Tuesday, 21 May 2024

The splintering of the global regulatory world

5 min read

By Tanya Angerer

The pace of regulatory reform has been relentless since the global financial crisis. From D-SIBs, TLAC, MiFID 2 to FRTB, the chain of regulatory acronyms that banks have to grapple with seem endless. Yet, are these measures working to make the banking system more secure or does their complexity cripple banks’ efficiency?

  • One of the biggest problems facing the financial services is that the explosion of rules has led to misunderstanding and contradiction
  • These days understanding regulations has become essential to companies’ strategies, while also becoming part of CEOs’ conversations
  • Growing fragmentation will make it more difficult to match cross-border finances

The regulatory world is one that by definition has to be in constant evolution. As the banking system morphs and new perils develop, regulators have the difficult task of keeping any new risks at bay. For many chief executives, however, there is growing fatigue at the constant game of regulatory catch-up and frustration over how onerous the rules have become. JPMorgan’s CEO Jamie Dimon complained that the current regulatory environment is ‘’unnecessarily complex, costly and sometimes confusing’’ in his annual letter to shareholders earlier this year. Meanwhile, Lloyd Blankfein, Goldman’s chief executive, has described the incremental layers of regulation as an ‘’overreaction’’.

The fact that bank CEOs are wading into the debate proves just how game changing these regulations have become.

‘’Regulatory change in the past never affected macro business strategy but now understanding regulations has become a strategic imperative,’’ says Kevin Nixon, global regulatory risk leader for Deloitte and global and APAC leader at the centre for regulatory strategy. ‘’That’s why it’s become part of CEO’s conversations recently.’’

Contradicting rules

One of the biggest problems facing the financial services is that the explosion of rules has led to misunderstanding, and sometimes contradiction. The European Union (EU)’s ambitious regulatory reform known as the Markets in Financial Instruments Directive, or MiFID 2 is a case in point.

The reform, scheduled to come into play on January 3rd, 2018, dictate that asset managers will have to pay financial institutions directly for research, instead of typically bundling those costs as part of a package of services.

Yet the EU rules clash with US laws that require any US business that sells research

to be a registered investment adviser. This had led the Securities and Exchange Commission, the US markets regulator, to issue a temporary reprieve of 30 months for US banks and brokers to charge their EU asset manager clients directly for the research. The current regulatory framework “is very complicated in the sense that there are all sorts of competing types of requirements, which can go against each other and the trade-off can be difficult,” said Peter Reynolds, partner in Oliver Wyman’s Hong Kong office, focusing on financial services.

“This is further complicated by the regional differences that exist.”

The inability of the Basel Committee on Banking Supervision to finalise Basel 3 and decide on a so-called “capital floor” is one example of the mismatch of goals in different jurisdictions. A showdown between banks and regulators in the US and Europe has arisen on the level of the capital floor, which limits the extent to which banks can use their own models to calculate the riskiness of their lending.

US officials like a higher capital floor, at around 75%, as many banks are already required to use higher calculations of risk weightings, meanwhile Europeans argue this would unjustly compromise their balance sheets.

Global policies vs nation’s interest

“There is an emerging trend politically to paraphrase President Trump that “we will only subscribe to global policies if it is in our national interest,” says Deloitte’s Kevin Nixon.

“And this isn’t restricted to just the US. Whether we are talking climate change, banking regulation or free trade, there is a clear political shift in conversations around the world to be more sceptical of regional or global agreements.”

Different countries’ plans on the adoption of the Basel Committee’s Fundamental Review of the Trading Books, or FRTB, is another illustration of how the global regulatory framework is splintering.

FRTB, designed to rein in banks’ trading risks by beefing up their capital requirements, is scheduled to come into effect in January 2019, but the Monetary Authority of Singapore is reportedly delaying the implementation, following similar postponements in Hong Kong and Australia. The Hong Kong Monetary Authority flagged at the time that “a number of practical implementation questions have arisen given the high complexity of the new standards.” Even the US Treasury and the EU’s executive European Commission have recommended stalling FRTB’s adoption.

Stressful testing

“Typically, the biggest challenge with complying with capital requirements and more trading-focused regulations is the data,” says Daniel Simpson, head of research at regulatory consultancy firm JWG. “In terms of Basel 3, one of the challenges is to retrieve the required data accurately and quickly enough to respond to things like stress testing.”

The idea that capital reporting should be able to be done in real time is something that is proving incredibly challenging for most banks where expectations of the regulators often outstrip capability from a technical point of view.

“Part of the reason why compliance remains so expensive is because banks’ have been slow to spend on new technologies and better infrastructure,” continued Simpson. Growing fragmentation of the regulatory world is worrying mainly because an increase in regulatory arbitrage would make it more difficult to match cross border finances.

Furthermore, a ballooning pile of guidelines would mean an even higher cost of implementation for the banks. 

Keywords: JP Morgan, Goldman Sachs, Basel III D-SIBs, TLAC, MiFID 2, FRTB
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