flexibility associated with the relational mechanisms embedded within many derivative contracts can play a useful role in promoting both institutional and broader financial stability. This has important implications in terms of the desirability of the recent push toward mandatory central clearing of derivative contracts. It also exposes the potential perils of recent proposals to use distributed ledger technology and smart contracts to execute, clear, and settle these contracts. By the same token, the widespread breakdown of these relational mechanisms can be a source of financial instability. This provides a compelling rationale for authorizing central banks to act as “dealers of last resort” during periods of fundamental uncertainty.
John C. Brinkerhoff Jr., FOIA’s Common Law, 36 Yale J. on Reg. 575 (2019). [PDF]
The Freedom of Information Act (FOIA) replaced the near-total control that agencies held over their records with a judicially enforceable “right” of public access to agency information. Underscoring the importance of this statutory right, FOIA rejected the judiciary’s traditional respect for agency expertise. It instead places the burden of proof on the government and mandates de novo review in litigation. And yet, agencies still effectively control the terms of information disclosure. The government wins nine out of every ten FOIA cases in court. This ratio is a startling departure from other areas of administrative law, where agencies generally enjoy much lower win rates.
This Article provides a framework for understanding this tension. Tracing FOIA’s doctrines to their roots, it finds that FOIA jurisprudence reflects the well-established “administrative common law” approach that courts apply elsewhere in administrative law. Specifically, courts have used functional or policy-based reasoning to transport preexisting evidentiary and administrative law doctrines to FOIA litigation, often in ways that challenge statutory text. Because these pre-FOIA doctrines overwhelmingly empowered the executive, the ensuing doctrines that courts grafted onto FOIA (“FOIA’s common law”) predictably and consistently favor agencies.
Recognizing FOIA doctrine as a subset of administrative common law holds broader implications. It provides a meaningful baseline for critique by situating FOIA within a larger debate over the judiciary’s proper role in the administrative state. It also offers new perspectives on how Congress can counteract the inertial forces driving FOIA’s common law. Finally, it informs the larger debate over administrative common law by showing the method’s resilience in an area where Congress has been uniquely active.
Daniel C. Esty & Quentin Karpilow, Harnessing Investor Interest in Sustainability: The Next Frontier in Environmental Information Regulation, 36 Yale J. on Reg. 625 (2019). [PDF]
This Article rethinks the theory and application of environmental information regulation in light of growing investor interest in sustainability. Academics and policymakers have long viewed mandatory information disclosure as a powerful regulatory tool for improving corporate environmental performance, with some going so far as to call environmental information regulation the third phase of American environmental law. Current thinking on environmental information regulation has failed, however, to keep pace with recent transformations in the investment community. Over the past decade, sustainable investing has rapidly moved from the fringes of the investment world to the mainstream as an increasing number of investors seek to align their values with the holdings of their portfolios. We argue that environmental information regulation, in the form of a mandatory corporate environmental, social, and governance (ESG) disclosure regime, could significantly facilitate this broader realignment of capital markets with sustainability principles. As we explain, standard models of environmental information regulation are ill-equipped to address the information needs of today’s investment community. Instead, this Article calls for a new design of environmental information regulation capable of harnessing mainstream investor interest in sustainability—and, in doing so, creating a new vector of leverage in support of a sustainable future for our society.
Daniel Hemel & David Kamin, The False Promise of Presidential Indexation, 36 Yale J. on Reg. 693 (2019). [PDF]
The Trump Administration faces mounting pressure from conservative thinkers and activists—including calls from its own National Economic Council director—to promulgate a U.S. Treasury Department regulation that indexes capital gains for inflation. Proponents of such a move—which is sometimes called “presidential indexation”—make three principal arguments in favor of the proposal: (1) that inflation indexing would be an economic boon; (2) that the President and his Treasury Department have legal authority to implement inflation indexing without further congressional authorization; and (3) that in any event, it is unlikely that anyone would have standing to challenge such an action in court. This Article evaluates the proponents’ three arguments and concludes that all are faulty. First, whatever the merits of comprehensive legislation that adjusts the taxation of capital gains and various other elements of the Internal Revenue Code for inflation, rifle-shot regulatory action that targets only the capital gains tax would be costly and regressive, would open a number of large loopholes that allow for rampant tax arbitrage, and would be unlikely to significantly enhance growth. Second, the legal authority for presidential indexation simply does not exist. The Justice Department under the first President Bush reached the conclusion in 1992 that the Executive Branch cannot implement inflation indexing unilaterally, and doctrinal developments in the last quarter century have—if anything—strengthened that conclusion. Third, a number of potential plaintiffs—including a Democrat-controlled House of Representatives, certain states, brokers subject to statutory basis reporting requirements, and investment funds whose tax liability could rise as a result of the regulation—would likely have standing to challenge presidential indexation in federal court. In sum, the promise of presidential indexation turns out too hollow, and calls for unilateral action should be spurned.
Saule T. Omarova, New Tech v. New Deal: Fintech as a Systemic Phenomenon, 36 Yale J. on Reg. 735 (2019). [PDF]
Fintech is the hottest topic in finance today. Recent advances in cryptography, data analytics, and machine learning are visibly “disrupting” traditional methods of delivering financial services and conducting financial transactions. Less visibly, fintech is also changing the way we think about finance: it is gradually recasting our collective understanding of the financial system in normatively neutral terms of applied information science. By making financial transactions easier, faster, and cheaper, fintech seems to promise a micro-level “win-win” solution to the financial system’s many ills.
This Article challenges such narratives and presents an alternative account of fintech as a systemic, macro-level phenomenon. Grounding the analysis of evolving fintech trends in a broader institutional context, the Article exposes the normative and political significance of fintech as the catalyst for a potentially decisive shift in the underlying public-private balance of powers, competencies, and roles in the financial system. In developing this argument, the Article makes three principal scholarly contributions. First, it introduces the concept of the New Deal settlement in finance: a fundamental political arrangement, in force for nearly a century, pursuant to which profit-seeking private actors retain control over allocating capital and generating financial risks, while the sovereign public bears responsibility for maintaining systemic financial stability. Second, the Article advances a novel conceptual framework for understanding the deep-seated dynamics that have eroded the New Deal settlement in recent decades. It offers a taxonomy of core mechanisms that both (a) enable private actors to continuously synthesize tradable financial assets and scale up trading activities, and (b) undermine the public’s ability to manage the resulting system-wide risks. Finally, the Article shows how and why specific fintech applications—cryptocurrencies, distributed ledger technologies, digital crowdfunding, and robo-advising—are poised to amplify the effect of these destabilizing mechanisms, and thus potentially exacerbate the tensions and imbalances in today’s financial markets and the broader economy. It is this potential that renders fintech a public policy challenge of the highest order.
Adriana Z. Robertson, Passive in Name Only: Delegated Management and “Index” Investing, 36 Yale J. on Reg. 795 (2019). [PDF]
This Article provides the first detailed empirical analysis of the landscape of U.S. stock market indices. First, I hand collect detailed information about the universe of indices used as benchmarks for U.S. mutual funds. I document substantial heterogeneity across indices and find that the overwhelming majority of the indices in my sample are used as a primary benchmark by only a single fund. I then turn to “passive” index funds and find that both these phenomena are even more extreme among the indices that these funds track. Far from being “passive,” my findings indicate that index investing is better understood as a form of delegated management, where the delegee is the index creator rather than the fund manager. Finally, I turn to ETFs and find that a substantial fraction of these funds track indices that they or their affiliates create. Even controlling for other factors, I find that these funds have, on average, higher expense ratios. My findings shed light on an overlooked part of the financial market and have substantial implications for investor protection.
Matteo Godi, Administrative Regulation of Arbitration, 36 Yale J. on Reg. 853 (2019). [PDF]
In Epic Systems v. Lewis, a case on arbitration agreements and class action waivers, the U.S. Supreme Court tangentially addressed the intersection of arbitration and agency deference. The Court’s opinion highlighted a gap in legal scholarship: very little has been written on administrative regulation of arbitration. By cataloging for the first time the instances in which agencies have regulated arbitration over the last four decades, this Note strives to jumpstart the scholarly debate around administrative regulation of arbitration. In the face of decades-old agency rules, this Note shows why Epic Systems should not be interpreted to preempt regulations of arbitration pursuant to general delegations of rulemaking authority. Such an interpretation, which assumes the incompatibility of the agency-deference case law and the arbitration jurisprudence, clashes with longstanding Supreme Court precedent.