Prior scholarship advocates for international harmonization of financial regulation as a solution to the problem of cross-border regulatory arbitrage. The scholarship is theoretical and rests on the contention that financial institutions can simply depart from an unfavorable regulatory regime. This Paper contributes an empirical foundation to the concern that financial institutions relocate following regulation, while also deeply qualifying claims that effective regulation requires international harmonization.

Using experience from swap markets following the Dodd-Frank Act, this Article provides the first empirical evidence that financial institutions migrate in response to derivatives regulation. This Article shows that U.S. banks substantially shifted inter-bank swap trading offshore while the delivery of swaps to U.S. customers did not decline.

Building on this case study, the Article develops theory for what policy goals are more susceptible to subversion through migration. Policy goals concerned with regulating relationships between financial institutions and their customers (e.g., goals of customer protection) are less vulnerable to relocation than policy goals concerned with inter-relationships between financial institutions (e.g., reduction of systemic risk). This distinction reflects well-informed priors on the relative costs and benefits of cross-border arbitrage to providers of financial services and their customers.

In exploring how relocation skirted some regulations and alternative regulatory designs for achieving the same policy goals, the Article solves a longstanding puzzle for international regulation. The claim that financial institutions can avoid territorially bounded regulation appears, on its face, suspect. If an institution truly removes its operations, what legitimate interest does a jurisdiction retain in regulating that institution? Through examining how operations may be restructured across borders, the Article shows that a lack of harmonization: (a) does not affect whether a jurisdiction can unilaterally implement its policy goals, but (b) does narrow the range of regulatory designs available to achieve policy goals. Absent harmonization, jurisdictions may be limited to regulatory designs that are more difficult to implement, for instance, due to politics, administrative costs or other frictions affecting efficacious lawmaking, supervision, or enforcement.