Unseen Edges: How Regulatory Loopholes Can Create Great Investment Opportunities (and Moats)
How some companies use regulatory red tape as a weapon to outcompete their rivals.
When I think about moats, three cornerstone works come to mind: 1) 7 Powers: The Foundations of Business Strategy by Hamilton Helmer, 2) The Little Book That Builds Wealth by Pat Dorsey, and 3) Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation by Michael Mauboussin and Dan Callahan.
I have to admit that Dorsey’s work has always been my go-to reference. That said, the other two are great resources as well.
When I’m looking for companies with durable moats, I usually think of the obvious ones: unique technology, strong brands, or best-in-class cost structures. But over time, I’ve come across a different, less conventional type — what some investors call regulatory arbitrage.
In his book, Dorsey introduces a first group of moats he calls intangibles (if I remember correctly). This group includes brand power, patents, and government regulations and licenses. Now, I’m not sure if Dorsey had regulatory arbitrage in mind when he discussed companies protected by government regulations, but that’s exactly what I want to explore in today’s article.
It might not sound glamorous, but trust me — you can find some really nice businesses using it. They either find the cracks between the rules — or for better or worse, help write the rules themselves.
Today, i’ll dive into how regulatory arbitrage works, share some example — especially those flying under the radar in the mid-, small-, and micro-cap spaces — and explore how this strategy can create — or destroy — a moat.
Let’s dive in.
What I Mean By Regulatory Arbitrage
At its core, regulatory arbitrage is about taking advantage of differences or gaps in the rules to create a business edge. In plain English: it’s when a company figures out how to legally sidestep a constraint that makes life very difficult for its competitors.
Sometimes it’s as simple as choosing the right place to incorporate — Delaware(?). Other times, it’s about structuring a product or service so that it falls into a lighter regulatory category, avoiding heavy costs and restrictions.
It’s important to be clear, regulatory arbitrage isn’t illegal. It’s about operating within the letter of the law — even if it sometimes skates very close to the spirit of it.
I like to think of it this way: wherever laws differ — between countries, states, or industries — there’s an opportunity for smart companies to shop for the most favourable conditions. And some companies are very, very good shoppers.
Now, the key thing I want you to keep in mind is that regulatory arbitrage can, in some cases, become part of a powerful moat.
How Regulatory Arbitrage Becomes a Moat
We usually define a moat as something that protects a company’s profits over time — something tough for competitors to replicate.
Now, regulatory arbitrage becomes a moat when a company is better than its peers at understanding, navigating and profiting from the rulebook. If it manages to build a business model around a regulatory advantage — say, operating under lighter compliance burdens, locking in special licenses, or selling products that others legally can’t — it can enjoy fatter margins, faster growth, or less competition.
In some cases, companies even go a step further: they actively shape the regulations themselves. They lobby, negotiate, and influence policymakers to tilt the playing field in their favor.
But enough with theory, let’s review a few concrete examples where I’ve seen regulatory arbitrage work particularly well.
The Fintech Rent-a-Bank Play
Let’s first analyze how fintech lenders exploit the “rent-a-bank” model.
In the U.S., interest rate caps vary widely by state. Some states, like California, cap interest rates for consumer loans at 36%. Others, like Utah, don’t have those restrictions.
So, what happens? A fintech can partner with a small Utah bank, have the bank originate the loan (even for a borrower sitting in California), and use federal law to "export" Utah’s lenient rules across state lines.
OppFi, for example, is one company doing this. They leveraged this model to make high-interest loans in states where competitors couldn’t. It gave them access to high-risk borrowers and good margins others couldn’t legally touch. This is a classic example of regulatory arbitrage.
Of course, it’s not without risk. Regulators in California and D.C. are now challenging OppFi, arguing they were the "true lender" and that the rent-a-bank model was a sham. It’s an ongoing situation.
The legality and future viability of this model are actively contested. Still, for years, this strategy gave OppFi an edge — and early investors who spotted it benefited greatly, with the stock more than doubling over the past year.
OppFi is in my watchlist and probably going to do a deeper dive in the coming days. It’s not only about the regulatory arbitrage. One thing I like about OppFi is how strong their customer reviews are:
You compare this numbers with other companies like goEasy, and the story is widely different.
Of course, this is a high-level view, and there could be more to OppFi than just regulatory arbitrage. Now, let’s review another example.
Orphan Drug Exclusivity
In biotech, regulatory arbitrage is particularly common.
One strategy that stands out to me is chasing Orphan Drug Act exclusivity1. If a company develops a drug for a rare disease, the FDA grants them seven years of marketing exclusivity in the U.S. No generics. No biosimilars.
So what’s the difference compared to trying to get a patent? Companies often pursue both. A patent can provide protection for up to twenty years, while Orphan Drug Designation (ODD) offers its own distinct advantages.
The seven-year exclusivity, combined with tax credits and fee waivers, lowers financial risk and boosts ROI potential. Investors often view ODD as a signal of a clearer path to market with reduced competition, making these companies attractive despite their small size.
Jazz Pharmaceuticals is a good example. They had early success with a narcolepsy treatment that received orphan drug status. That seven-year shield allowed them to charge premium prices without fear of competition.
For small- and mid-cap biotechs, this is often a deliberate strategy: target rare diseases, secure orphan status, and lock in monopoly-like margins.
Old Drugs and Price Hikes
Then there’s the darker side: acquiring old, niche drugs protected by regulatory loopholes and raising prices dramatically.
Questcor Pharmaceuticals did exactly this with Acthar. They took an old drug, realized no generic competition was likely (thanks to grandfathered FDA status and complex formulations), and increased the price from $40 to over $34,000 per vial.
This increase happened over a couple of years. It’s well…not ethical, but it worked — for a while. Questcor’s stock soared, and they were eventually acquired for billions.
Another well-known example is Turing Pharmaceuticals and their acquisition of Daraprim. In 2015, Turing, under CEO Martin Shkreli, raised the price of Daraprim — an essential treatment for parasitic infections — from $13.50 to $750 per pill overnight.
Just like Acthar, Daraprim was an old drug with no direct generic competition.
You may remember Shkreli’s move generate, justifiably, a lot of public outrage, congressional hearings, and eventually, his downfall (although the charges that sent him to prison were unrelated to Daraprim,). Still, for a brief period, regulatory gaps let Turing extract massive margins from a captive market.
What’s the common thread? In each case, the moat wasn’t scientific breakthrough. It was exploiting regulatory blind spots: either the difficulty of developing generics for older drugs, the slow-moving nature of price oversight, or both. These companies innovated in taking advantage of the rulebook.
Other Examples
Valeant Pharmaceuticals: Another well known example, Valeant used a similar strategy, acquiring old off-patent drugs and raising prices dramatically, such as with Cuprimine and Syprine, which treat Wilson disease.
Rodelis Therapeutics: Rodelis acquired Cycloserine, an old tuberculosis drug, and raised the price from $500 for 30 pills to $10,800.
Tesla’s Credit Arbitrage
You probably know this about Tesla. For years, Tesla made a fortune not just from selling cars — but from selling emissions credits.
Because Tesla only sells zero-emission vehicles, they accumulate regulatory credits that they can sell to traditional automakers.
In 2024 alone, Tesla generated $2.76 billion in credit revenue. That’s pure margin — the so-called "free money."
Tesla’s credit sales are a classic example of regulatory arbitrage, where a company capitalizes on differences or gaps in regulatory frameworks to generate profit.
Tesla leverages strict emissions standards — like the EPA’s greenhouse gas rules, California’s ZEV program, and the EU’s CO₂ targets — that penalize high-emission automakers such as GM, Ford, and Stellantis.
These legacy automakers, slower to transition to EVs, buy credits from Tesla to offset their emissions deficits, effectively subsidizing Tesla’s growth.
Many legacy automakers feel they’ve "funded" Tesla’s rise.
Anyways, let’s continue.
Biomass and Carbon Accounting
Another interesting example I found is Enviva2, a U.S.-based biomass producer. In this case results were less than ideal.
Enviva’s entire model depends on a regulatory loophole: the European Union classifies burning wood pellets as carbon-neutral.
Thanks to that definition, power plants in Europe can claim renewable energy credits for burning Enviva’s wood pellets — and receive subsidies.
Now, there’s a lot of debate about how green wood pellets actually are. What’s more, Enviva just finished restructuring its debt after declaring bankruptcy last year.
So, these situations are not without risks. This is a reminder that regulatory arbitrage can create markets from thin air — but those markets can also vanish if the rulebook changes.
So, What Are The Risks?
As much as I like discovering companies that exploit regulatory arbitrage, you always have to be mindful of the risks.
Here’s what I keep top of mind:
Regulations Change. A favourable rule today can become a costly liability tomorrow. When a moat depends on politics, it’s inherently unstable. That’s why I like regulatory arb as part of the moat and not as the only source of competitive advantage.
Public Backlash. Companies that abuse loopholes too aggressively many times can generate a political backlash. Pharma price hikes, fintech interest rates—these become media firestorms and regulatory targets.
Competition. Once a loophole is generally well known, typically others rush in, or complexity makes execution harder and costlier.
At the end of the day, the best companies usually use regulatory arbitrage to enhance their core business—not just as a crutch to prop up a weak model.
Wrapping It All Up
Regulatory arbitrage isn’t the first thing I usually think about when hunting for moats. But in sectors like finance, healthcare, and green energy, it can become a real source of edge.
Is it a foundation for a solid moat? It debatable, at least. But what is clear is that it definitely helps strengthen a company’s competitive position.
Whether it’s a fintech lender partnering with the right bank, a biotech securing orphan exclusivity, or a green energy company riding emissions rules, these businesses have turned regulatory nuance into good profits.
The key, as I see it, is to distinguish between regulatory advantages that are durable — rooted in deeply entrenched systems or hard-to-replicate expertise — and those that are fleeting, dependent on political winds.
Disclaimer
This newsletter (the “Publication”) is provided solely for informational and educational purposes and does not constitute an offer, solicitation, or recommendation to buy, sell, or hold any security or other financial instrument, nor should it be interpreted as legal, tax, accounting, or investment advice. Readers should perform their own independent research and consult with qualified professionals before making any financial decisions. The information herein is derived from sources believed to be reliable but is not guaranteed to be accurate, complete, or current, and it may be subject to change without notice. Any forward-looking statements or projections are inherently uncertain and may differ materially from actual results due to various risks and uncertainties. Investing involves significant risk, including the potential loss of principal, and past performance is not indicative of future results. The author(s) may or may not hold positions in the securities discussed. Neither the author(s) nor the publisher, affiliates, directors, officers, employees, or agents shall be liable for any direct, indirect, incidental, consequential, or punitive damages arising from the use of, or reliance on, this Publication.
Orphan Drug Designation (ODD) is granted by the FDA under the Orphan Drug Act to incentivize development of drugs for rare diseases (affecting fewer than 200,000 people in the U.S.). It focuses on encouraging investment in treatments for conditions that might otherwise be unprofitable due to small patient populations.
Enviva, the world’s largest industrial wood pellet producer, filed for Chapter 11 bankruptcy protection in March 2024 due to financial distress and excessive debt. The company’s restructuring plan, confirmed by the U.S. Bankruptcy Court in November 2024, eliminated over $1 billion in debt and brought in new financing and ownership structure. Enviva has since emerged from bankruptcy, with American Industrial Partners becoming its largest shareholder, and the company claims to be positioned for long-term growth and improved financial health