Talking Heads: a matter of principle
Five years on from the financial crisis and banks still face a rising tide of regulatory initiatives. Daily News at Sibos asked several industry executives whether the price of regulation is becoming too high
Larry Thompson: managing director and general counsel, DTCC
The regulatory environment emerging from the 2008 financial crisis is only beginning to take shape, but it is clear that market participants will face significant costs to comply with the new mandates. Financial market infrastructures will face their own set of challenges, but there is growing recognition that there is an opportunity for these entities to play a more prominent role in helping firms reduce risk, enhance efficiencies and drive down compliance costs.
Infrastructures help to promote market growth by utilising a wide range of back-office functions, such as clearance and settlement or data management. Market participants can leverage these infrastructures to reap the benefits of scale and standardisation in other processes, such as collateral management or OTC derivative transactions reporting. However, in their efforts to bring greater efficiencies to users, infrastructures must ensure they do not inject additional risks into the system.
In the OTC derivatives market, for example, the mandate to channel most transactions through execution platforms and CCPs may concentrate risk in these infrastructures. As a result, it becomes even more critical for infrastructures to be totally transparent to their members and to the public as to how their governance works and what their risk management tools and techniques are – and indeed what risks they bring to the marketplace themselves.
The increased use of market infrastructure also raises the bar for global supervisors. In this regard, global, principle-based standards have become a critical component of ensuring consistent oversight of these entities.
Werner Steinmueller: managing director, head of global transaction banking, Deutsche Bank
The global financial system has gone through a dramatic crisis, which has significantly damaged trust. We must all learn from this and take the next right steps, including defining new sector boundaries. Regulation, of course, plays a key role in this process, but regulators need to focus on ensuring they take the right steps, and coordinate globally to put them in place. This is vital to maintaining a global balance and avoiding regulatory arbitrage. An analogy that I like to use, and which underscores the importance of financial system regulation, is that of prescribing medicine for a patient. It is crucial that we make the right diagnosis, and thereby prescribe the correct dosage of the correct medicine to address the problem without adverse side effects.
As well as helping the industry to regain trust, regulation can also drive innovation. Transaction bankers have a strong client focus, and efforts to help clients navigate regulatory change can often result in the creation of new products and solutions. For example, because of Basel III’s focus on banks’ cash flows over a 30-day period, we are offering structured term deposits, which enable our clients to benefit from higher yields. Another important opportunity stems from Sepa, which can unlock significant efficiency opportunities for multinational corporations active in Europe.
Looking beyond regulation, the financial industry must focus on redefining its core values to strengthen and “future-proof” its business models. In this respect, I am convinced that a cultural change will result in a more sustainable financial system.
Alex Merriman: head of market policy, SIX Securities Services
Over the past five years, the banking industry has been hit with all manner of additional regulatory requirements, ranging from capital add-ons, to leverage ratios, liquidity buffers, recovery and resolution plans (RRPs) and bonus caps. Now it is the turn of the post-trade financial market infrastructure (FMI) world, driven by the desire of regulators to make FMIs ‘safe’ as well. This is being brought to us through the CPSS-Iosco Principles, the European Market Infrastructure Regulation and the CSD Regulation in particular, with the addition of RRPs in the future.
Does it make the FMI world a safer place? Well, yes and no. We can’t really argue against improving levels of capital, driving more efficiency through shorter settlement cycles and greater discipline, while enhancing risk management processes and protection of customer assets. There are also underlying harmonisation and competition threads that all help to prevent a race to the bottom. However, some features of the enhanced regulation point in the other direction – less flexibility in risk management choices, continuing absence of global regulatory consensus, OTC derivatives concentrating more clearing risk in CCPs and the virtual disappearance of unsecured transactions, meaning that if collateral is not in short supply, it is in the wrong place or of the wrong type. Does this matter? Only time will tell.
Bruno Prigent: head of Société Générale Securities Services
Everyone agrees that we have been facing a regulatory tsunami since the financial crisis in 2008.
As far as financial markets and securities services are concerned, not only regulatory initiatives have to be considered but also those launched by market infrastructures and national central banks, which makes them even more difficult to follow, understand and finally implement. They are occurring in, and contributing to creating, a more and more complex environment and it is therefore complicated to ensure a coherent global picture.
Keeping up is difficult and costly, both for regional and global players, especially at a time when resources are scarce and budgets are under pressure.
Costs related to regulations are always considered way too high, leading to an arbitrage between business-oriented developments and what are often perceived as unproductive investments. But although regulatory initiatives clearly represent a constraint, they remain crucial to the overall proper functioning of all organisations in the financial sector. The financial crisis has proved how damaging absent or even inadequate regulation and supervision can be for the entire community. Costs and losses incurred have reached tremendous amounts, totally out of proportion with the investments resulting from the in-depth review of the previous regulatory framework. Regulation is unavoidable and although some industry complaints are justified, stakeholders have no choice but to deal with it. It then seems more appropriate to consider ways of limiting the affects of regulatory excess and, even more so, of leveraging them, like, for instance:
- transforming constraints into business or organisational opportunities for the benefit of our clients;
- being associated with the various initiatives from their inception onwards; and
- establishing the ad hoc organisation necessary to ensure the right level of coverage of initiatives and countries, and to be in a position to react in time and efficiently.
Tim Keaney: chief executive, investment services, BNY Mellon
The financial crisis of 2008-2009 will be seen as an inflection point in economic history that also represented a departure from previous regulatory and supervisory practices. Across the globe, regulators are focusing on more detailed and granular regulation of banks.
In particular, we are seeing a shift from viewing banks on a stand-alone basis – that is, less of a focus on bank-specific risks – to viewing banks through the prism of financial stability. As regulators focus more on financial stability and less on individual banks, larger and more systemically important firms are faced with a changing regulatory policy landscape.
This will have multiple consequences. First, we need to re-examine how reform measures could affect core parts of our business. Right now, for instance, we are analysing how money market fund reform, more stringent credit exposure frameworks, the final Basel III rules and the EU’s proposed financial transactions tax may have an impact on our investment services business.
Second, many regulations are focused on the same problems. This creates a layering effect and raises compliance issues. For example, new Basel III rules, proposed single counterparty credit exposures and derivatives reforms are all focused – in one way or another – on the regulatory concern that larger banks became too interconnected before the crisis, which exacerbated financial contagion. Managing duplicative and cumbersome regulations will be a burden for bank leaders going forward. In addition, cross-border resolution initiatives address one of the core problems regulators faced during the crisis: how to wind up financial institutions with presences – and assets and liabilities – around the globe. This problem requires regulators to harmonise their own processes and may require significant changes to the legal and regulatory structures in many countries.
The pace and scope of reform efforts since the crisis has been remarkable. But while all of these myriad reform efforts will combine to reshape how larger banks, investment managers and other financial institutions operate, they will also present us with strategic growth opportunities, given our core competencies across our servicing platforms.
John Owen: chief executive, international banking, Royal Bank of Scotland
On the whole, it is worth remembering that the regulations introduced since the financial crisis have brought a number of positive developments. They have forced banks to ensure they properly understand and manage their risks, undoubtedly creating a safer and more resilient financial system. Getting the right balance is key and we need to engage with regulators, the wider financial services industry and our clients to deal with new rules constructively.
The array of regulation around the world has certainly reached unprecedented levels though, and we need more international coordination. There is a complex array of regional and global rules and various, sometimes contradictory interpretations of them in different countries. This gives some a competitive advantage over others but can also drive up the costs of developing and delivering financial products.
More coordination is clearly a challenging goal with many different bodies and regulations involved, but greater commitment to a set of high-level, global principles would be welcome. There have been some moves towards this but more needs to be done.
An example of the rising price of regulation is the drive from some regulators for banks to locate capital in countries where they operate – as well as the country of their headquarters. This need to keep capital in two places is not efficient from a bank’s perspective and potentially has an impact on the products we can deliver to clients.
Ruth Wandhöfer: global head, regulatory and market strategy, Citi Transaction Services
The cost of regulation has increased due to the exponential increase in regulatory measures that are being proposed or implanted between jurisdictions across the globe. However, the increasingly fragmented nature of regulations: global versus regional or local, different interpretations of regulations and varying adoption timetables, create a great deal of inconsistency and the risk of Balkanisation. This in turn naturally leads to increased cost but also demonstrates how difficult it is to get a truly accurate picture of what the impact of regulatory change will be.
Wherever you look, there are diverging regulatory proposals and implementation schedules. For example, the US and Europe are approaching the Basel III recommendations in different ways. There are also differences in recovery and resolution planning between the UK, the US and Europe. The US and Europe are also diverging over the question of multilateral interchange fees for payment cards.
Citi works closely with regional and global industry groups, such as Baft-Ifsa and the European Banking Federation, in order to address common challenges regarding financial regulation. Membership of local banking associations in most countries where we have a presence is also a requirement as well as continued dialogue with central banks and market infrastructures. Our key goal is to maintain global consistency, the ability to operate cross-border and at scale. Failure to do so would create inefficiencies, lack of connectivity and reduction in service, which is the opposite of what a globalised economy needs.
FI clients – banks, asset managers, treasurers – need to develop or upgrade their IT platforms or justify fixed cost investment in people and resources to develop services in-house. With so many regulatory and legislative changes happening simultaneously, many of our clients are looking to leverage proven solutions from a partner with the scale, knowledge and regulatory readiness. This will enable them to then focus their in-house resources where they can add the most value to their client base.
Nick Burge: head of OTC clearing, Lloyds Bank Commercial Banking
It is timely to ask this question now, as we are in the middle of implementing many of the new regulations that have been developed over the past few years.
As some of the pieces of Dodd-Frank, Emir, CRD IV and Basel III take effect it is worth asking whether the wave of new regulation is serving its purpose of making a safer and more secure financial system that works for all its participants.
Ultimately, we have to accept that the goal of a more stable global financial system does come at a cost.
These costs are twofold. First, there are the direct costs of implementing and complying with the regulations, with the investment in infrastructure, including technology and people and the higher capital requirements, such as collateral. Then there are the higher economic and consequential costs that are passed on down the value chain to the real economy.
The initial costs of regulation have to be balanced against the benefits that will accrue to everyone from a safer financial system. The upfront costs may be challenging, but savings should materialise later on as there is greater stability in the system as the markets adapt to the new conditions.
The overall principles of much of the proposed regulation are sound and based on improving the security of the system. We just need to be careful to balance the impact, at a detail level, of the new regulations hitting users of financial services at a time they are looking for growth.
The cost of improving the system will not be too high as long as the effects on end-users, in particular in terms of higher costs and complexity, do not have too significant a knock-on effect on growth in the economy. To ensure this, we need to monitor closely for unintended consequences.
Al Danino: associate, Peterevans
Is the cost of regulation too high? In one three letter word: yes. Regulations, as a government policy instrument, have been growing for some time now, particularly in EU member states. In an attempt to correct perceived competition and consumer protection problems in particular economic sectors, regulations have had the unforeseen consequence of increasing the operating costs in those sectors. From agriculture to health to finance, operating costs keep increasing. As organisations endeavour to comply with new requirements, ostensibly aimed at transparency, bottom lines are being compromised on a daily basis.
Examples are plentiful. The Markets in Financial Instruments Directive (Mifid) had no less than 20 articles that specified technical implementation measures, significantly adding to the costs of implementation for financial institutions. It is a well documented fact that these technical implementation costs were significant, as reported by the UK’s Financial Services Authority at the time.
Moreover, in a 2012 survey the total costs of complying with regulations were estimated as 10 per cent of revenue and a thundering 50 per cent of profits in the UK’s investment management sector. Finally, as if complying with EU regulations were not enough, organisations have to increasingly cater for the extraterritoriality of US financial regulation such as the Dodd Frank Act and the Foreign Account Tax Compliance Act to name but two.
These are but three brief examples. If you then extrapolate this by the number of EU directives and regulations with which a financial institution has to comply, and then factor in the new wave of regulations such as Mifid II, the fourth European AML Directive, Transaction Reporting, Payment Services Directive and so on, there can be only one conclusion.