Managing the flow of regulation

If there is a consensus on any of the consequences of the 2008 financial crisis, it is on the wave of new regulation it triggered. This movement began with the Pittsburgh G20 resolutions in 2009 and was further fuelled by the “never again” attitude of political leaders around the world.

The industry was expecting this wave, albeit with a certain apprehension.

The apprehension proved to be justified because an increasing number of voices are concerned about the risk to the finance industry of regulatory overload.

The reality on the ground speaks for itself. For example, in its regulatory oversight, ALFI [1] has listed and is currently monitoring more than 30 initiatives, Directives and draft Directives from the European Commission alone.

Among the heavyweights muscling-in on the regulatory agenda are UCITS IV and UCITS V, which govern one of the flagship activities on the Luxembourg market, and the Alternative Investment Fund Managers Directive (AIFMD), which is aimed at creating a regulated European area for alternative management. They line up alongside the Basel III banking directive on capital risk for banks and its counterpart in the insurance sector, Solvency II.

Then there is the infamous FATCA [2], both in terms of principle and in terms of cost and workload. This regulation, unilaterally imposed by the US on the whole world, transforms all financial intermediaries, including investment funds, into agents of the US tax authorities at the risk, in the event of non-compliance, of having a penalising level of tax imposed on all their financial income generated in the US.

What are the key issues in this regulatory wave?

• The financial costs: Even if it is difficult to put a figure on them, the monitoring, adaptation, opportunity and additional risk capital costs are huge for the industry and it would be naive to think that they will not in part be charged, directly or indirectly, to the end-clients.
• The speed at which the regulatory initiatives are being produced, within an overloaded and uncoordinated timetable: This, more than their number, poses a real problem. The bodies at the origin of the initiatives are not working in a coordinated fashion. This makes the planning of resources difficult, if not impossible, especially as the obligatory response deadlines are often unreasonable in relation to the importance of the issues. The fact that the regulators are themselves collapsing under the weight of their own initiatives is only a small consolation, given that ultimately their resources are financed by the taxpayer and added to the overall costs.
• The European legislative process: It is often appallingly cumbersome as well as complex and costly in terms of time and effort.
• The strategic and competitive risk: Global or regional regulations are being applied to a financial domain that has been globalised for a long time and is strongly interconnected through numerous intermediaries in a number of countries and without technical borders. The risk of unexpected and unintended collateral effects on other products or functions in other localities is considerably increased and further complicates the impact analysis. Similarly, a regulation that is poorly prepared or unsuited to the realities on the ground can very quickly cause an unintended shift of the activity or the client base to other financial centres or products, requiring vigilance at all times.
• Systemic risk: This could be generated by an excess of regulatory constraints on certain parties, encouraging their concentration, but by the same token limiting competitive choice and increasing global risk in the event of one of them coming unstuck on “too big to fail”.

Now, however, although the aspects of cost and burden on our companies and associations are important, and rightly highlighted, we concede this regulatory wave has also engendered a much broader awareness of the strategic importance of good management and positive support of regulatory initiatives, whether at the level of our individual groups, the financial market place, or our industry in the wider sense.

With reason steadily gaining the upper hand over emotion, the attitude of initial refusal is being transformed into a more strategic reflection. This is aimed at anticipating, seeking dialogue, influencing and giving as much emphasis on seeking opportunities as to highlighting the problems.

While there have been unfortunate experiences of regulation, less by intention than in the way the process has been managed, there are other examples which, conducted in a positive spirit and with good dialogue, have been transformed into successes, giving rise to a host of opportunities unforeseen at the outset.

The UCITS directive, now a flagship product for the Luxembourg and Irish fund industries, is often cited as such an example. Conducted in close collaboration between the regulators and market operators, with clear objectives regarding product quality, effectiveness and investor protection, this regulation has led to the emergence of a globally recognised standard for quality – proof that it is possible.

The solution to the problem of the regulatory wave does not lie in an attitude of opposition to change. In any case, this would be poorly perceived by public opinion and our investors and clients who legitimately expect clear regulations, greater transparency and better protection of their assets.

On the contrary, the solution lies in better anticipation and active management of the regulatory process as well as in seeking dialogue between the parties.

As the general environment becomes more complex, the definition of new rules becomes all the more difficult and risky, necessitating on both sides a good understanding of the issues, technical constraints and indirect consequences.

It is therefore encouraging to note that regulators are expressing a growing need to understand the complex issues and mechanisms of our industry and are receptive to technical propositions and explanations. It is our responsibility, and that of our associations, to address regulators in a targeted and structured way and with one voice.

It is also down to us to make an effort to propose solutions that respect the spirit and objectives of the regulatory initiatives, while at the same time making sure that they can be part of an acceptable operational and commercial reality.

Numerous professional associations and European committees are doing remarkable work in this area, both through their direct contribution to a great many initiatives, or, as was the case in 2010 for ALFI, by opening up a permanent representation in Hong Kong to seek and maintain dialogue with the regulator and local industry.

These associations are more indispensable than ever for managing the flow of regulation, but their credibility and effectiveness will depend directly on the contribution of their members – financially and in terms of expertise.

From now on delegating to them our best people and supporting their initiatives must be the normal procedure in our various organisations. This is in our own interest and in the interest of the marketplace and our clients.

Jean-Michel Loehr
Chief Industry & Government Relations

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