How HEC Paris’ finance research feeds the national debate on regulation
Achieving financial stability in the world is perhaps the main driving force behind academics’ research in finance. Such stability in both banking and trading is also largely determined by well thought-out, strong regulation. By developing close ties with the regulators, HEC Paris fosters a symbiotic relationship in which regulators help academics and vice versa.
HEC Paris has a strong bond with regulators, but this was not always the case. For a long time regulators, certainly in banking, were reluctant to share data with academia. This left academics frustrated as they lacked all-important data for their research. After the 2008 crisis, this began to change as regulation had to be strengthened and this paved the way for collaboration between regulators and top business schools like HEC Paris.
Today HEC Paris enjoys strong links with France’s AMF (the financial markets regulator in France) by way of Thierry Foucault who sits on its Scientific Advisory Board. HEC also set up a chair in 2013 on regulation and systemic risks with the ACPR, France’s banking regulator.
Within the ACPR chair, HEC faculty currently work on optimal banking regulation and its effects on the real economy, the funding of banks, and systemic risk. Pre-crisis, banking regulation was micro-prudential, which means that if every bank is safe individually (e.g. it has enough capital at the individual level), the system as a whole is also safe. But post-crisis, there was a regulatory shift from a microprudential to a macroprudential approach to financial regulation, in which the focus is on the stability of the system and not only on the solvability of each constituent bank. Along these lines, HEC researchers study important economic mechanisms such as (1) why financial institutions take large risk exposures and why they choose to be exposed to similar risks; (2) how losses in one financial institution spills over to another; and (3) why relatively small shocks can lead to large aggregate impacts.
The HEC-ACPR relationship has been hugely beneficial to all parties. “This [chair] has created a win-win situation, whereby we are provided with more data we can crunch to work on applied topics and present our work to banking regulation experts, while they can get some inspiration and contribution from academia,” says Christophe Pérignon, associate professor of finance at HEC Paris and the chair’s deputy head. This invaluable interaction has enabled him and his colleagues to come up with some interesting research that could shape regulation. Given that HEC’s work is based on scientific grounds, whether regulators agree or not, the results lead to discussion: “We can challenge what they do because we have much more data now,” says Pérignon. He and his team’s long term goal is to provide a framework for regulators to have a more global view, not merely an addition of individual policy tools that target just one sort of behavior or risk.
Guillaume Vuillemey, assistant professor in the finance faculty, along with his colleagues, has managed to challenge the dominant view about certain issues like the short-term funding of European banks – all thanks to large amounts of new data via the Banque de France. Recently they were given access to a privileged data set, the “raw material” comprising hundreds of thousands of transactions. Then, by examining a large number of European banks and exploring their short term funding at daily frequency over a period spanning the global and European debt crises, the researchers painted an accurate picture of events. “For years many economists’ claims on this were not based on any evidence or detailed data,” says Vuillemey. The prevailing view on this question, he explains, was that after Lehman Brothers collapsed in 2008, short-term funding markets were completely frozen and the European Central Bank had to intervene to help those banks that could not borrow because the markets were dysfunctional. But Vuillemey and his colleagues found reality more nuanced. They saw that there was no drop in volume in those funding markets – at the same time some banks lose while others increase funding. “Our conclusion is important because it tells us that maybe the way we used to think about those markets is not how they actually work or at least it’s not the complete picture,” says Vuillemey. “We believe that a lot of the policy measures adopted after the crisis were based on a view of risk in those markets that may not exactly reflect reality,” he concludes.
When it comes to HEC Paris’ relationship to financial market regulators, it is often from discussing issues in the AMF Scientific Advisory Board meetings that Thierry Foucault gets the inspiration for his research. Foucault, finance professor at HEC Paris, sits on the regulator’s scientific board alongside other top academics and actively participates in current regulatory debates. This provides him with food for thought and research ideas.
This currently includes research on high-frequency trading, when goods are bought and sold at very high speeds automatically. “There are big debates in the world about whether high frequency trading should be regulated and whether one should slow it down,” he explains. The professor has been providing a framework to consider these issues in economic terms and assess the social benefits of these activities versus the social cost. By discussing his findings with the board, he contributes to the debate. “When you are an academic, regulators are interested in discussing your research because it is directly related to what happens in the marketplace,” he explains. However his goal is not to influence regulation. “Science is about percolation of ideas from academic reviews to the real world,” says Foucault. HEC Paris’ bond with regulators certainly makes this process smoother.