The Trouble With One-Size-Fits-All Regulation

Douglas Flint, chairman of HSBC Holdings, has added his voice to the chorus of complaints about the burden of regulation. He said “the demands now being placed on the human capital of the firm and on our operational and systems capabilities are unprecedented. The cumulative workload arising from a regulatory reform program that is unfortunately increasingly fragmented, often extra-territorial, still evolving and still adding definition is hugely consumptive of resources that would otherwise be customer facing.”

This is a huge issue for our industry, and I have, on several occasions in this blog, noted my amazement at the resigned acceptance of industry management of the flow of complex and often ambiguous or arcane regulations.

Regulation is global. Extraterritoriality may be raised at the coming G20, mainly driven by French concern at the scale of penalties levied on BNP Paribas. But regulation will remain global because the firms operate globally. Extraterritorial reach is not within the gift of politicians. Without denying that recent actions from the U.S., especially, have been outrageous, extraterritorial reach is an unfortunate fact of life for firms with active presences in multiple jurisdictions. As Douglas Flint stated in another section of his report, the penalties have influenced behavior. But, before the supporters of mega-fines jump for joy, it is also noted that a logical by-product of the process is confusion in the industry as to the scope of their liability and reticence to take on risk. That is one of the reasons behind the stories of banks withdrawing services from segments or sectors of the community.

Risk is now the driver of management thinking. Management focus is less and less on clients these days and ever more directed to risk avoidance. Risk avoidance is a good thing, up to as point. It will re-establish some logic in the risk/reward ratio. An article in the Summer Plus 2014 issue of Global Custodian (“The only way is up” by Paul Amery) noted the firms pulling out of the OTC derivatives clearing business and suggested, albeit not with universal support, that one by-product would be higher fees. Alexandra DeLuca, in her column in the same issue, raises the question of indemnified stock lending, requiring capital support at banks under Basel III. She notes that BlackRock, which is currently not governed by Basel III, has an indemnified lending program of $118 billion and is 105% covered by collateral in markets. I would note that, in crisis, markets move massively more than that figure.

The trouble with the solutions we are seeing is that, despite the parentage of the G20 or the International Organization of Securities Commissions (IOSCO), regulation is only coordinated at a high level. I was recently listening to a debate on the Markets in Financial Instruments Directive II (MiFID II); it has similarities to the European Market Infrastructure Regulation (EMIR). But do they have technical co-ordination at a detailed reporting level? The answer is no. There are similarities. Both will use Local Entity Identifier (LEI) structures, and that is the driver behind the explosion of LEI registrations. But the data requirements of the two do not converge. They appear to be being developed by people sitting in different universes, albeit under the auspice of the same organization. And that is a key critique of the ever-insatiable current appetite for data in the world of regulation.

The mountains of data being collected are going to be difficult to produce because each firm will have its own unique dataset and reporting model. More importantly they are going to be hard to align. Will the next stream of fines come from a firm producing conflicting data across different regulatory streams? The good news for the firms is that it is highly unlikely that the regulators have the technical capacity to manage the data in such a sophisticated manner. The bad news, given the costs of the exercise, is that it is unlikely that the bulk of the data produced will provide any real value to the market. It is true that a complicated post event review of the data may bring some clarity to a past catastrophe. But the real value of data is not to punish the dead (assuming that the delinquent firms in the catastrophe do not survive) but to provide regulators with tools enabling them to prevent catastrophes.

And the regulators have to recognize that many of our global firms, and definitely those that have been designated globally systemically important financial institutions (G-SIFIs), are not a collection of homogenous entities. Some have re-engineered their IT architecture and have a powerful data mining capability. But the reality is that many remain, sometimes even for specific local regulatory reasons, a series of data islands with an ability to consolidate, albeit rarely on the perfect linear basis assumed by outsiders.

I was also reading an article in the latest Global Custodianabout the challenges of OPERA (editor’s note: the article was written by Charles Gubert, the son of this blog’s author). This is a private sector risk management tool that goes under the appealing full name of Open Protocol Enabling Risk Aggregation. It definitely is value added but, as its critics point out, the problem is that it outlines a set of common principles and languages, and thus tends to generalize. Such criticism is valid, although it has to be pointed out that the segments that suffer from such generalization tend to be specialized ones rather than mainstream.

And therein lies the major problem. We are in a world of one size fits all. The reality is that it does not. OPERA has the right approach. We need to simplify and standardize regulatory reporting, recognizing that this will lead to exceptions. We need to work out how to deal with those as exceptions and not seek to complicate the basic standard by making it fully universal.

A lot of businesses are retrenching because they became too complex to manage—either geographically or functionally. It is time for regulators to take a deep breath and look again at the G20 principles. If they are brave and realistic, they could cull the flow of regulation by well over half. For much of the coverage they are demanding will not serve much purpose in the ultimate objective of ensuring that regulation works, is equitable to all stakeholders and prevents that crisis scheduled for one of the coming years.