Clarity Gap

Terry Flanagan

A fog of regulatory uncertainty over capital markets shows no signs of lifting.
Market participants’ first questions arose around the fall of 2008, when the collapse of Lehman Brothers and a close call with financial armageddon made it all-but-certain that the regulatory pendulum would swing back toward tautness.

Little was settled by 2010, when Dodd-Frank was signed into law in the U.S. and MiFID II gained traction in Europe. The initiatives cemented the notion that new and significant regulation was forthcoming, yet details were lacking and the timeframe, and even certainty, of final implementation remained a ways off.

Now, as the global financial crisis approaches its fourth anniversary, investors and traders remain vexed as much remains unknown. Rulemaking has moved forward, but only in fits and starts and with delays; some specific codes such as the Volcker Rule are still up in the air; and political forces in a U.S. presidential-election year threaten to scrap Dodd-Frank in its entirety.
“Uncertainty is high whenever many regulations have not been translated into final rules,” said  Max Dufour, principal at trading-technology provider SunGard Global Services. “It’s especially high when the proposed rules are complex, demanding and applied by multiple agencies, without the test of time to validate the process.”

Market participants and financial regulators such as the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission have always had an uneasy co-existence. Over the past couple years, this tension seems to have ratcheted up, and market players consistently cite the lingering fog of the process as a sticking point. It’s almost as if the market would prefer strict, but clear and definitive, rules to an continually developing picture that leaves questions.

Dodd-Frank and Basel III in Europe are currently in the implementation process, and the details of the hundreds of rules are written. Dodd-Frank, meant to take effect this July, is expected to be rolled out gradually over a period of months; regulators have said they’ll take longer to get it right rather than rush.

That view may be constructive for the market in the long term, but for now it remains unclear what, if any, restrictions will be placed on high-speed traders and dark pools; how much big banks will have to rein in or restructure trading operations; and how much of the OTC derivatives market will be brought onto exchanges.

“While regulators spend a lot of time trying to extract signals from noise, they have not yet had a chance to answer some of the fundamental questions raised by the regulations,” said Philippe Buhannic, chief executive of execution-management provider TradingScreen. “With basic questions about scope and jurisdiction still up for grabs, it’s doesn’t seem like we can expect clarity on the details of this regulation any time soon.”

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