Buy-side spies stormy skies ahead

Asset managers at Sibos 2014 see few silver linings among the dark clouds of post-crisis regulation.

The storm of financial regulations continues to hang over the industry with banks, asset managers and other institutions all looking to avoid being caught up in the wrath of the tempest.

For as hard as regulators have worked at reforming the financial markets into a more transparent and stable environment, unintended consequences are threatening to compromise the post-crisis reconstruction. 

The regulatory overhaul stretches to all corners of the earth, with each jurisdiction boasting its own complex and fear-inducing range of acronyms.

The roll-out has not gone as smoothly as planned in any jurisdiction, and many of the rules are still being finalised, with the uncertainty another thorn in the side of buy- and sell-side firms.

During the Sibos 2014 panel ‘Regulatory avalanche: any silver linings amongst all the dark clouds? panelists struggled to find positives within the changing regulatory landscape, which they deemed full of challenges while opportunities are scarce.

“I’m not sure there really is [a silver lining],” said John Bruno, senior vice president, partner and counsel, Wellington Management Company, a Boston-based asset manager.

“I’m not sure that all these changes have fundamentally changed the ability of the regulators to avoid the next financial crisis.”

Extraterritorial impact

The rules have come thick and fast since 2008 with the US Dodd-Frank Act first out of the blocks, and the European Market Infrastructure Regulation (now well on its way to implementation the across Atlantic, along with the Markets in Financial Instruments Directive II).

A major aim for all those regulations has been the revamping of OTC derivatives markets, to reduce risk and increase transparency in line with Group of 20 recommendations. The key pillars of these reforms include the mandatory central clearing of standardised OTC products, the reporting of trades to data repositories to increase transparency and increased capital costs for non-cleared derivatives transactions.

But the extraterritorial impact of these pieces of complex legislation is forcing financial institutions out of overseas markets.

Despite efforts at coordination, there are many issues to be resolved on how differences in US and European rules can be resolved. As a result, the cost of trading and investment in non-domestic jurisdictions is set to sky rocket.

“We are finding that clients want to opt out of trading in the US markets if they are in Europe, and vice-versa with US clients not wanting to deal with the complexity of trading in multiple jurisdictions,” added Bruno.

“We are seeing a trend where large global asset managers have clients trading just in a single jurisdiction. It is not a good thing for market liquidity as ultimately you want to ensure markets are liquid and clients have the ability to transact at the lowest price and when they need to. I don’t think this is what the regulators intended.

Conflicting messages

Unintended consequences will continue to cast a shadow over the whole reform process as the industry debates the intended benefits of the changes versus the adverse impact on liquidity. In some cases, the rules are contradictory, noted said Matt Nevins, associate general counsel for the asset management group of the US Securities Industry and Financial Markets Association (SIFMA).

“In dealing with the whole amalgamation of regulation – whether it impacts trading in the markets, asset management directly or some of these downstream effects – you wind up with a conflicting message from the regulators whereby you have the G-20 pushing for clearing in derivatives, but then you have the [Basel III] capital and leverage rules which are pushing banks in the other direction.”

Justin Chapman, senior vice president and global head of industry management group, Northern Trust, highlighted the capital issues seen in Europe. 

“What we are starting to see from brokerage and clearing firms is that they are going to have a big capital issue associated with clearing bilaterally for clients.

“We have seen brokers and clearing firms pulling out of [providing services to] small- and medium-sized organisations, because they would rather take the large clients in that particular environment.

Keeping track of the changes has meant applying greater resources, being subjected to increasing costs and having to reappraise relationships with their clients.

Jean-David Larson, director, regulatory and strategic initiatives, Russell Investments, said it is key for asset managers to align the expectations and investment options of their clients.

“That’s a dialogue you want to have with your clients early on and not in a time of crisis,” he added.

“The arrangements you structured years ago made sense in that environment. Now you must look at build in flexibility, which means having ongoing dialogue and focusing on expertise.”

While there appeared to be no obvious silver linings to the regulatory storm, Larson did add that the relationship with the client can be strengthened in the long term through increased dialogue.

“I think it [the silver lining] is developing and expanding the trust with the end-client. A lot of the regulations are impacting clients in ways they didn’t expect. Previously they didn’t worry too much about how the sausage was made.”