U.S. Watchdog Hits Out At London’s Regulatory Approach

Terry Flanagan

London has come under attack from a senior U.S. lawmaker over its perceived light-touch regulatory landscape, which has been blamed for causing some of the recent financial crises.

The U.K. capital wants to keep its place as one of the world’s leading trading centers and has been fighting its corner with the European Union over strict new regulations that are set to come into force to reduce risk following the global financial crisis of 2008.

Gary Gensler, chairman of the Commodity Futures Trading Commission, the U.S. futures market regulator, told a congressional hearing earlier this week that the U.S. was vulnerable to trading losses in London, such as JP Morgan’s recent $2 billion derivatives trading loss which originated from its London branch.

“Often [risk] comes right back here, crashing to our shores,” said Gensler. “If the American taxpayer bails out JP Morgan, they’d be bailing out that London entity as well.”

Carolyn Maloney, a Democratic lawmaker, also told the hearing: “It seems to be that every big trading disaster happens in London.”

Gensler added that AIG had been hit by its financial products unit in London while Citigroup had been harmed by special purpose investment vehicles set up in the U.K. capital. He also attributed Lehman Brothers’ 2008 demise, in part, to its London operations.

“The nature of modern finance is that financial institutions set up hundreds, if not thousands, of legal entities around the globe,” said Gensler.

“During a default or crisis, risk of overseas branches and affiliates inevitably flows back into the United States. This was true with AIG. It was also true with Lehman Brothers.

“Among Lehman Brothers’ complex web of affiliates was Lehman Brothers International (Europe) in London. When Lehman failed, this London affiliate, with more than 130,000 outstanding swaps contracts, failed as well. The U.S. mother ship, Lehman Brothers Holdings, had guaranteed many of the contracts.”

However, some market participants in Europe believe that the region is beginning to take its lead from the U.S. over regulatory matters.

“More and more regulation is appearing in Europe,” 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.

“It is much more towards the prescriptive style of regulation that you see in the U.S., rather than the light touch regulation that you have seen previously in Europe and we are used to here in London.”

However, the U.K’s financial watchdog also sees flaws in the current system as giant U.S. banks can run parts of their U.K. businesses as branches, rather than locally authorized subsidiaries which would be better supervised by the Financial Services Authority (FSA).

“What is deeply unsatisfactory is that we have very little prudential oversight of a branch,”
Hector Sants, chief executive of the FSA, the U.K’s financial watchdog, told the Financial Times.

Earlier this week, a group of trade bodies from both sides of the Atlantic, called the EU-US Coalition on Financial Regulation, warned in a report that the current regulatory stances of Europe and the U.S. were encouraging legal risk, compliance complexity, regulatory uncertainty and added transactional costs in an increasingly fragmented approach.

“You are seeing growing strands of regulatory extraterritoriality—we are in a world of clashing rules,” Anthony Belchambers, chief executive of the Futures and Options Association, a European trade association for the derivatives market, told Markets Media.

“Regulatory coherence is essential if the international competitiveness of the transatlantic marketplace and its contribution to global recovery is to be sustained.”

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