Regulatory Rethink May Be Needed, Warns European Buy-Side Chief

Terry Flanagan

As Europe’s policymakers continue to look at ways to shore up the region’s creaking financial system, some market participants are urging that regulations put in place to put markets back on a firmer footing should be re-examined.

Following the collapse of U.S. investment bank Lehman Brothers in September 2008 and the onset of the global financial crisis, regulators in Europe have looked to stabilize the region’s financial markets with a phalanx of regulations aimed at reducing risk and increasing transparency.

These regulations—including MiFID II, Solvency II, Basel III, AIFMD and Emir to name but five—are either beginning to bite, or are set to be introduced in the coming months and years.

“Investment managers depend upon banks to provide liquidity to the market, which means putting capital at risk,” said Richard Saunders, chief executive of the Investment Management Association (IMA), a U.K. buy-side trade body representing around £3.9 trillion funds under management, in a submission made to the U.K. government’s Parliamentary Commission on Banking Standards. “Make the banks too safe and there is a question as to whether markets will function properly.”

Other proposals looking to address the current financial malaise and reduce systemic risk in the markets include recommendations made in the Vickers report by the U.K’’s Independent Commission on Banking to create a split between retail and investment banking in the U.K., although the British government now looks like it may water down these proposals.

Saunders says that the U.K. should adopt in full the Vickers recommendations, while the IMA chief hopes the similar Volcker Rule in the U.S. ends up in the statute books as intended. Although he admits to frustration at a lack of action from the European Commission on the matter, perhaps reflecting “the very entrenched role that universal banks play in continental Europe”. Saunders, though, thinks the issue is one of the keys to solving the financial crisis.

“Until it is addressed, the response to the crisis will remain superficial and the root causes will not be tackled,” said Saunders.

Financial scandals, such as the manipulation by Barclays and other banks of the Libor benchmark lending rate, have also had an adverse effect on the perception of the banking industry in Europe. While Saunders believes that regulators may be missing the point with some of the regulations.

“Reform, probably structural reform, is needed to sort these issues out,” said Saunders. “Frustratingly, though, the response of regulators, particularly at EU level—where most of the regulation comes from these days—has consistently failed to address the fundamental points. We have had measures on everything under the sun from hedge funds to short selling, and now new anti-market abuse provisions to deal with situations like the Libor episode.

“These are all very interesting, but amount to addressing the symptoms not the cause.  While debate continues about the contribution of regulators and of monetary policy, there is no doubt that the conduct of the banks, together with the incentives underlying that conduct, were key factors in what has happened with the banks and the economy over the last five years.

“These incentives need to be addressed, including the business models of many banks, the impact on funding costs of the implicit—or these days not-so-implicit—government guarantees they enjoy, and accounting rules which no longer err on the side of prudence.”

However, one financial regulator sees it slightly differently. In a speech today at the annual central bankers’ gathering at Jackson Hole in Wyoming, Andrew Haldane, a leading official at the Bank of England, said less, and not more, regulation may be needed to solve the current problems.

“Modern finance is complex, perhaps too complex,” said Haldane, the executive director for financial stability at the Bank of England. “Regulation of modern finance is complex, almost certainly too complex. That configuration spells trouble. As you do not fight fire with fire, you do not fight complexity with complexity. Because complexity generates uncertainty, not risk, it requires a regulatory response grounded in simplicity, not complexity. Delivering that would require an about-turn from the regulatory community from the path followed for the better part of the past 50 years. If a once-in-a-lifetime crisis is not able to deliver that change, it is not clear what will.”

From next year, the Bank of England will assume control of macro-prudential regulation and oversight of micro-prudential regulation in the U.K. with the current watchdog, the Financial Services Authority, set to be abolished.

“[An] alternative approach to financial supervision is beginning to be recognized,” said Haldane. “For example, this approach— which is less rules-focused, more judgement-based—will underpin the Bank of England’s new supervisory model when it assumes prudential regulatory responsibilities next year.”

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