Can regulators really regulate?

I blogged a while ago about David Doyle, expert on all things in finance with a Brussels flavour.

David and I regularly tag-team on MiFID and the PSD, and in the wider context of Europe's Financial Services Action Plan.

In particular, he has an inside track on all this stuff and presented
the latest updates on Europe's Directives at the Financial Services
Club Ireland last week.

What struck me as David outlined the massive change agenda in plan, is
that the process of drafting regulations is fine ... but can any of
this work?

Answer: probably not.

First, there are all the local regulations, such as Faster Payments in the UK.

Then there are the national implementations of European regulations already in play, such as the PSD.

These all have slight variations in that every country’s policymakers have a different view of how the PSD impacts their national banking structures. In France, it means direct debit charges have to be slashed by a third whilst, for most countries, it just means adding on some bells and whistles.

For example the FSA’s approach, published in March, splits responsibilities between the FSA, the Office of Fair Trading and the Financial Ombudsman. However, it also tries to explain how to interpret every aspect of the PSD.

Ruth Wanderhofer, Vice President for Cash Management in Europe within Citibank's Global Transaction Services Division, claims this is bad.  Speaking at this year’s European Banking Forum, Ruth stated that “the PSD is very complex and can be interpreted and read in so many different ways every day that you don’t necessarily want a supervisor to write down what it is supposed to be meaning”, especially as the FSA's interpretations go “far beyond the scope of the PSD”.

Then there is the EU process of evolving regulations for Capital Adequacy and Solvency II, UCITS IV, Retail Investment Products, Market Abuse and more.

Finally, there is now the global agenda of the G20 to create consistent supervision across regions as well as within regions. So far, this has been an aggressive agenda in the EU covering:

October 2008
Commission appoints ad hoc high-level group on financial supervision, chaired by Jacques de Larosière

15 November 2008
G20 summit in Washington agrees five-point action plan to reform global financial markets

25 February 2009
De Larosière groups hands in report.

5 March 2009
Commission tables proposal for G20

19-20 March 2009
EU summit endorses common position for G20

2-3 April 2009
G20 summit in London.

April 2009
Commission to present measures on hedge funds, private equity, retail investment products and remuneration in financial services.

By end of May 2009
Commission to present European financial supervision package.

June 2009
Expected agreement on follow-up to De Larosière report;
Commission plans to present a White Paper on Tools for Early Intervention to Prevent Crises, and legislative proposals to increase the quality and the quantity of prudential capital; and Legislative proposal from the Commission on hedge funds and private equity.

Before end 2009
EU expected to finalise approval of financial regulation measures

This is also a very broad agenda.

As David made clear last week, the Commission is taking a 'safety first approach' to regulating capital markets and market actors, filling in the gaps where European or national regulations are insufficient or incomplete. In particular, these will be created for:

Credit rating agencies (April 2009)

Hedge funds and private equity: to include private equity and other systemically important market players (April 2009).

Crisis prevention: A White Paper on tools for early intervention to prevent a crisis (June 2009).

Derivatives: A report on derivatives and other complex structured products will provide a basis for Commission initiatives to increase transparency and ensure financial stability (June 2009).

Prudential capital: Legislative proposals to increase the quality and quantity of trading-book activities and tackle complex securitisation (Due: June 2009), and to address liquidity risk and excessive leverage (Autumn 2009).

Along with a rolling program to update and create a far more consistent approach to global and European supervisory rules.

But I just cannot see all of this working, and beg the question: can regulators really regulate such a broad and aggressive agenda, or are they smoking dope?

It took us ten years to develop the European Financial Services Action Plan, and where did we get to? A vast array of Directives which some countries implement and some do not. These Directives have attacked the simplistic areas of retail financial products, insurance, payments and investing. Now, with the credit crisis and the realisation of the complexity of global derivatives, we are tackling the complex financial areas of exotic options, futures, clearing and settlement.

So how does this work?

How can a regulator create global, regional and national rules that are all harmonised, consistent, integrated and cooperative?

What happens when countries, such as Costa Rica, opt out?

These are all the tough questions for the regulators and policymakers to answer but, my own view … no matter how much regulation the governments of the world draft and create to address this crisis and harmonise rules:

(a) can they be implemented
(b) can they be enforced?
(c) are they truly global and how do you deal with countries that are non-cooperative?
(d) are they water-tight or can market operators wriggle around them?

… and more.

Not throwing rocks or anything, as we do need regulatory enforcement, but I would suggest that:

(a) it is still light-touch, as detail will constrain implementation
(b) it is enforced via regional and global co-operation of the G20
(c) the G20 and United Nations sanction nations that are uncooperative
(d) if it is light touch, then it is not water-tight but should be clear enough that any non-compliant market operator is hounded out of the markets by other market operators being whistleblowers about their bad behaviours.

Whoops.

Did I say that they should be whistleblowers?

Hound out the non-compliant market operators?

No way.

After all, the role of most market makers is to find ways to create risk to make money, not to be compliant with the rules.

I guess the answer really needs to be that the regulators and policymakers are clued up enough about the complexity of these markets that they can slap down any non-compliant performers before they create another bubble such as the leveraged debt of the credit default swaps markets.

And how do they do that?

By being intimate with all market operations from the simple to the complex, not just the way they’ve behaved to date which is to hire administrators who can draft rules about the simple stuff.

Postnote:

David's presentation is available to Club members, including remote online members. 

The Financial Services Club also runs a European Financial
Regulatory Advisory Group who provide clients with in-depth knowledge of the European Reglatory landscape and draft Directives.  If you are interested in such services, let me know.