Regulation is now the greatest challenge to the survival of the industry. From the main sessions through to the new innovation of a compliance forum, SWIFT is a welcome catalyst for debate on regulation. But am I alone in believing that we are now living in a more dangerous world, where compliance with regulation is becoming almost impossible? And what do I feel are the most dangerous of those new regulations?
Compliance with regulation is a prerequisite of our industry. We have, though, two fundamental problems. The first is the sheer volume of regulatory directives; the second is the complexity and the ambiguity of much of that regulation.
I do not need to make a list of all the regulation in flow. Any attendee at Sibos will hear those incredible acronyms rolling easily off the tongues of the experts. Some compliance specialists and lawyers are now overbearingly bright eyed and bushy tailed. One even admitted to me that he thought litigation and arbitration in certain areas of the new regulations would keep him in the upper tax brackets for the rest of his professional life.
I always thought Dodd-Frank was the regulatory equivalent of War and Peace. Unfortunately, its storyline is more difficult to follow across its 2,300 pages of complex wording. Way back in 2010, the Committee on Capital Market Regulation warned that the current rulemaking process is sacrificing quality and fairness for apparent speed and that rather than using a prudent deliberative process, sweeping reforms are being quickly pushed forward without providing adequate time for meaningful fact-finding or dialogue.
It would take a financial Luddite to call for the repeal of the act, for it does reduce risk in major insolvencies and tackles the real too-big-to-fail problem. The trouble is that it also includes many other politically correct issues, such as the bizarre inclusion of reporting requirements on conflict minerals. And it introduces the horrifically ill-defined Volcker Rule with its multiple and diverse possible interpretations.
European Market Infrastructure Regulation (EMIR) is another excellent concept, but the move it promotes to central counterparty clearing house (CCP) clearing, as does Dodd-Frank, is predicated on the correct assumption that it will reduce risk. It is, though, not cognizant enough of the concentration risk it creates and the potential frailties in the margining philosophies of clearers at times of extreme crisis.
Basel III is a further prime example of sound thinking and flawed execution. It is obviously right that banks have adequate capital buffers to withstand worst-case scenarios. We have experienced the cost of failure, and the taxpayer would not tolerate another hit. But it is illusory to pretend that the capital rules of Basel III are not adding to deflationary pressures, for they require banks to accrue more capital.
The reality is, with European banks, as an example, having called on $200 billion of added capital from stakeholders, that source of funding is closed. Outside further government support, the only way to hit the capital targets is through retentions or reduced leverage. The outcome will undoubtedly be a combination of both. But we have also had strange variances in risk weightings attributable to similar risks from country to country in order to assist local banks to achieve the regulatory targets. It would be more logical to go slower and be more consistent.
AIFMD and UCITS V are prime examples of investor protection gone mad. Again, there is much in the regulations that has to be welcomed. But requiring intermediaries to assume country risks is outrageous. Investors have a choice to invest in distinct strategies and markets. Prospectuses (and the EU Prospectus Directive is hardly a model of logic) should identify the risks. The duty of care cannot be a guarantee.
And finally, over the last weeks, I have looked at the EUs CSD Regulations. Risk mitigation and political shenanigans are being confused. The ICSDs are valuable parts of the securities infrastructure. Their business model is highly effective and has withstood the test of time. Separation of banking and securities operations makes sense were the ICSDs (and those few CSDs with banking licences) operating outside the realm of short-term transaction support on a secured basis. The logical regulation would be to insist on the limited-purpose nature of the ICSD and CSD banking arms. In that model, separate incorporation does not make sense; it is merely a likely extra cost and risk for users.
Worryingly, lawmakers are continuing the regulatory deluge. There is no sign of any willingness to reconsider the scale, speed or scope of new regulation. I recall the great Gerald Corrigan, then president of the New York Federal Reserve, talking in London in the 1980s, at the time of the launch of the first G30 recommendations for our markets. He said words to the effect of, I am worried. And if I am worried, you should be worried. After all, it is your money.
The problem today is that regulators are removing choice and acting as if it were their money. Caveat emptor for an investor has been replaced by seller beware. A broad range of products is at risk of emasculation from over-burdensome investor-protection rules. And service scope by intermediaries will be limited by a logically conservative appetite for the new risks they are being asked to absorb.
As we all squeeze into the new regulatory straitjacket, is the world really safer? Or are we just praying that the right deep pockets have been identified for the flaws that will remain in the system and the risks that are an intrinsic part of all investment strategies?
-John Gubert