The Cost of Compliance

There has been a roll call of compliance-based acronyms across the financial sectorFATCA, AML, KYC and others. But they all have one thing in common. And that is a huge cost tag. The standard CEO comment at the company general meeting used to relate to the growing cost of compliance. Now, that has been far superseded by the fining and restitution regimes in most countries.

There has been a roll call of compliance-based acronyms across the financial sectorFATCA, AML, KYC and others. But they all have one thing in common. And that is a huge cost tag. The standard CEO comment at the company general meeting used to relate to the growing cost of compliance. Now, that has been far superseded by the fining and restitution regimes in most countries. I do, though, have a nagging suspicion that the penalties and the process have serious shortcomings and may well harm consumers in the long term.

There are undoubted cases where banks and other financial institutions have been at fault. Overzealous targeting of product sales in personal financial services definitely led to mis-selling of U.K. retail loan insurance and swap products. Banks have suffered modest fines for this action and severe financial penalties in terms of the reimbursement costs to clients.

Nobody doubts that several banks AML structures may not have been fully fit for purpose. As more and more regulation is piled onto the books, it is inevitable that other areas of control will over time prove to be lacking. Extraterritoriality has meant that control can move from local to global through accidents of structure or client origin. A dollar payment between two non-U.S. entities is technically a U.S. transaction. A single parent of U.S. origin can alter the tax status of an individual. Most banks fined for AML offences have been penalized for delinquent process and not criminal activity, either intentional or inadvertent. Yet, most commentators talk of guilt as if crimes had been committed.

In the U.K., new legislation is planned that will allow the regulatory authorities to reveal names of individuals suspected of breach of regulations, prior to certainty of any proof against them. This occurs in other jurisdictions but would inevitably mean that the accused would be forced to resign their post or, at least, suspend their activities until proven guilty or deemed innocent of the accusation made.

And therein lies the major problem of the new trend. There is a change from the basic proposition that an accused is innocent until proven guilty. By definition, paying fines and penalties, or being accused by a regulator, carries such a stigma that the accused is transported into a world where they are guilty unless proved innocent. Goodbye, Magna Carta!

I would suspect that Standard Chartered were motivated to settle the recent New York Department of Financial Services accusation that they were a rogue institution (somewhat intemperate language for a regulator!) by the implied consequences to their business of fighting the case. Aggressive regulation may be politically astute, but it is commercially dangerous. In the long term, aggressively regulated centers should prove as unattractive to global markets as unregulated ones. In the short term, such an approach must sour the environment between regulators and regulated.

There is a similar result in the retail market, where products may have been mis-sold but never to the extent claimed. In fact, the reality is that a (retail loan insurance) product not used could be deemed mis-sold simply because the insurance was, after all, not needed to meet the clients debt obligations. This philosophy of guilty bank and automatically innocent client, without any duty of care for their actions, must have serious consequences and will impact the bankability of certain client segments.

For custody, there are many parallels. I have often argued that the weight of regulation has created a minefield of risk that cannot be easily navigated. We are all going to be caught out one day by that footnote to a sub-clause in a regulatory tome. My historic logical solution of more discretion to regulators and principle-based (as distinct from attempted legally watertight detail) regulation will not work. Neither side trusts the other. We have more of a war of attrition than a collegiate regulatory structure.

And client side, globally, I sense a move to Hammersmith & Fulham. This related to a U.K. court case in the later 1980s where a London municipality was allowed to cancel a substantial number of swap transactions on the basis that they were ultra vires (beyond its powers) and that their counterparts (not their own officials) were totally responsible for ensuring this was not the case. This parallels the lack of any concept of buyers beware in retail markets.

Regulation is now too dangerous. It is dangerous because it is too complex. It is dangerous because it is biased against the supply side. And it is dangerous because regulators are becoming prosecutors, and guilt is being assumed on the basis of a case for the prosecution without any real right of reply.

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