Regulation risk: the case of Solvency II

This paper is a piece for contributing to the sustainable European stake to interlock financial systems with the objectives of the 2030 Agenda (the UN's SDGs). It is intended to be used as a platform for discussion between risk management practitioners in the financial industry and the regulator, to mitigate regulation risk. In its 2018 report, the High-Level Expert Group of the European Commission (2018, p. 48) introduces the idea that the short-term behaviours could result from the regulation itself. There would be a risk created by the regulation, a regulation risk. In this paper, it is argued that a part of the observed short-termism on financial markets is indeed due to a regulation risk based on a falsehood way to understand the randomness in the case of long-term horizons and uncertain risks. The argument makes a detour through the philosophy of science, exemplifying the usefulness of philosophy for finance and the contribution that philosophy can offer to finance for puzzled issues. It is argued that short-termism created by regulation risk is the visible outcome of the pervasive use of the Leibniz' "principle of continuity": change is continuous. The principle of continuity trickled down into all fields of contemporary finance. The "no-arbitrage opportunity" which represents the intellectual cornerstone of the dominant contemporary financial approaches derives from the principle of continuity. The "market consistency" valuation in the Solvency II directive is thought as an outcome of the principle of continuity. The principle of continuity embedded in Solvency II has overseen a general disqualification of traditional risk assessment methods. Hence Solvency II exemplifies a specific case of regulation risk by creating an unexpected effect of short-termism. In its 2018 report, the High-Level Expert Group of the European Commission asked that consideration be given to "how Solvency II could be adapted to further facilitate long-term investments". In the present paper, using a philosophical approach, it is answered: by removing the principle of continuity from the epistemological background of risk models used in the technical contents of the Solvency II framework. At the end, if the absence of philosophy is one the of the main reasons for the flaws in Solvency II, this paper argue for a renewed role of philosophy for finance and regulation.