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Steering clear of regulatory balkanization

The hero gets stuck in quicksand and struggles to get out, only to end up sinking even deeper. This has long been a staple Hollywood plot device in films since Lawrence of Arabiato the more recent The Mummy and the latest Indiana Jones flick.

The capital markets industry, which faces fragmentation due to regulatory timelines, implementation standards, and regulatory regimes, is stuck in its own type of quicksand. Regulatory balkanization is expected to drag the industry’s RoE down by 2-3 percentage points[1], and has made it very difficult for decision makers to make any significant moves or chart major revenue-generating initiatives while keeping regulatory requirements in mind.

A number of banks have responded by “running to the fire” and complying with new rules well ahead of time. Responding to regulatory developments without a well-articulated and strategic approach is deeply reactive, and only adds to the US$8–12 billion spent by the industry on regulatory compliance and remediation.

Regulatory balkanization, now in 3D
Global banks find themselves confronting a balkanized regulatory environment for one of three principal reasons:

  • Differing interpretations of a globally shared vision by regional regulator
  • Differing regional timelines for implementing related proposals
  • The emergence of new regulatory regimes

Any (and sometimes all) of these contributors can fragment the regulatory authority. Although most regulatory problems are due to varying timelines, the issues posed by differing interpretations and multiple regulators are more serious, since they prevent banks from developing an organized enterprise-wide regulatory strategy.

Shared vision, diverging interpretations
For the shared objective of consistently identifying parties to financial transactions, regulators have developed two independent systems: the GIIN (Global Intermediary Identification Number) for FATCA[2], compliance and the LEI (Legal Entity Identifier) for EMIR[3], compliance and CFTC[4], swaps record-keeping.

Similarly, the EMIR and the Dodd-Frank proposals share the objective of introducing central clearing for OTC derivatives. However, they differ significantly on issues of product coverage, segregation of collateral, and exemptions.

The differences in regulatory implementation extend from these operational details to the operating models proposed. To limit the spread of contagion from the proprietary trading business to the retail banking business of a bank holding company, each market has adopted diverging approaches. In the US, the Volcker Rule separates ownership for these two lines of business, in the UK, the Vickers Commission aims at functional separation of these business lines (a.k.a. ring fencing), and in the EU, the Liikanen Report proposed a middle ground of sorts.

An alphabet soup of regulatory authorities
As if coping with different implementations for each geography wasn’t difficult enough, each regulatory regime has multiple regulators, each with its own requirements and schedule. In the EU, banks must report to the ESFS[5], EBA[6], and ESMA[7]. Similarly, in the UK, banks must report to the FCA[8], PRA[9], and newly created FPC[10], The situation doesn’t get better in the US either, with banks reporting to the SEC[11], the CFTC, various federal banks, the FDIC[12], and the FINRA[13], among others.

Getting out of the quicksand
To get out of this mess, banks need to avoid knee-jerk responses to individual regulatory developments, and keep their responses in line with broader enterprise-wide regulatory strategy. This means banks must wait until their listening posts—industry bodies and legal experts—can clarify the regulatory requirements, and only then develop their IT strategies—platforms and operational services.

At the cost of tighter development timelines, this delay helps keep IT costs in check while banks develop capabilities that are useful for the bank’s own analysts and can potentially contribute to revenue-generating lines of business, instead of complying with regulatory requirements and little else.

[1] Morgan Stanley – Oliver Wyman report, 2013
[2] Foreign Account Tax Compliance Act
[3] European Market Infrastructure Regulation
[4] Commodity Futures Trading Commission
[5] European System of Financial Supervision
[6] European Banking Authority
[7] European Securities Market Authority
[8] Financial Conduct Authority
[9] Prudential Regulation Authority
[10] Financial Policy Committee
[11] Securities and Exchanges Commission
[12] Federal Deposit Insurance Corporation
[13] Financial Industry Regulatory Authority



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