Financial market participants must be prepared to take account of three layers of regulation that will scrutinise their activities ever more closely, according to Howard Davies, former director, London School of Economics.
Speaking on 6 July at the London City Day event hosted by trading technology provider SunGard, Davies, who served as the first chairman of UK regulator the Financial Services Authority (FSA), argued that intensified global, European and UK regulation meant that complying with the rules is likely to become an even more complex process. At the same time, he contended that a shift of many powers currently held by national regulators towards global bodies such as the Financial Stability Board (FSB) is almost inevitable.
At the global level, the key post-crisis change to the financial supervisory structure has been the replacement of the Financial Stability Forum by the FSB. Called into being by the Group of 20 (G20) political leaders in response to the financial crisis, the legal basis for the FSB is likely to be formalised as part of the G20 summit in Cannes in Q4 2011. Currently, the responsibilities of the FSB range from assessing vulnerabilities in the world financial system to assessing the quality of supervision in different countries and overseeing the establishment of new financial standards.
“The FSB is going to become more important as the central nerve centre of the global regulatory system,” said Davies. “Those who want to look for clues about the regulation of the future, should look at the regular reports of the FSB to the summit.”
Beneath the global level, market participants must also face the prospect of dramatically increased regulatory input at the European level. Referring to the state of Europe's regulatory infrastructure as a “tangled mess” in recent years, Davies suggested that the confusion created by numerous overlapping bodies, each with similar functions and no clear authority over each other, was now being addressed.
Europe's regulatory structure has been simplified with the introduction of the European Systemic Risk Board and the tripartite system of financial supervision consisting of the European Banking Authority, the European Insurance and Occupational Pensions Authority and the European Securities Markets Authority (ESMA).
These three bodies have the task of building a single European rulebook and policing it. Recognising the tension at the heart of European regulation between these new authorities and the powers of existing national regulators, and despite the objections of certain member states such as Germany to the increase of regulatory powers at the European level, Davies suggested that market participants should get used to the idea of European regulators playing a bigger, much more prescriptive role in the oversight of Europe's securities markets.
“This is not popular everywhere,” he said. “However, the conclusion that many drew from the financial crisis was that we need more common European regulation, not less. Therefore, market participants should expect that these bodies will increasingly be where the action is. Europe is moving towards maximum harmonisation.” Davies noted that, in the aftermath of the crisis, being ”intrusive' is seen as politically advantageous, whereas a ”laissez-faire' attitude is relatively discredited.
ESMA has an increased remit in Europe to set out and enforce regulatory standards across the region, but has not yet been granted the necessary powers. The body will have a mandate under MiFID II to ensure greater convergence between member states and prevent national regulators from interpreting certain parts of the directive as they see fit. It will also be able to impose rules on national markets as if it were a national regulator in times of crisis.
Based on the feedback to the European Commission (EC) consultation on MiFID II, which closed in February 2011, MiFID II is expected to add to ESMA's powers, giving the authority responsibility for overseeing the development of the European consolidated tape, development of technical standards for trading venues, a reduction in delays to post-trade reporting and a tighter regulation of automated and high-frequency trading. However the process is currently being held up, as the release of legislative proposals has been delayed from its original planned release in Q1 2011, until after Europe's summer break.
In addition, the European Market Infrastructure Regulation is being introduced by the EC to provide guidelines for central clearing and risk mitigation of OTC derivatives, requirements for central counterparties (CCPs), post-trade interoperability, reporting obligations and requirements for trade repositories. This too falls under the remit of ESMA.
Turning to the UK, Davies suggested that the level of regulatory complexity was likely to increase yet further, following government reforms. In June 2010 George Osborne, the Chancellor of the Exchequer, confirmed the UK government's decision to abolish the FSA, and the tripartite system of regulation between it, the Bank of England and the Treasury, on the basis that the “regulatory system utterly failed to identify let alone prevent” the financial crisis as it affected the UK.
The FSA's role is to be split between the Financial Conduct Authority (FCA), which will be responsible for regulating the conduct of financial services firms, and the Prudential Regulation Authority, a subsidiary of the Bank of England, which will become responsible for systemic regulation of financial firms. In addition, the Financial Policy Committee (FPC) has been established within the Bank of England to oversee macro-prudential regulation.
However, Davies criticised the Treasury for ignoring the common analysis of the crisis – that the UK's tripartite system was too complex to deal effectively with the challenges of regulating the financial system – and called into question how replacing this with a five-part system would lead to any improvement in efficiency.
“This has created a system that is far more complicated and confusing than before,“ he said. “The interaction between these bodies is going to be very complicated and it remains to be seen how this will work out.”
On 16 June 2011 the UK Government published a white paper, detailing the duties and structure of the regulatory bodies and a consultation document, which will further guide development of legislation. It also produced a draft bill, which makes a number of changes to the Financial Services and Markets Act 2000, for pre-legislative scrutiny. The draft bill will have to pass through Parliament before it becomes law; the government has stated that it will also carry out its own consultation on a number of questions listed in the document. The consultation period closes on 8 September 2011.