The Bankwatch

Tracking the consumer evolution of financial services

Financial Services and regulation | too misunderstood and too political

The burden of regulation in financial services.  This is all the talk in Europe at the moment, and this article sums it up in a way that resonates personally for me, and in a way that we can compare to the rules in Canada through our experiences with peer-to-peer lending oddly enough. (P2P lending is governed by securities regimes hence the personal connection through my association with CommunityLend)

Investing: Tangled up anew | ft.com

One of those start-ups is Premier Alpha Capital, run by Brian Cordischi, the American former head of investment management at Barclays Wealth. “The rules look like they will be an increased burden for us,” he says. “We are looking at having to hire a compliance manager.” For two-man outfits such as PAC, such obligations could make business more ex­pensive and time-consuming. “Regulation is a good thing,” says Mr Cordischi, “But not necessarily if you’re a very small hedge fund with only a handful of investors – it makes sense to have a two-tier regulatory system.”

The comparisons I will draw here are not any kind of shot at regulators.  In this blog I am interested in solutions to the banking crisis of 2008.  That is also the context of the ft article quoted in their analysis section and in particular the Alternative Investment Fund Managers Directive (AIFMG) and the recently released 110-page draft of “supplementing rules” (which I cannot locate online – if anyone has let me know).

In simple terms the banking crisis was precipitated by a realisation that the asset values on bank and fund balance sheets were in doubt.  It was not that they were worth 10% less or 20% less.  The doubt was complete;  are they worth anything.  The interconnectedness of those balance sheets led to a faulure of inter institutional trust, and markets froze.  If it stopped there it might have been ok;  an investment bloodbath but survivable.  However those institutions are the banks on the street corner where everyday people (the 99%) retain their savings and retirement accounts. 

All of a sudden came the realisation that this bloodbath would interfere with everyday people (the 100%) using their debit card to buy groceries.  That singular realisation in September 2008 by politicians led to a mass panic towards that which governments do and can only do;  regulate.

So now we have the classic battle between Financial Services and Government.

Financial Services:

  • leave us alone and let the market optimise
  • it is our role to maximise shareholder value and inconveniences such as capital restrictions and breaking off parts of the bank do the opposite to shareholder value (and my bonus)

Government:

  • balance sheet issues can be controlled by capital restrictions
  • insulate government deposit guarantees (retail bank) from risky investments (investment banking)

On the face of it this is not an insurmountable problem.  Find some middle ground with decent capital requirements and that should ensure the deposit guarantees do not flow through to provide cheap capital to the pesky investment banking cowboys.

But its not that simple. 

  1. cross jurisdiction differences, and intra jurisdiction differences;
  2. political influences that result from from economic impact of a large financial services industry
  3. lack of understanding of the problem;  the terminology can result in incomprehensible discussions between the sides
  4. shadow banking, off balance sheet financing and derivatives;  the largest smoking gun.  Here is where point 3 really comes in to play.  I don’t care whether you are Barney Frank or George Osborne.  This aspect is not understood for the enormous risk it presents.

My own experience:

In setting up a Peer-to-Peer Lending service, we were governed by the securities regimes.  That means compliance, hiring a Chief Compliance Officer, designating a Privacy Officer, completing regular reporting to the securities regime, etc.  So I understand the complaint of Cordischi above when he bemoans a two man shop having to take on the burdens of regulation.

What regulation really means:

Lets take it a stage further.  When you are regulated in this way the securities commission has the right to audit, investigate, and make charges through their enforcement branch.  This could result in jail terms – ask Bernie Madoff.

So now lets ask Cordischi again.  What is it that he is afraid of when he bemoans the regulatory impacts.  Is it costs of another salary or two, or is it personal risk.

Lets take it a stage further.  He mentions that he has a handful of investors suggesting that does not make compliance worthwhile and he presumably has a comfortable working relationship with them.

Lets ask those investors:  would they be willing to give up their right to take any legal action in any circumstance related to the management of their investments?

Relevance to Bankwatch:

Incidentally I obviously do not know Cordischi and I am sure he does a stellar job.  However there is a fundamental trust and a fine line that all investors need to be comfortable with their Portfolio Manager.  Cordischi is right and he can go to the Caymans.  That should be his right and acceptable to the Governments in Europe despite any loss to GDP from rents and ancillary benefits from the industry.  They could still control the movement of money coming from the likes of the Caymans through fiscal methods.

At the end of the day the things getting in the way of clear sensible regulation is misunderstanding and politics.  We are destined to muddle along until the next crisis.

Written by Colin Henderson

June 2, 2012 at 16:14

Posted in Uncategorized

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