Regulation 2020: back to the drafting board?

These are torrid times for compliance departments and corporate treasuries: the regulation pipeline seems endless, as authorities worldwide target financial crime and attempt to prevent a repeat of the 2007-09 financial crisis. At the same time, the changing political scene in the US and Europe has thrown uncertainty into the mix.

In testimony to the US House of Representatives last December, Anthony Carfang, managing director of consultancy Treasury Strategies, raised concerns about the “unintended consequences” of the simultaneous implementation in the US of Dodd-Frank, Basel III and money market fund (MMF) regulations. These included impaired market liquidity, higher costs and less certainty for borrowers, reduced access to credit for businesses, reduced access to capital for state and local governments, and reduced capacity for economic growth.

These recent financial regulations “and many more, separately and in concert with each other, have triggered regulatory and compliance cost burdens that radiate through the economy,” Carfang said. “Ultimately, this is choking the US economy and paralysing American businesses and financial firms that had nothing to do with the financial crisis.”

There has been speculation about the future of the Dodd-Frank Act under the new US administration. The direction of US financial regulation was set out in president Donald Trump’s executive order of 3 February 2017. It contains the core principles of policy under his administration:

  • Empower Americans to make independent financial decisions and informed choices in the marketplace, save for retirement, and build individual wealth;
  • Prevent taxpayer-funded bailouts;
  • Foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry;
  • Enable American companies to be competitive with foreign firms in domestic and foreign markets;
  • Advance American interests in international financial regulatory negotiations and meetings;
  • Make regulation efficient, effective, and appropriately tailored; and
  • Restore public accountability within Federal financial regulatory agencies and rationalise the Federal financial regulatory framework.

Global consultancy PwC believes the new administration will focus on changing the regulators, rather than the regulations. “While Dodd-Frank and its related rulemakings have been difficult and painful to adopt and implement, the medicine has largely already been taken, especially by the largest US financial institutions,” wrote PWC’s financial services regulatory practice in a ‘first take’ note published last November.

“Despite the pain (or perhaps because of it), the global competitiveness of the US financial services sector has never been stronger because the rest of the world – particularly Europe’s banks – has been slow to address the necessary balance sheet, structural, and business model transformations to compete in the post-crisis regulatory world.”

The real issues for most globally active US banks subject to Dodd-Frank are the ever-increasing demands of regulators, very narrow or non-transparent interpretations of complex – and at times contradictory – provisions and punitive enforcement actions, the note states. These areas are where most of the “excess” pain resides, and where the Trump administration can most have an impact on financial regulation.

PwC believes that Dodd Frank will not be repealed, although some elements will be rolled back – such as the Volcker Rule limits on proprietary trading, which critics suggest have adversely affected market liquidity. Derivatives rules are likely to remain unchanged as the remaining work to be done is deemed uncontroversial. Rules around money laundering and terrorist financing are also expected to remain untouched. “…Trump is likely to continue the Obama administration’s focus on cross-border cash and wire movement to combat terrorist financing, with a reinvigorated effort on transaction data collection,” the note concludes.

Europe, where next?

European banks and corporates also face multiple, concurrent regulatory burdens and uncertainty. and uncertainty. With the triggering of Article 50 on 29 March, the UK began negotiations over its withdrawal from the European Union (EU). In addition, there are several important elections due in Europe in the coming months, including in France, Italy and Germany. EU- sceptic parties have made headway in many countries across the region as continued austerity policies prove increasingly unpopular. A more significant break-up of the EU could be on the cards, which would have a significant impact on the regulatory scene in Europe.

At a seminar for clients in January, commercial law firm Slaughter and May said corporates were in “wait and see” mode regarding Brexit. It advised that until further clarification is available, companies should understand that the loss of passporting could mean some banks have to restructure; transferring loan and derivative contracts to other banks. Post-Brexit, corporates face potentially very different financial counterparties from those they have now. The loss of passporting will also affect loan contracts and lenders may have to change transfer provisions.

EMIR

The European Commission (EC) is reviewing the European Market Infrastructure Regulation (EMIR), its body of legislation for regulating over-the-counter (OTC) derivatives, but believes its overall framework is satisfactory. The review will address certain elements of EMIR such as the burdens on non-financial counterparties (NFCs). In response to the Commission’s EMIR Review Report published on 23 November 2016, the European Association of Corporate Treasurers (EACT) stated: “Well-intentioned moves to simplify EMIR’s corporate hedging exemption should not undermine the fundamental principle that commercial hedging represents responsible risk management.”

EACT welcomed the Commission’s objective to reduce costs and alleviate disproportionate burdens on NFCs, as well as its recognition that NFCs have a low level of interconnectedness with the financial system, EU law already captures the specific and limited cases of systemically relevant financial activity by corporates, and that NFCs in Europe experience less favourable treatment compared to their international peers. Given these points, EACT urged the Commission not to impose clearing and margin requirements based simply on the volume of transactions, as proposed in the review report.

Independent treasury consultant Paul Stheeman reports that many corporate treasurers believe the burden of EMIR should fall solely on banks, because they caused the financial crisis. He adds that the European Securities Markets Authority (ESMA) has yet to publish any analysis of the data of the billions of FX transactions that are reported to it that shows such reporting is worthwhile. “There is nothing visible on this topic and it is one of the reasons why corporates don’t like EMIR – they can’t identify any benefit in the work they are doing on it for themselves or the wider financial world.”

Know your customer

At a 2016 international payments conference in London, one treasury executive complained that compliance with know your customer (KYC) rules was “killing” business and banks. “We are being treated like we are crooks,” he said.

Stheeman says fulfilling KYC requirements is becoming increasingly complex for corporates. “Companies cannot open new bank accounts in under six weeks because of the KYC requirements of the banks. These requirements differ from bank to bank and often within the same country. There is no standard format for KYC, which makes it extremely painful for corporates and consumes a great deal of time.”

It is, however, highly unlikely that KYC rules will be changed any time soon, particularly as there is no single regulatory or regional regulatory body that oversees the rules. However, it is possible that a common, global regulatory approach to KYC could emerge. This would be useful for corporates, he says, as it would enable them to send the same information to each bank with which they deal.

Significant change is also not anticipated across the general regulatory landscape during the next few years, suggests Laura Cox, a senior financial services risk and regulation partner at PwC. “Most of the big pieces of financial regulation that came out of the G20 work have been implemented,” she says.

“Given the potential change in leadership of some G20 countries in the coming year it is unlikely that anything significant will come out of that avenue for banks.” The same applies to the EU, where implementation of many regulatory initiatives, such as Payment Services Directive (PSD2) and the Markets in Financial Instruments Directive (MiFID II), will continue over the remaining months of 2017.

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