Chris Skinner looks at the many regulatory battles taking place in the financial markets around the world and wonders who will win.
In the UK, there's a massive feeding frenzy over faster payments, best execution benchmarking, soft commissions and bundled brokerage. This reflects the changing regulations across Europe where the Markets in Financial Instruments Directive (MiFID), Solvency II, the Payments Directive and the Financial Services Action Plan are driving everyone crazy.
The USA is no better with RegNMS, FFIEC's Authentication rules, Rule 22c-2, NASD Rule 3011, Michael Chertoff, Homeland Security, Disaster Preparedness, the Bank Secrecy Act and more.
Meanwhile, the Gulf Cooperation Council (GCC) is rumoured to be creating a Financial Services Action Plan for all of the Middle Eastern oil-producing nations, which would compete with the euro and the dollar. China is deregulating through 2007 to comply with the World Trade Organisation's requirements. India has announced deregulation of their markets through 2009.
Overriding all of this is the fact that banks globally are dealing with Basel II, which has to be in place by next year.
In fact, all of the changes above have to be completed by around 2010.Are we mad?
I could go on and on about all of these individual regulations, but my insomnia isn't that bad. What prompted me to think about this in the first place was a debate between the European Commission and the Banking and Insurance Community.
The debate asked the question: "Do we need a pan-European regulator", and comprised a panel of stature.
In the financial services corner were Rolf Breuer, former chairman of Deutsche Bank, and Henri de Castries, chief executive and chairman of AXA Group.
In the politician's corner was Alexander Schaub who recently retired as one of Charlie McCreevy's troops in the European Commission's grand plan for European Financial regulations, and Ieke van den Burg, a member of the European Parliament (MEP). On the regulator's side was Fabrice DeMarigny, secretary general of the Committee for European Securities Regulators (CESR), which drew up MiFID.
The referee was Antonio Borges, vice chairman of Goldman Sachs International.
A little bit like the boxing match in Frankie Goes to Hollywood's 1980s hit, Two Tribes, where the chorus goes: "When Two Tribes go to war, a point is all you can score,"
these two tribes did try to score some points.Round one
The match opened with Rolf Breuer of Deutsche Bank addressing the question, "Do we need a pan-European regulator?" by saying something to the effect of:
"There are three issues in financial markets supervision - effectiveness, efficiency and accountability. The effectiveness of financial markets supervision is concerned with key decisions being taken at the group level, not the subsidiary level, because we need to look at group-wide rather than national supervision. The efficiency of supervision is that highly educated resources are needed, which are scarce and costly. The duplication of resources is a waste and creates a non-level playing field where competition can get distorted and unnecessary supervisory burdens create unnecessary costs. The accountability structure is also unclear."
This makes sense and scores a point - bankers 1, politicians 0.
Breuer followed up with another scrunching blow to the stomach: "For the near term, there should be a lead supervisor for firms such as ABN Amro, BNP and Deutsche. These firms should only have one point of contact in their home country for all operations across Europe. For banks that are only national players, the national supervisor should be their contact point and regulator. In the long-term, there should be transparent, stable and consistent EU supervision. The result would be a pan-European range of supervisors comparable to the Eurosystem for Central Banks. A Euro-FSA in other words. The Euro-FSA would then resolve national regulatory conflicts and release rule-sets such that member states work to a common set of rules, with national regulators purely supervising national banks and applying those rule-sets."
Another good point - bankers 2, politicians 0.End of round one
A good opening salvo for the bankers which made me think about Fabrice DeMarigny's CESR Committee, who I suspect had sparked up the whole debate, about whether there should be a pan-European regulator.
The debate has been fuelled by CESR’s a-bomb piece of regulation called MiFID (my last thoughts on this one can be found at 'the MiFID Monster'
). As you will know by now, MiFID is intended to make Europe's pre-trade operations as competitive as the US’s through best execution and price transparency. The only problem is that the directive is being implemented across Europe by member states that have their own discretion as to how they implement it.
As one banker recently said to me:
"I went to the Committee of European Securities Regulators (CESR) and asked them to define the phrase 'facilitates consolidation', a term used in the wordings of MiFID. The response was, 'it will be up to your competent authority'. I asked whether 'competent authority' was my home regulator, my host regulator or the regulator of the most liquid market of the stock that I'm consolidating?' I had a standard politician's answer, which was to ignore that question."
Considering the question he asked, I would have probably said: "I don't know what the question means." Because it gets far too complicated. In fact, how politicians, regulators, bankers and corporates get to talk through this stuff at all, in a common language, amazes me. Maybe that is the problem, there is no common language; and no common language means no common rules.
Hence, the argument over national versus regional versus global regulation. By way of example, another banker recently said to me: "Charlie McCreevy has said that the Financial Services Action Plan is the last regulatory development in Europe but then we also hear people saying 'we may have got this wrong'. We, as bankers, should be asking Europe for a single regulator operating under a single series of controlling rules, regulations and procedures."
This banker's concern was that the countries around Europe can define their own rule-sets. This is also the concern of Rolf Breuer and most other bankers. In fact Germany, Netherlands, Finland and a few other member states, have said that they will not meet the November 2007 deadlines for MiFID anyway and will implement in 2008.
Round Two began with Fabrice DeMarigny, Secretary General of CESR. Fabrice, surely we need a pan-European regulator?
"CESR will force supervisory convergence. A precondition for this to work is that all supervisors should be networked with equal powers … where two national regulators disagree on passporting, they can talk to a group of peers to gain a decision."
In other words, if two regulators disagree, go and get a decision from your friends and, if you don’t like their views, then what do you do?
Sorry, can't give you a point for that one.
But it turns out M. DeMarigny had other priorities: "CESR will go through a metamorphosis by focusing on operational areas and creating common working methods and prioritising where these can be integrated. Our priorities for supervisory convergence are based upon risk, EU-wide impacts and the ability for CESR to manage these. Therefore, the areas we shall focus upon will include a moratorium on home-host issues; developments of IT data sharing of cases and data management overall; the implementation of MiFID; the consistency of IFRS implementation and asset management; the corporate governance directive; and cross-border bank activities with a view toward opportunities for self-regulation."
OK, he has enough on his plate but still nil-point. What do you think European Commissioner for the Internal Markets, Mr Alexander Schaub?
"A single EU supervisor has gone away as a term because it takes us back to the idea of single structures and single EU markets. That is too simplistic. In some circumstances, harmonisation is the right answer. In others, it is only part of the answer. In others, it is completely the wrong answer."
I think you are hedging your bets. Come on Alex, what do you really think?
"What we need to develop is a European system of supervision, which does not mean a single supervisor. It means a European system of common rules that can be implemented nationally."
So what you think we need is a way to avoid political confrontation. After all, if you start taking Brussels Directives and saying, "Mr Blair – we are taking over the FSA and Madame Merkel, give us BaFIN" and so on, you end up in a political war.
Let's throw it back to the bankers and see if they can make it work.
Nope, no points there. Bankers 2, politicians 0.End of round two
In fact, what really struck me at this point was how the politicians were sitting next to the bankers and the juxtaposition of their earnings.
How much does Mr Schaub earn per annum: €100,000 a year? €200,000?
And the gentleman sitting next to him, Antonio Borges, vice chairman of Goldman Sachs International? €10 million a year? €20 million?
No wonder bankers and politicians and regulators do not get on. I mean, the financial guys are making all the money out of the impoverished politicians and citizens, aren't they?
Maybe this is the point.
The politicians see bankers and insurers making loads of dosh (if you prefer moolah, spondulicks, you name it) out of the citizens, so they whip the regulators into action. The regulators try their best to interpret what the politicians want but are purely acting as go-betweens between politicians' dreams and market realities. In other words, the regulators will never win.
Alongside all of this, the industry may complain about the cost of regulation but continue to rake in the profits. The Top 1000 world banks showed record pre-tax profits of $544.1bn and a record return on capital of 19.9% in 2005, after-tax profits grew by 30.3% compared to 65.4% in 2004. Not great, but still a healthy delivery of cash.
The industry claims this is a temporary bull market high and various folks are predicting a banking bust in 2006. This would be due to a variety of factors such as consumer demand for lending reaching breakpoint, the housing sector going belly-up, interest rates and inflation rising, stock markets blowing apart through hedge fund systemic risk and so on.
But it has not happened … yet.
However, the fragility of the markets is one of the reasons why all these regulators are hitting us with regulation - to try to avoid a banking meltdown. Not forgetting the other objectives, such as to liberalise their markets, promote free trade and increase globalisation and competitiveness.
The result is that to be in banking, banks need licences from governments and regulators and, to get those licences, they have to comply and spend. The average bank has to keep up with over 100 regulations from dozens of regulators.One in five Tier 1 European banks are spending over 15% of overall costs on compliance.45% of Europe's biggest banks will spend over $60 million 2006-2007 on Basel II.36% of that spend will be on IT systems and interfaces.HSBC spent over $500 million on regulations in 2004, up 25% from the previous year
They have to spend to be in banking to get the great returns when risk is minimised and markets are liquid.
Another reason they have to comply and spend is that, during these buoyant periods of high returns, banks can get greedy. Shockingly, some might even abuse their clients. Names like Frank Quattrone, Henry Blodget and Jack Grubman come to mind. No time to explain here but these guys weren't very popular with State Attorney General Eliot Spitzer during the early 2000s.
The politicians want fairness, while citizens want safety, open community and respect. They just do not trust the financial institutions to provide this without being forced into it.
Bang goes any idea of self-regulation.
Therefore, as we go through this sea change of financial markets worldwide over the next five years, all I can think about is where will we find stability and growth? The more the regulators meddle with the markets, the less stable the markets become. After all, as you change things you create instability, and markets and people want stability. We do not like change.
Anyway, I droned into Round Three of our Euro match.
Round Three was running around the final comments until Henri de Castries, chief executive of the largest global insurance firm AXA Group, piped up. Mr de Castries made many highly lucid points such as:
"Supervision should mean safety, not stability, at the right cost and with the right levels of capital. The right level of capital means the right level. Too little creates risk and too much creates wastage. There should then be incentives to make investments of that capital in the right categories of assets. All of this should be supporting innovation, rather than creating stagnant market... We are starting to create a world where we are spending too much capital on a system that is not supporting the safety of the customer."
As the point sank in, I think I saw a little wobble amongst the politicians.
He then illustrated the consequences of the meddling with the markets with a potentially lethal point for Europe … and the GCC, China, India.
"Every national regulator, every quarter, adds bells and whistles to the European framework. This means we are less and less convergent at higher and higher cost. For example, European Solvency II regulations mean that AXA has to reserve €23 billion to cover capital requirements for solvency. An equivalent USA insurer with a Triple-B S&P rating only has to reserve €19 billion (AXA is A3a rated) according to our risk models. That means AXA is reserving €4 billion more than it needs to because the EU does not recognize the strength of our diversifications. If that €4 billion were invested, we would realise €900 million a year in additional growth of investment funds. The result is that we lose €900 million a year in lost opportunities on that €4 billion."
In other words, the European Union is forcing our institutions to invest in weak assets and poor returns in order to comply with regulations. As this occurs, global firms with global ambitions could relocate.
The politicians fell to the floor but managed to stagger up again slightly shakily.
At this point Henri de Castries, in a kind of Rocky Balboa moment, launched in with a right hook to the chin: "The benefits of the EU construction of the FSAP must be for the EU constructors. If the EU penalises EU firms, compared to other regions, then capital moves and companies move to where the markets are the most efficient. This means that prices rise in those markets that are inefficient."
The politicians were down and out for the count.
A clear knockout, but who cleans up?
In the small skirmish I saw in Brussels, the financial industry clearly won on points, but they do not own the governmental controls, the legal authorities, the issuing of licences and the regulatory mandates.
The politicians and regulators are shaping the markets the best they can and know that somehow they have to make this work. The question is how?
The answer is that they do not know how. They are trying to compromise, to gain agreement amongst warring cultures, countries, companies and markets. It is not a pretty sight to watch because in any boxing bout, there will be blood on the floor.
Some will be from the banks, some from the banks' customers, some from the banks' home countries and some from the banks' host countries.
As we look worldwide at regulatory change, we see the bouts of upper cuts and stomach blows happening in all geographies. American banks are beaten up with post-9/11 sticks. China is opening up through world trade ambitions and their banks are being knocked out by foreign bank investments. Kuwait, Saudi, UAE and company seek to leverage their petrodollar billions and will find dollar and euro goliaths waiting in the wings to take over.
Just as Rocky Balboa got knocked out by a Russian, banks around the world will be knocked out and consolidated, merged and acquired. During this dramatic reshaping of our markets, only a few will win and, just as in war, the only folks who make money are the arms dealers.
Who supplies the arms to each side here?
Chris Skinner is a director of TowerGroup and founder of Balatro.
Web links: TowerGroup and Balatro