Don't look back now

A torrent of regulations is starting to wash over the financial services industry. Trevor Morton asks how the industry is coping as directives for regulatory change and better risk management start to kick in

On reflection, the years running up to the credit-crunch and discussions around GRC (governance, risk and compliance) now appear as background noise. For many, it was a mere distraction. Soothsayers of the impending crash were, for the most part, ignored. But as we ponder the hangover from 2008, it’s clear much is about to change. Recent discussions of credit risk or political intervention in the banks have petered out.

Regulation is back as national and supra-national regulatory bodies; national governments and industry groups’ deliberate policies that are set to steer directives and legislation that will not just change, but potentially reshape the industry for years to come. For many in the industry, concerns are that the emerging regulatory landscape could both strangle growth and tip the balance inexorably away from London. As if we need to remind the bank bashers, the nascent recovery of banking we are so in need of depends on a healthy and thriving banking sector and dynamic capital markets. Lost contribution from the taxes banks pay to the UK Exchequer would have lasting effects.

Whilst we have been preoccupied at home and on Wall Street with the crash and its aftermath, the rest of the world has changed. Singapore and Hong Kong have joined London and New York as truly global financial centres. Fears that the Far East may tempt overtaxed traders away from the Square Mile have proved to be a red herring. But in its place lies the risk of real and significant damage if banks domiciled in London were to follow. Liberal regulatory interpretations in other jurisdictions could instead tempt firms to up and move. After all, capital is mobile and will go where it can be allocated most efficiently. So the consequences of a stricter regulatory environment in the UK, or ‘gold plating’, that surpasses both EU directives or global standards, could, it is feared, have far reaching consequences for UK PLC.

If the increasingly complex array of regulatory directives is set to compound the compliance burden as the edicts of the EU, the SEC, IMF, HM Treasury et al, how will firms react? Smaller firms may see moving away from London as unavoidable faced with the soaring costs to staff-up and resource a regulatory and risk programme. Setting up here too may have already become less attractive if, according to London based Compliance Services LLP, cycles-times for company authorisation significantly increase as the Financial Services Authority (FSA) looks in more detail at each application. Is this a foretaste of a renewed vigour as FSA restructures for the regulatory road ahead?

But in an open letter addressed to the Chancellor George Osborne, Marcus Agius, Chairman of the British Banker’s Association (BBA), outlined the considerable concerns for the maintenance of a level playing field in order to preserve the UK’s ability to compete in global markets. The issues raised in the letter highlight concerns of an over-zealous approach of stricter UK interpretation than other jurisdictions, pre-emptive implementation, and the FSA’s approach to the contentious topic of liquidity. “Applying these requirements in a manner that is super equivalent in the UK, results in a non-level playing field, particularly with those countries with which we compete most critically. This is most notable when the UK applies additional requirements to the agreed standards; implements them earlier than others; and when it does not use flexibility the standards permit, or not in a manner reflected elsewhere.”

Written in January 2011, the letter concluded that “the issues contained are not just for the banks but impacted the provision and price of finance to the (UK) economy.” Agius urged the Chancellor to bring UK authorities and the banking industry together to determine the steps required to “level the playing field.”

The provisions from Basel III are aimed at protecting institutions from future shocks, as well as creating a safety net for investors. But it comes at a price. Increasing regulatory capital for market-related activities will result in a reduction in the return on equities. In response, banks will need to up their risk profile to meet levels of returns for equity investors. The unpalatable alternative is to pass costs on to customers. The BBA’s views are mirrored by ratings agency, Standard & Poor’s. Its view is that constraints on banks’ lending activities such as the ability to trade on derivatives markets would inhibit the inter-bank market and result in a shift to short-term lending. But Basel III does address a good number of the shortcomings of its predecessor. It should lead to stronger and more stable banks. The burden of compliance varies according to size and activities undertaken. Large loan books and securities holdings come with greater capital requirements. Retail banks, driven by customer deposits, should find with Basel III compliance issues easier to address.

The BBA is not alone in representing the concerns of its members. In other sectors such as insurance and mortgage lending, industry groups are becoming strident in their views. The Association of British Insurers (ABI) believes that in Europe the ‘twin peaks’ model can work efficiently, but the proposals have to ensure the two regulators work together at all levels and have objectives that regard the work of the other. Not doing so leaves scope for insurance companies to receive conflicting or contradictory sets of instructions. To be effective, regulation must reflect the risks and business models of different activities; insurance therefore needs to be properly resourced and recognised with equal status to banking. “The ABI recognises the drivers for regulatory change and is working with government to make the reforms work. It is essential that they do, and, that they maintain the competitiveness of the UK’s insurance market. If they don’t it will harm the economy and it will harm consumers as it will restrict the choice and value they receive” said an ABI spokesman.

The emerging regulatory landscape will be vast and the burden should not be underestimated. On commenting how the industry might cope, Selwyn Blair-Ford, head of global regulatory policy at risk management consultancy FRSGlobal, said: “The biggest challenge for many organisations will be keeping abreast of changes given that timely and relevant information is critical to the management of regulatory affairs and risk. Next, comes the problem of understanding and communicating their implications – whether it’s in the context of Basel III, SEC or the FSA. Associating such changes with your risks and policies is one thing, but prioritising is another and will be onerous when there could be thirty actions arising. People and systems will need to be proactive, not reactive. Going forward, compliance and risk must be conjoined and the approach consistent (across any one organisation. Information can no longer exist in silos.” Despite long lead-times there is no room for complacency. “The industry can not afford to be too relaxed. Making ready the people, policies and robust systems to manage them is a long process,” Selwyn added.

Deliberations over headline issues such as liquidity, stress survival periods and the effects of implementation timing are set to run and run. Resistance to gold-plating the UK industry is strong and well articulated. And, too much is at stake for the position of the London markets to be sidelined. But for those affected by and responsible for coping with torrent of regulatory compliance and risk, the devil, as always, remains in the detail. And that is a good enough reason as any to get prepared.

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