With the torrent of regulation facing custodians, the question of whether it is possible for them to operate in the current environment is becoming more pressing. According to John Gubert, an advisor to the securities services industry on risk and regulation, the volume of regulation is impossible to manage and the industry does not have the time or the competence to respond effectively to all of the consultation documents dealing with these regulations.
Gubert believes the industry is not putting robust practitioner driven solutions in place and as a result that vacuum is being filled by regulation, comprising a tool-box of who does what to whom rather than the core principles of industry led practices, which is how it should be.
Speaking at the Global Custody Forum 2011 recently, Gubert, managing director of JSG Consulting and an external advisor to UniCredit’s Global Securities Services business, counted regulation such as T+2, the European parliament short-selling rules, AIFMD, and Dodd-Frank as among the key regulatory developments that were largely born out of the financial crisis. He noted there are roughly between 5,000 and 10,000 pages of regulation and the industry does not have the ability to respond effectively as it is too detailed in scope. He remarked that while about 600 lawyers are writing the Dodd Frank Act, a further 36,000 were looking at loopholes for their clients and prospects.
In a presentation titled European Regulation: Too Much or Too Little, Gubert commented on the level of detail in the regulation, noting AIFMD as an example, pointing out that Europe cannot survive with multiple different definitions of capital. “Didier Millerot (European Commission) says AIFMD needs finetuning. We think it needs substantial rewriting,” he said, adding that regulation is moving from being principled and to containing too much detail.
Gubert also called for a central arbiter in the forming and monitoring of regulation. He noted a lack of clarity between the European Commission, the central regulators and the country regulators. “If there is ambiguity you wont get out of the crisis,” he said.
He noted the potential of regulation to change the liability of fund administrators in different domiciles. “With AIFMD, administrators are also starting to take on an element of investment risk that is unsound,” he added.
In terms of settlement regulation and upcoming infrastructure changes, Gubert said there would be no logic to having the current CSD framework in Europe. However, there is a ballooning of the amount of liquidity that CCPs will need, he noted, adding that there are no prime banks to take on some of that liquidity in order to absorb some of those risks.
Commenting on the most pressing types of regulation, notably settlement regulation and AIFMD, Gubert noted that the cost of compliance could involve fines and penalties from the regulator. “We need greater clarity on who bares the risk in terms of risk protection and concentration,” he said. “There’s a fine line between the level of detail and what the buyer has responsibility for. He added that the industry appeared willing to accept the legally enshrined detail in the regulation, which would destroy the business.
Talking further to Global Custodian about the threat of the detailed regulation after his presentation, Gubert noted shortcomings in the way the securities services industrys views are presented. The views of single entities are not taken into account, he said. Instead they are presented as a collegiate and that means individual viewpoints are compromised, he added.
Gubert also remarked on the threats of regulation on the day-to-day operational aspects of the industry where custodians would have to foot the bill for regulatory change: “There is a level of intrusion that infrastructure (changes) and regulation have, which impacts our planning, he said. In technology we can upgrade to ensure we’re running our business as usual and making systems resilient. We can also automate to take out certain risks. But adding in extra (investment) for T2S and to accommodate the building and maintaining of that infrastructure is challenging. On top of that, in factoring in the changes that have to be made for regulation we end up with zero budget for innovation and new ideas. This is important because I’ll need to expand my products and services. Due to fee attrition, it is necessary to keep up income generation in order to invest. But too much is going towards infrastructure and regulatory spend. This is difficult to manage.”
In the long term, he said, this is a growth business. But in the short term, there will be many challenges, he added.
Commenting on custodians ability to transpose the highly detailed regulation into their operations, Gubert said: “Regulation is now going into so much detail that it is like an operations manual, which has no place in legal documentations. Custody manuals have core principles of how to operate including service level agreements, based on flexible agreements that can be changed. With regulation this has to be changed through various forms, including bilateral agreements, which take a long time. With an SLA you can change those agreements overnight, its a commercial decision.
“Its important that the minutiae of regulation is covered on a practical level and that these rules can be subject to change.”
(JDC)