Regulation And The Fear Of Unintended Consequences
Market participants in Europe are worried that the slew of financial regulations, aimed to preventing another global financial crisis, that are set to come into force over the coming months and years will likely create a more risk averse landscape and cause outcomes that were not originally intended.
“There’s a whole raft of regulations coming in from all different quarters, some of which step on each other’s toes, but the regulations all have the general gist of wanting to increase market efficiency, reduce risk and increase settlement certainty,” David Lewis, a London-based senior vice-president of Astec Analytics at SunGard’s capital markets business, a trading and technology firm, told Markets Media.
“I can see a lot of positive objectives that all these regulations have got and I kind of understand that but what they all have in common is the risk of unintended consequences. It’s all very well if we can reduce risk here or increase certainty there, but you cannot eradicate risk through legislation.
If you got anywhere near that you would find that there would be no return there and these organizations, funds or banks or whatever sector you want to pick on, all need to make money for themselves and their clients so there has to be a certain relationship between the risk and return they want to take.”
In Europe, a host of regulations and directives are currently snaking their way through the corridors of power in the European Union, including an updated Markets in Financial Instrument Directive (MiFID II), which governs European financial markets; the European Markets Infrastructure Regulation (Emir), which will require all over-the-counter traded derivatives to be processed through clearing houses; and the Alternative Investment Fund Managers Directive (AIFMD), which aims to bring hedge funds and other private equity funds under greater regulatory supervision.
The unintended consequences of Emir will likely concentrate risk in central counterparties (CCPs), which may drive new risks outside of them. This includes increasing costs for the buy and sell side as a result of enhanced margin, collateral and capital requirements; significant impacts on booking systems; increased data reporting to trade repositories; enhanced risk management; a decrease in hedging activity; and potential for increased netting. Other risks could be a lack of interoperability between CCPs, issues with third country equivalence and an increase in systemic risk with CCPs in general.
“We are hearing a loud chorus of objection from capital markets participants, on both buy and sell sides— MiFID II and Emir have all been repeatedly excoriated,” said David Morgan, marketing director, trading and client connectivity at SunGard’s global trading business.
“There is fundamental common sense in many of the objections, which focus on the costs and risks of unintended consequences. As such, they should be persuasive to decision makers who want to maintain effective, functional capital markets.”
Changes in delegation could lead to increased costs for investors and retaliation from other domiciles.
EU funds routinely delegate portfolio management to hubs including New York, Tokyo and Hong Kong.
The regulator recommended changes in 19 areas including harmonizing the AIFMD and UCITS regimes.
Most funds are managed cross-border using passporting rights.
KPMG is researching how the alternative fund regulation has worked in practice.