In the wake of the 2008 financial crisis, global regulators agreed to adopt a co-ordinated response to protecting the financial system against future shocks. But policymakers on both sides of the Atlantic are now pursuing increasingly disparate approaches.
In 2009, the G20 leaders agreed to take a number of co-ordinated measures to guard against future systemic risks in the financial system. Since then, the highly complex network of bodies that govern the different parts of the financial system have gone into overdrive, and the result has been a deluge of financial regulation across the globe.
Under the weight of this regulatory onslaught, it is not surprising that financial institutions, and those that use their services, have complained that they are suffering from regulatory fatigue. A recent survey of the UK financial services sector, commissioned by Moorhouse Consulting, found that approximately 40% of financial services institutions are not coping with the volume of regulatory change, even though two in every five projects initiated concerns with regulatory compliance. Furthermore, this volume is preventing 88% of organisations from proactively addressing other business priorities.
It is not just the speed with which the regulatory landscape is changing that is causing this lethargy, but also the way in which regulation is diverging across jurisdictions. Undoubtedly, there are broad similarities between the various frameworks adopted in the EU and US, but a number of significant differences have appeared.
In the case of Basel III, the point of divergence has occurred as the regulation has been transposed into national law. In some cases, national regulators have sought to bolster Basel’s minimum requirements – the US regulators’, for example, recently proposed to double the original leverage requirement. In other instances, implementation has been fast-tracked, leading to a situation whereby some countries are well ahead of schedule and while a handful have made little or no progress.
“If you contrast the approaches of Europe and the US, you can clearly see that the substance of the regulation varies to different degrees,” says Ruth Wandhöfer, Global Head of Regulatory and Market Strategy at Citi. “Interestingly the US has not yet proposed the liquidity rules, which were planned to come into effect by 2015. Instead, they have pressed ahead with a modified proposal for a Leverage Coverage Ratio (LCR), whilst Europe has maintained the Basel III approach thus far and refrained from setting firm deadlines for compliance as of yet.” The upshot of all this is that one ends up in a very different place on the balance sheet, adds Wandhöfer – and that’s even before beginning to factor in the different accounting regimes.
Approximately 40% of financial services institutions are not coping with the volume of regulatory change, even though two in every five projects initiated concerns with regulatory compliance.
Structural bank reforms are another example of how the US and Europe are moving in different directions. Earlier this year, research published by the International Monetary Fund (IMF) claimed that “potentially significant global costs” could result if systemically important banks are forced to simultaneously comply with the Volker rule in the US, the Liikanen proposals in Europe and the Vickers report in the UK. The combined impact of materially different rules may force institutions to move to the highest common denominator, the report argues, leading to higher costs than would be incurred through compliance with any of the measures in isolation.
In addition to banking regulations, there is the reform of over-the-counter (OTC) derivatives. In the US, one of the aims of the sprawling Dodd-Frank Act, enacted by US Congress in 2010, was to minimise the systemic risks associated with derivatives trading and increase transparency by requiring market participants to clear their trades and report more information about them.
In 2010, a survey of 500 senior executives in the financial services industry undertaken by Ernst and Young found that a majority (79%) felt that much more needed to be done to harmonise financial regulation at a global level.
Across the pond, the European Market Infrastructure Regulation (EMIR) has many commonalities with Dodd-Frank, but there are also significant differences. For non-financial corporates, the most relevant disparity concerns the reporting requirements. EMIR requires mandatory reporting of both OTC derivatives and exchange-traded derivatives; whereas Dodd-Frank, by contrast, only requires OTC derivatives to be reported. EMIR is also less flexible compared with Dodd-Frank in that requires both counterparties to report a trade, while only one side needs to report under Dodd-Frank.
“In 2009, the G20 decided that they want to have enforced central clearing of OTC derivatives,” says Alexandra Foster, Global Head of Strategy and Business Development at BT. “But what we have now is one interpretation of that by Dodd-Frank and another interpretation by EMIR. As a result of this, we are going to see a differing impact upon different parts of the financial ecosystem.” It will create a legal minefield for a financial institution or corporate operating across borders, she explains. “Now an organisation has to work out whether it is operating according to home rules, or to the rules of the jurisdiction they are in.”
Wandhöfer agrees with Foster that differences between the EU and the US on derivatives reform had initially left everyone in the industry confused about what rules they were to follow. “Although the EU Commission and the US Treasury recently announced they will be working together to align aspects of the derivatives trade regulation, at first they were focusing on their own developments, which were not aligned with each other,” says Wandhöfer. “That left cross-border institutions like us in legal limbo as it was unclear whether a cross-border OTC derivative trade might land us in jail because of the conflicting EU and US regimes.”
Time to get together
None of these concerns are especially new. In 2010, a survey of 500 senior executives in the financial services industry undertaken by Ernst and Young found that a majority (79%) felt that much more needed to be done to harmonise financial regulation at a global level.
Nick Voisey, Director at the Loan Market Association (LMA), says this is also a point his organisation have been endeavouring to make to the regulators for some time now. “One has to remember just how interconnected the global regulatory and financial environment really is,” he explains. “Of course realistically, countries – given their various economic, political and social priorities – are going to implement things in slightly different ways and within different timeframes. But we now have numerous regulatory proposals on the table, and no one at a high enough level has sat down and looked at the impact of them all together and how they will affect the wider European and global economy.”
Many have placed a lot of confidence in the trade talks between the US and EU, which began in July 2013, hoping that politicians on both sides would seize the opportunity and begin doing exactly that. “The financial sector has been strongly advocating for the inclusion of financial services into the transatlantic trade pact,” says Wandhöfer. US Treasury Secretary Jacob Lew recently poured cold water on this prospect, citing concerns that the inclusion of financial services in the trade talks might end with the Dodd-Frank Act being watered down. But to the contrary, Wandhöfer thinks that such a discussion should not be about resolving all the differences between Dodd-Frank and EMIR or the Volker Rule and Liikanen, but instead it should establish a structure for co-operation between the two jurisdictions going forward. “If we establish a framework for co-operation in this trade round between Europe and the US, we can make sure that in the future when we propose laws that we inform each other ahead of time,” she reasons.
Navigating the changing regulatory landscape
“I think we are now in a constantly changing regulatory world, and it looks like that will continue,” says BT’s Foster. In this brave new world, she thinks that corporates will need to adopt a more flexible and strategic approach to issues relating to regulatory compliance.
Often, organisations choose to adopt a step-by-step approach to compliance, but Foster thinks that taking a longer-term view is what organisations now need to be taking to help them to adapt to regulatory changes, both now and in the future. “By having that flexible, adaptive approach means that you will be covered for any eventuality. There are underlying themes to all these regulatory changes we’ve seen recently – Basel, Dodd-Frank, EMIR – and once you’ve considered those you can be more confident about planning your roll-out than you would be,” she says. “It is about trying to become more proactive with your compliance strategy and less reactive.”
Getting ready for EMIR
“As mandatory reporting for both OTC and listed derivatives becomes a reality in Europe, banks, corporates and other buy-side firms need to think carefully about their obligations to their regulators,” says Andrew Green, Global Head of Account Management at the Depository Trust & Clearing Corporation (DTCC).
Unlike the Dodd-Frank Act, where the reporting obligation rests primarily with derivatives dealers, obligation to report rests both parties to the trade with EMIR. “It is important therefore that all parties understand their reporting requirements and the options available to them,” says Green. “This includes reporting directly to a trade repository, or utilising a third party or the counterparty to report on their behalf. Regulators, dealers and trade repositories themselves are a good source for this type of information.”
EMIR has certainly become a growing concern for corporates in the past year. According to a survey by Chatham Financial published in May 2013, a majority of derivatives end-users facing compliance requirements under EMIR are not yet ready to meet their key obligations. Among a sample of 177 companies, approximately 66 (44%) stated that they were unsure of their status under EMIR, while 111 (74%) said they are not yet fully prepared for the transition.
The results appear to correspond with the message the banks are hearing from their corporate clients. “The clients we talk to are now feeling quite comfortable with Basel,” says Per-Magnus Edh, Client Executive, Head of Global Financial Solutions, FI Coverage, SEB Merchant Banking. “What they are concerned about right now is EMIR.”
Edh expects that companies with little intragroup trading will outsource their reporting to their banking partners. However, Carlo Scotto, a Senior Product Specialist at SuperDerivatives, cannot envisage the banks providing this service without charge. “The bank will not offer it for free,” he says, “so smaller treasury operations which lack the resources required to handle the execution and management of collateral themselves will need to rethink how much budget the hedging team will need.”
For parent companies reporting on behalf of numerous subsidiaries meeting the requirements under EMIR will inevitably be an even more complex task. These companies will not only need to maintain relationships with their existing brokers, but will also need to develop relationships with the yet-to-be-named trade repositories.
So, what steps do these types of companies need to take between now and the 2014 deadline, and where can they ask for help? One of the ways consultants can assist is by carrying out an assessment of the current infrastructure and using that to design a target operating model, says Scotto. “These activities are generally run by big consulting firms who will advise corporations on how to move from one point to another and how to change the business model so that they have a clear picture of what gaps need to be filled before the regulator comes in to check what is missing.”