The regulatory burden for banks, brokers and fund managers trading in Europe is set to increase this year, as the authorities try to improve their oversight of an increasingly complex business. However, regulators must ensure there is consistency between national and European rules.
The globalisation of the capital markets, characterised by increased cross-border investment, is well-documented but less apparent are the challenges this presents to national and international regulators.
In Europe, national regulators, such as the UK’s Financial Services Authority, and multinational authorities, such as the European Commission, are increasingly required to work in partnership to ensure consistency between procedures for transacting business within a jurisdiction and between one market and another.
But while they attempt to stimulate market harmonisation, they do not always practise what they preach when it comes to the unification of different regulatory regimes. This has the potential to become a problem this year, with more reforms in the pipeline.
Consistency between regulators is sometimes complicated by the different approaches taken by these watchdogs. A recent report by consultancy TowerGroup argued the contrasts between “principles-based and rules-based approaches to financial regulation among major financial services centres will inhibit global financial regulatory harmonisation”.
The warning followed a pledge by the FSA to adopt more principles-based regulation this year, a move TowerGroup called “a radical and controversial stand against the trend in financial regulation globally, which is towards rules-based regulation”.
Bob McDowall, a senior analyst at TowerGroup, said: “Although they may wish to adopt principles-based regulation, most regulatory jurisdictions will be prevented from doing so by the difficulty of enacting national primary legislation and by consumer and political resistance.”
McDowall said principles-based regulation will demand “innovative approaches in the deployment of technology, presenting significant business opportunities for vendors and service providers” but added that financial institutions “will succumb to regulatory arbitrage by using principles-based jurisdictions to accelerate implementation of financial innovation”.
Such regulatory arbitrage would be mitigated, in Europe at least, by a single, centralised EU regulator – a proposal that was discussed last year. For the time being, European finance ministers are working on a comprehensive work programme, which provides for evolution of the existing framework, but the focus will be on practical steps to improve the quality of its output, rather than a leap to more centralised EU arrangements.
Some parts of the market have benefited from the co-operation between different regulators. Jon Carr, head of public policy at Swiss bank UBS, welcomed the news late last year that the US Securities and Exchange Commission will consider allowing US companies to use international accounting rules following the regulator’s decision that non-US companies could submit accounts using the international standard.
The rules eliminate the need for foreign companies to reconcile their financial statements prepared under the International Financial Reporting Standards with the US’s Generally Accepted Accounting Principles.
Carr said: “The November 2007 decision by the SEC to allow foreign issuers listed in the US to file their accounts under IFRS without reconciliation to US GAAP, was a significant and welcome step towards a high-quality, global accounting language, for which the EU authorities, led by internal market commissioner Charlie McCreevy, deserve considerable credit.”
Less well received has been the roll-out of the markets in financial instruments directive, the trading reforms led by the EC but implemented – or not, as it turned out in some cases – by the local regulator in each of the 30 European countries.
Eleven countries failed to meet the November 1 deadline for passing the trading rules into law in their individual markets, with four countries only partly hitting the target and seven, including Spain, Poland and Portugal, not getting that close.
The Netherlands and Finland left it to the day before to define how the laws would be applied in their domestic markets, despite having originally been set a deadline of January 31 to do so. The regulators have committed to catch up this year but their tardiness is causing confusion for investment companies operating in multiple countries.
Jitz Desai, a director at Mifid think-tank JWG-IT, said: “The reason the EC set a January deadline for transposition was to allow companies in those markets nine months to prepare for the changes. Until the rules are enforced, investment companies may find themselves unclear as to their position regarding customer challenges.”
Recent research by JWG-IT suggests that as many as four in five European banks, brokers and fund managers expect to be questioned over their compliance with Mifid, while two in three of those surveyed think they will be called to task before the end of March.
PJ Di Giammarino, chief executive of JWG-IT, said the failure by a third of European countries to implement the rules has left “thousands of firms little time to adjust”. He added: “This is a critical time for the market, as it has taken the first few steps in the four-year Mifid implementation.”
Niki Beattie, head of market structure at Merrill Lynch, has welcomed the Mifid changes, which allow banks and brokers to challenge the quasi-monopolies historically enjoyed by European stock exchanges. However, she is under no illusion that the industry’s Mifid efforts were eased by the passing of the November 1 deadline.
She said: “Implementing regulation, like Mifid, was a great challenge last year and its impact will continue to drip-feed into this year as it is implemented fully across Europe. I suspect that we won’t see any major regulatory change this year at a pan-European level for secondary markets as the Committee of European Securities Regulators and the national regulators assess the full impact of Mifid, particularly looking at new challenges such as liquidity fragmentation.”
Beattie is convinced there will be a Mifid II at some stage, focusing on “some of the issues that arose out of the first directive and other asset classes, such as the European debt and derivatives markets”. She advises European authorities to assess the impact of the regulation that is in place, rather than press ahead with new directives.
Mifid-related problems have arisen, with brokers complaining about the lack of a centralised list of pan-European stocks, making trading and trade reporting more complex. The emergence of dark pools – alternative trading systems that allow banks, brokers and fund managers to trade anonymously, thereby reducing market impact – is another concern for regulators.
Mifid may have left some of Europe’s national regulators wanting but the EC seems to have done rather better with its voluntary Code of Conduct on European clearing and settlement. The code, which came into effect on January 1 with the backing of Europe’s top exchanges, clearers and settlement depositories, exemplifies a more flexible approach by European regulators.
Coming to Europe
Beattie also welcomes the code, arguing that clearing and settlement will come into regulatory focus this year, with the London Stock Exchange moving into these services after its acquisition of Borsa Italiana, and the Depository Trust and Clearing Corporation, the dominant US clearer, set to come to Europe with its EuroCCP.
Beattie said: “The code of conduct is not a piece of regulation and we prefer the lighter touch of the code rather than a directive, which could take another two or three years, but we also want to see progress in harmonising European clearing and settlement.”
She has argued a single clearing house could drive down the cost of clearing and settlement in Europe, making it more competitive with the US for international trading.
New regulations – including Solvency II; capital adequacy rules in the insurance sector; Ucits, which determine the practices of collective investment schemes; as well as more Mifid – are being lined up for this year, but banks are quick to warn the watchdogs against overreacting to market crises.
It is unclear how global and EU public authorities will decide to respond in the longer term to recent market developments, although the markets like the fact they have tended to refrain from any kneejerk regulatory response.
The UK’s Walker report on private equity has proposed increasing the disclosure requirements for buyout companies, while Alistair Darling, UK Chancellor of the Exchequer, is proposing reforms to the capital gains tax requirements that could force private equity firms in the UK to pay as much as 18% tax on profit.
The regulatory burden on companies trading in Europe looks set to increase again this year but, unusually, London-based investment banks seem broadly pleased with the scale and tone of regulation in Europe, citing the famous principles-based approach of the FSA as a factor in this success. However, they are quick to warn the regulators against complacency.
In an industry that thrives on innovation, it is the responsibility of regulators to ensure they are matching the pace of change set by the banks and honouring their commitment to protect investors without hampering companies’ endeavours to make money.