Sell-Side Insight

Two years on from the beginning of the credit crisis there has been much activity from policymakers and regulators in an attempt to make the financial markets a safer place in which to do business. And while there are plans afoot to pass new laws, as yet, it is unclear as to how these will be implemented in practice. The European Market Infrastructure Regulation, or EMIR as it is now known, is a good example of this uncertainty. While its first reading in the European Parliament is due to take place next week , even when the text has been agreed, much of the detailed implementation will be remain within the powers of the European Securities Market Authority, or ESMA which, while due to be formed on 1 January 2011, still has no appointed leader. With this implementation vacuum in place, how do both sell-side and buy-side firms prepare for the impact of the juggernaut of regulation which is heading their way? The most effective way of comprehending this impact is to listen to those running global operations functions of the sell-side who tend to be the most sophisticated from an operational point of view, and therefore the most insightful commentators out there. At one of our recent industry webinars, one such sell-side client provided some invaluable insights. In terms of macro-financial impact, the view is that current regulatory initiatives will create greater liquidity requirements and scarcity of capital. This will be accompanied by a focus on long term debt, more restrictions on balance sheet usage and less proprietary flow which will create a lower return on equity. Other potential trends in the front office that were cited included a change in client mix, more trading activity on exchanges or trading venues and an increase in the development of new products as OTC derivatives become increasingly expensive to transact. Further insights were offered on the predicted impact on post trade functions. These include greater margin requirements to cover counterparty risk, along with an increase in reporting requirements and a rise in central counterparty usage. As a result of the more onerous regulatory environment, it is likely that client mandates will increase as they look to the sell-side to help them navigate through more complicated regulatory requirements. Finally and unsurprisingly, there will likely be a huge increase in IT and compliance costs. As we summed up our industry discussion, the biggest negative was cited to be the level of uncertainty around the range of regulatory unknowns, making it difficult to know exactly where and how to invest the IT and compliance budget. There was, however, a positive theme to take out of the discussion: namely that the industry is not starting from scratch in this process. There are many existing infrastructure solutions that can help the industry comply with the proposed regulatory changes. Examples provided were existing trade repositories and existing electronic affirmation/matching services. Other encouraging noises were made about the level of industry collaboration which is currently taking place. In short, 2010 has seen significant discussions and consultations on regulatory and legislative proposals; hopefully, 2011 will bring the much needed detail required for their practical implementation.