Market Users Fear Regulatory Uncertainty is a Certainty

Terry Flanagan

Regulatory change and uncertainty around the world is forcing the international financial community into reactive mode.

“The scale of regulatory change that the investment management industry faces at the global level over the next five years is perhaps unprecedented and undoubtedly due to the global financial crisis felt in every market around the world and still making waves in nearly all of the interconnected economies,” said John Lehner, chief executive of Eagle Investment Systems, a unit of BNY Mellon that provides systems for asset management firms.

In the U.S., the Dodd-Frank Act of 2010 has created a new regulatory framework awash with new rules touching almost all aspects of the asset management business, including investment advice, securities trading, clearing of exchanged-cleared swaps and the marketing of funds.

The Act also required hedge fund managers to register with the Securities and Exchange Commission by the end of the 2012.

“New rules aside, the SEC itself is stepping up the intensity of its scrutiny,” said Lehner. “In addition to establishing a special enforcement task force for the asset management industry, the SEC is prepared to deem a firm ‘higher risk’ if it considers that the business does not have a serious and healthy attitude towards compliance.”

Banks are also about to be hit with a substantial new regulatory regime in the form of the Basel III capital adequacy rules, which will now come into effect from 2015.

The aim of Basel III is to stabilize banking by reducing the cyclicality of the industry, strengthening banks’ capital, enhancing bank liquidity and reducing the amount of leverage used by banks to enhance their profits prior to the crisis.

“In some ways, these new rules could not come at a worse time, as banks already have a plate full of problems to deal with including stagnant economies, increasing bad debts that are reducing already scarce capital, lower margins from trading and soaring regulatory compliance costs from implementing Dodd-Frank and Emir [in Europe],” said Bob Park, chief executive of FinCad, a provider of risk analytics, in a blog. “Bank profits are already being squeezed.”

The complexity of the regulations “is simply mind-boggling”, Park said.

The first incarnation of Basel, introduced in the late 1980s, was 30 pages long. Basel III, on the other hand, is over 500 pages and “requires dozens of calculus calculations”, Park said. “And this comes on top of Dodd-Frank, which mandated the creation of more than 300 specific rules and some say will require more than 29,000 pages of documentation,” he added.

While many emerging regulations from different jurisdictions in the U.S., Europe and also Asia have significant overlap in areas they address, such as increasing transparency, decreasing systemic risk, improving capital adequacy, putting in place further investor safeguards for protection or tightening loopholes to enable more efficient tax collection.

“The impact of new regulations will span across the whole firm including front office and trading areas, client areas, operations processes, firm-wide data and the systems that are applied across the business,” said Lehner at Eagle Investment Systems. “It’s also important to note that investment firms are not only going to be affected by asset management regulations in many countries but if they manage pensions, bank or insurance funds, or are owned by banks, insurance companies or venture funds, then they are subject to regulations for those industries, too.”

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