- Sylvie Goulard – MEP, Committee on Economic and Monetary Affairs, European Parliament
- Steven Maijoor – Chair, European Securities and Markets Authority (ESMA)
- Greg Medcraft – Chairman, Australian Securities and Investments Commission and Chairman, International Organization of Securities Commissions (IOSCO)
- Kara M. Stein – Commissioner, U.S. Securities and Exchange Commission (SEC)
- Chris Allen – Global Head of Regulatory Policy, Barclays PLC
- Michael C. Bodson – President and Chief Executive Officer, The Depository Trust & Clearing Corporation (DTCC)
- John K. Hughes – Managing Director, Chief Operating Officer for Emerging Markets Trading, Bank of America Merrill Lynch
- Faryar Shirzad – Managing Director, Office of Government Affairs, The Goldman Sachs Group, Inc.
Improving transparency, accountability and enforcement in policy and rule making
Three elements are essential for handling policy and rule making effectively: transparency on how regulatory processes are conducted and decisions made; accountability in order to ensure that rules are legitimate and that responsibilities are properly identified; and an appropriate enforcement of the rules. While there is generally a high level of transparency and accountability in domestic regulatory processes (e.g. in the US, Australia and also in the EU) with open consultations and regular interactions with the parliament and the media, this is not quite the case at the international level, some panellists stressed. The way policy decisions are made at the global level is not always easy to understand and even if consultations are conducted, more transparency on the way the details of the rules are elaborated and may evolve in the proposals would be needed for the industry. The need to clarify the accountability of the international regulatory bodies was also pointed out, since democracy is at present only organised at national and regional levels. It was however emphasized that many on-going reforms are derived from the G20 commitments and that regular reporting is issued notably by IOSCO and the FSB regarding the achievement of objectives.
Further consistency is needed across jurisdictions and between prudential and market regulation
Much progress has been made in the definition of global standards following the G20 commitments, notably in the OTC derivatives and bank resolution areas, and there has been a positive impact of the coordination between Europe, the US and the UK, several panellists considered. Coherent rules have also been delivered regarding credit rating agencies and benchmarks. However, more progress remains to be made in order to achieve sufficiently consistent outcomes at the global level.
Post-crisis reforms have created liquidity and fragmentation issues in the market that need to be addressed, some panellists stressed. The reduction of liquidity in securities markets and the increase of frictional costs with the implementation of Basel 3 were cited as well as the risk that new rules regarding e.g. uncleared margins could further impact market liquidity if they are not appropriately calibrated. The development of subsidiarisation in the banking sector and the fragmentation of bank balance sheets in locally allocated capital pools as a consequence of the bank resolution and TLAC agendas were also pointed out.
Some examples of the difficulty in implementing requirements at the global level were also highlighted. Trade Repositories (TRs) and reporting requirements have not been implemented in a global perspective, a panellist argued, making it difficult to provide a global view on systemic risks; the process of going from the macro-strategic view of the G20 commitments into the micro view of regulation has caused fragmentation in this case, as regulators have transposed the rules in many jurisdictions very differently and according to their domestic requirements. The connection between prudential and market regulators could also be improved. For example, the fact that regulatory changes affecting securities markets (e.g. MiFID II and EMIR) are implemented at the same time as prudential requirements constraining the activity of market makers makes the impact of these market rules quite “acute”; stronger interactions between prudential and market regulators would also be needed for the definition of uncleared margin requirements in order to avoid some inconsistencies and additional costs.
Improving coordination at the international level and between prudential and market regulators is essential
Coordination among national regulators is “not natural”, as regulation is often an expression of national sovereignty and regulators tend to protect their home markets, some panellists considered. This creates fragmentation and may lead to international standards that are the “almost lowest denominator” that everyone can accept rather than best practices. At the same time cross-border entities and their clients are subject to a much more extensive set of rules than in the past and are impacted indifferently by prudential and market regulation. Moreover the financial system is increasingly interconnected, which augments systemic risks. The challenge is to reconcile the existence of sovereign borders with the global dimension of markets, which requires a successful interaction of the regulatory community and a global approach to regulation. Coordination problems within Europe have generally been solved with the implementation of the European Supervisory Authorities, which have an objective to develop common rules and common interpretations of these rules, going beyond national sovereignty.
Three key elements are required to achieve effective cross-border coordination at the international level from an IOSCO perspective: consistent international standards in the areas where they are required, consistent implementation of these standards which involves a focus on coherent outcomes and cross-border cooperation on supervision and enforcement (e.g. through Memoranda of Understanding), although the latter element is often ignored.
Different solutions were proposed by the panellists to improve regulatory coordination at the global level. A first option could be for domestic policymakers to have a clearer mandate to consider the international impact of their rules. One issue that makes coordination difficult is indeed that primary domestic legislation often does not take international issues or the presence of foreign players into account. A second element is for regulators to define standards or at least common views in the areas that have a strong international dimension in order to enable regulations to build on these standards if needed. For example credit rating agencies form an area where there has been a “reasonable“ harmonisation of rules across the world because standards were available, whereas OTC derivatives have been more problematic because of the absence of sufficiently granular standards. A third area of improvement which is underway is developing a toolkit to facilitate the implementation of regulations on a cross-border basis. The IOSCO taskforce on cross-border regulation has recently proposed three main tools - national treatment, recognition and passporting – as well as recommendations for implementing them. The possibility of developing stronger multilateral coordination by further empowering international bodies, notably in the enforcement phase, was proposed but some speakers considered that this latter solution would be hard to implement.
Increased flexibility in the rulemaking would help to better mitigate the unintended consequences and cumulative impacts of regulation
It is essential for national and international regulators to be outcomes-focused and to consider separately the areas on which regulation has a direct impact and those where the impact is more indirect, such as some broader effects on the economy, a panellist stated.
A lesson from the reforms drafted after the crisis, several speakers emphasized, is that some solutions may seem appropriate when taken individually but may have adverse cumulative outcomes. Some regulations may also have unintended consequences at the domestic and international levels. Such issues can be identified through consultations and impact assessments, but there is not always the time available to anticipate all unintended consequences, which is why it is necessary to have some flexibility in the regulatory process. Moreover having some flexibility is essential when trying to deal with outcomes-based equivalence determinations at the global level. At present ESMA does not have the ability to change or not implement certain parts of primary legislation, unlike the US SEC and CFTC, which may use a general exemptive authority or issue more specific no action letters for example. A panellist however warned that flexibility could be interpreted differently across jurisdictions; therefore such an objective should be framed more precisely.
Improving the assessment of emerging and systemic risks is essential
Although much effort has been made with the post-crisis reforms to make individual firms stronger, the system as a whole might have become weaker to a certain extent with increased fragmentation or liquidity drops. A matter of concern is that the current fragmentation of data makes it difficult to identify potential systemic risks on a global level and the tools used at present are more appropriate for “solving the previous crisis” than for anticipating a new one, a panellist emphasized.
Regulators need to be forward-thinking in order to be able to identify emerging risks and to engage with the industry as early as possible to evaluate potential problems and whether any regulatory action is needed. New bodies have been created at the global level and in some jurisdictions to better anticipate emerging risks, taking into account the high level of interconnectedness of the financial sector, but input is needed from the business to anticipate and evaluate these risks.
SummaryAs a background, the Chair explained that a draft own-initiative report has just been tabled in the European Parliament, to be discussed and amended, on the role of the organisations dealing with regulation and supervision at the global level and the role and influence of the European Union in them. The European Parliament is in favour of the free movement of capital and of a global development of business and would like to raise awareness about the need for global standards. However, the reality is that democracy is only organised at the national or regional level in Europe. It is not easy to have global rules and ensure that they are considered legitimate by citizens if there are no appropriate governance structures.
1. Improving transparency, accountability and enforcement in policy and rule making
There are three key issues to be addressed regarding financial regulation at the international level, the Chair suggested. The first one is how to improve transparency on how the bodies involved in policymaking and regulation at the international level function and how rules are defined. Very often it is hard to explain to the wider public who makes decisions at the EU and global levels and the role e.g. of the Basel Committee or of the FSB. The second issue is accountability. There is a need for experts and independent analysis but at the same time elected politicians have to take their responsibilities. A new dialogue has to be "invented" between elected representatives, experts and independent bodies. Lastly, commitments have to be enforced. One of the key problems right now is the lack of trust of citizens in the financial system at large and in the political system. They see in the media that promises have been made at the G20 meetings to tackle the issue of taxation and improve stability for example, but then they wonder whether these commitments have been implemented and what difference they have made. One area where such questions arise about the way legislation is defined and implemented is OTC derivatives.
An official believed that the points raised by the Chair are very challenging and that there is no easy solution. These issues are the same in the US and were experienced during the financial reform process. It has been "intriguing" to see how far away the rules have moved in some cases from what the original intention was in the US and even more so at the international level with the G20 commitments.
How democracies can be transparent and accountable to their citizens and then enforce appropriately the commitments made should always be in the minds of policymakers, the official stated. In the regulatory context, the Administrative Procedure Act in the US has been very helpful. Policymakers draft a proposed rule, then it is open for comment for three months or more to the industry and wider public. Then, policymakers go back and draft the final rule. There is inherent transparency in that process, accountability of the policymakers and the members of Congress involved and an ability to verify if the rules that have been implemented correspond to what was asked in the first place. It is difficult however to be accountable for commitments on a personal basis, since politicians or members of an administration can change while a commitment is being implemented. But that is an issue common to all democracies.
A regulator remarked that in Australia also, the regulator is subject to a high level of accountability and transparency. The head of the Australian Securities and Investments Commission (ASIC) appears in front of parliament several times a year for four hours each time and there is extensive media coverage. In terms of accountability, the Australian government states its expectations with regard to the level of risk it is willing to bear in particular sectors, and this defines goals in terms of the risk outcome. Then the regulator reports to the parliament and to the community regarding the achievement of these objectives, which also contributes to transparency; that type of annual reporting is also in place at IOSCO and the FSB. What is most important in that reporting is to define the intended outcomes to be achieved and to measure to what extent they have been achieved.
It is important for regulators to be outcomes-focused and to consider separately the areas on which regulation has a direct impact and those on which its influence is indirect, such as some broader effects on the economy, the regulator added. Most importantly, regulators should be very transparent and engage with the community and particularly with the industry to make sure that there are ultimately no unintended outcomes.
Ensuring sufficient transparency of the regulatory process is a simplistic but really important aspect, an industry representative considered. Many of the global standard-setting processes are open to comment from the public for a relatively short time and it is often quite hard to know who the decision-makers really are and how the decisions get made. For example, with the NSFR, a 20% proportion appeared in the very final text for derivatives payable that had never been in the previous versions during the two and a half years of the gestation of the global standards. It is very difficult for industry players who have been participating actively in that process to find out that something has been added at the very end, and then to hear from the national regulators that this requirement will have to be implemented at the national level because it has been decided at the global level, when nobody had advance notice of it or an opportunity to comment on it. No impact assessment was made either.
There is "a whole litany" of these types of issues that everyone on the industry side of the table can go through, the industry speaker noted. There needs to be an effort to open up the process and for national regulators to determine what it is that they need to have resolved, before they go into the global standard-setting process. That way, when they bring the decisions back, they will comply with the domestic mandates from their national legislators and will be consistent with their legislative charter in terms of what they need to do. Unexpected results, which make it difficult for the industry as they can have systemic implications that nobody wants, may thus be avoided.
A regulator agreed that international organisations need to be transparent and accountable and that international standards cannot just be implemented without any consultation. The European Supervisory Authorities (ESAs) for example are fully transparent and accountable to the European Parliament.
2. The examples of OTC derivatives and bank resolution: the risk of fragmentation and impairment of liquidity
Much "good work" has been done in the OTC derivatives area, an industry representative emphasized. Industry players (e.g. in the trading area) have seen a great deal of positive impact from the coordination of regulations, especially between the UK, Europe and the US. What is to come is "a little worrying", the speaker believed, as new rules may have a further influence on market liquidity. Uncleared margin rules are the main concern at present. The potential impact of these margin rules is probably underestimated across the market, since it could be much higher than that of the Swap Execution Facility (SEF) trading rules, the clearing rules and the reporting ones. Their expense and impact in Europe and in Asia will be very significant. There is a need for those clearing and margin rules to be appropriately calibrated in order to avoid the global market becoming increasingly fragmented.
The risk of fragmentation and of liquidity impairment due to these rules has been mentioned by the industry and traders in particular on numerous occasions, the industry speaker pointed out, but it is now happening. This is not "liquidity for the sake of liquidity". Liquidity means the ability to be able to manage risk and to offset it on a timely basis. An asset manager on another panel mentioned that their approach to portfolios has fundamentally changed: they now have a buy-and-hold strategy because they cannot trade in and out anymore. This is an example of how the marketplace is radically changing with the huge increase of "frictional costs" due to the different rules that are being put in place.
Another industry representative believed that now is "the best and the worst of times" for evaluating the way legislation has been implemented at the global level. The way the G20 commitments are being carried out is a "prime example" of the difficulty of implementing rules globally. The starting point was a very macro-strategic view of what needs to be done but by the time it has been articulated in the regulations it has become a micro view. Market regulators are acting appropriately, but the process of going from a strategic to a more tactical perspective has caused fragmentation. What has been achieved with the Global Trade Repository (GTR) area in 3 years’ time is quite impressive. For example DTCC, the largest operator, is pretty much active in every major country, 1.1 billion messages are being processed every month, 300 reports are being produced in Europe to 38 different regulators. The issue, however, and the lesson that can be learned so far is that the G of the GTRs has disappeared. These are no longer Global Trade Repositories, but just Trade Repositories. It is right that people should make commitments, such as the G20 ones, but those commitments have to be realistic in terms of how things will get done and much more prescriptive in terms of what the end result has to be, enforcing cooperation around the world. Without that, the implementation process will not work on the global level. If an issue is global - and the risks of OTC derivatives are global – there must be a realistic expectation that regulators will work together to come up with a global solution and this has to be put in place right from the start.
Fragmentation in global markets is a reality of the current market environment, an industry speaker agreed. It is not a future threat. This is a topic that is much discussed in the context of securities markets, but some aspects of the bank resolution agenda and of the international TLAC dialogue and projects of structural reforms in the banking sector in certain regions are driving fragmentation in the banking sector also, with a fragmentation of balance sheets in locally allocated capital pools in particular. A key issue is that when "quintessential changes" are effected in the securities markets such as MiFID or EMIR, these happen against a backdrop of substantially reduced and constrained balance sheet capacity among many of the principal market-makers, due to bank prudential regulations. This makes these "market-related matters" considerably more acute than perhaps they would have been otherwise. Why effective coordination at the international level is so important is because fragmentation has "a real world impact", the industry representative stated.
3. The challenge of improving regulatory coordination at the global level
The Chair asked whether cooperation can work on a voluntary basis with the present organisation that involves sovereignty at the national level and markets that are global, or whether a "fully fledged" international organisation for finance in charge of the enforcement of regulations at the global level would be needed. Trying to work on a voluntary basis might be "absurd" and could be similar to trying to enforce speed limits on the road with no police.
Coordination of policy development and rule making
The importance of coordination at the international level and also between prudential and market regulation
Coordinating is not "a natural thing" for national regulators, an industry representative considered, because legislating and regulating are the "ultimate expression" of national sovereignty. Coordinating regulation that has been drafted at a domestic level is felt as a constraint. Industry players want coordination and complain bitterly when that coordination falls apart, but they understand how hard an exercise it is. At the same time, fragmentation and the market and liquidity impacts mentioned previously by some other panellists are a real matter of concern.
When the crisis happened, the first big mandate was on global coordination and on standard setting, the industry speaker remarked. That has generally worked well, although some improvement could be needed. Over the last few years there has been more coordination between market and prudential regulators, and more industry outreach, which is an improvement. There have been incremental, but insufficient, efforts to do better impact assessments. More progress needs to be made in this regard.
In the current environment, cross-border or cross-territorial entities are exposed to much more extensive rules than ever before, another industry representative emphasized. The materiality and relevance of the question about the successful interaction of the global regulatory community is therefore probably far more significant and acute than it has ever been. Such interaction is fundamental to the capacity to undertake certain business activities. EMIR and MiFID are examples, but there is a long list of regulations for which, given the entities and the markets to which they apply, it would be artificial and very difficult to suggest that they should be limited in scope just to the European Union.
There should also be an appropriate coordination between prudential and market regulators, the industry speaker added. Those that are subject to regulation, whether it is the businesses, their investors, or the end consumers, do not distinguish between the notions of prudential regulations or securities regulation. They may be subject to both, and they are holistic enterprises that interact in the markets without regard to these somewhat "artificial delineations" that sometimes exist within the regulatory environment. One illustrative example of the interactions between prudential and securities market requirements is related to uncleared margins. This may be a "glitch" in the regulation, but the provisions relating to uncleared margin in Europe may require dealers to post margin in jurisdictions where exposures cannot effectively be netted. The consequence of that is to potentially increase risk, but then "ironically" regulatory capital has to be held against that enhanced risk, which from a risk or commercial point of view would otherwise never have been carried out. This example, one of many, speaks to a wider theme of a real need for effective coherence and coordination, not just in the context of the international dialogue, which is a given, but also of the dialogue that takes place between the prudential and securities markets regulators.
Regulators should have a clearer mandate for looking at the international impact of rules
"Where there is a will, there is a way. Where there is not a will, it is more difficult", an industry representative claimed. The incentives of domestic regulators to work together cooperatively at an international level appear sometimes to be lacking. There seems to be a great deal of talk among regulators, but the impact of that is not seen that much. Domestic regulators need to be empowered and to have a mandate to look at the international impact of their rules. This issue is related to the G20 commitments and these commitments cannot be achieved without coordination. Reporting is a good example of that since trades are not reported for the sake of reporting them. The whole idea behind reporting is to identify systemic risk on a global level, by product, by region, and by counterparty in order to avoid another Lehman, but such data is not being shared. In fact fundamentally different rules and different trade aspects are being reported so much more cooperation is needed in order to achieve the G20 goals.
One issue that has made coordination very difficult, a regulator stressed, is that Level 1 (primary) legislation does not take international issues into account. The idea probably is that regulators of different regions should then be asked to figure out together how the rules can work in an international setting. But many problems of international consistency that regulators face are Level 1 issues. There is a need for example to take into account in the primary legislation that foreign players will be allowed to operate in the market. This could possibly be done by some kind of equivalence system or a registration system with a compliance mechanism.
In Dodd Frank there is an element of admonition from Congress to the regulators to consider the international implications of regulations, an industry speaker remarked. During the Bush Administration some effort was made regarding the Administrative Procedure Act to make international cooperation or international competitiveness an element that US regulators in all sectors needed to at least assess when implementing regulations. This may sound like a small effort, yet if a regulator does not even have any statutory mandate to look at the issue, it is hard for them to take input on that point and then figure out how to take it into account in their analysis. In terms of the hierarchy of issues they should think about, it will not be the first issue but it needs to be one issue; and that requires specific measures.
Within Europe the coordination problems have generally been solved, with the establishment of the ESAs, a regulator considered. A public representative noted that the EU is trying to go beyond national sovereignty and to develop common rules and common interpretations of these rules, but the ESAs are not always provided with the necessary resources to support this evolution. There is for example a "typical gap" between the speeches made by some politicians who want ESMA to control the credit rating agencies and all the securities markets, believing that then everything would be fine, and the budgetary discussions where no one seems to be supporting the attribution of the resources that would be needed.
The availability of standards
A regulator emphasised the importance of coordination at the global level and the need to address the problems that exist. Increasing the dialogue between parliaments, governments and international regulatory bodies is needed to ensure that there is a move to more coherent international standards.
Looking back at past years, there are certain areas where there has been some success in being reasonably coordinated across the regions of the world, the regulator observed. One of the important factors in this success was the availability of standards, the fact that the international organisations already had them and had thought about these issues. Subsequently, when a need for governments and parliaments to regulate these areas appeared, views were based on the available international standards. It is important that regulators should address issues as much as possible before a regulatory process is launched by politicians and policymakers and before the societal impacts of regulation start being assessed. There must be a conversation between international standard-setting bodies, governments and parliaments to better understand both the regulatory issues and also the needs of societies with respect to the regulation and supervision of certain areas. For example, credit rating agencies form an area where there has been reasonable harmonisation across the world because standards were available, the regulator pointed out. The area of derivatives has been much more problematic. Very high level standards were available for CCPs, but they were not granular enough. There is now a move in the right direction regarding bilateral clearing for which standards are available.
A proposed toolkit for facilitating the cross-border implementation of regulation
Regarding the issue of effective cross-border coordination, there are three key elements from an IOSCO perspective, a regulator explained. One is to actually have consistent international standards in areas of markets where they are required, which involves consultation etc. The second is to clearly encourage consistent and harmonised implementation of those international standards, which means focusing on having consistent outcomes. The third one, which is often ignored, is facilitating cross-border cooperation on supervision and enforcement. Having the same rules for global markets is essential because this will help to achieve consistency, even if cross-border supervision and enforcement "fall down". IOSCO, which is basically built on collaboration, is working to support those three elements, notably in terms of providing guidance through its assessment committee.
IOSCO’s taskforce on cross-border regulation has just completed a report, which is a good step forward in this area, the regulator believed. The taskforce took a very realistic approach and acknowledged that the existing global regulatory architecture does not lend itself to a centralised and multilateral approach to regulating cross-border markets, the regulator emphasized. There are sovereign borders, that is a fact, but often markets are global, so it is a question of trying to reconcile the two. Obviously, bilateral approaches need to be developed to get more practical contributions towards having cross-border market regulation. This report sets out an overview of a toolkit and outlines the key features of three cross-border regulatory tools and the way people can work together. The first tool is national treatment, meaning that a foreign market participant can be regulated in a given jurisdiction; the second one is recognition between countries, which includes concepts such as equivalence, substituted compliance and regulatory comparability; and the third tool is passporting, where governments agree to have a common set of rules, as in Europe. For different markets, different tools are needed. Recognising the existence of these tools is important. The report also considers potential implementation issues, how they may be solved and how these tools might be used in the future. It might simply mean having sessions with regulators, who are experienced in implementing the various forms of cooperation between one another. Another idea for supervisory cooperation might be having a register of Memoranda of Understanding (MOUs) where countries define how to work with one another on supervision. These are "baby steps", the regulator acknowledged, but at least they are a first step towards having better coordination. There needs to be a vision of how to move towards globally integrated markets in the next 20, 30, 40 or 50 years. This can be done, but regulators have to think about how to make it happen.
There is more to be done on implementation, an industry representative emphasized. Taking national legislation and implementing it at the regulatory phase is complex both at the national and at the international level, but there is a clear gap between what was decided at the international level and what is being implemented at the national level. The European Parliament's report on the role of all the organisations dealing with regulation and supervision at the global level will be welcome. What IOSCO’s taskforce is doing on the cross-border implementation of regulation, on recognition and deference, is also critically important.
The prospects of a stronger multilateral coordination of global regulation
An industry representative stressed that the role of IOSCO has evolved and should continue to evolve even more in terms of having "more teeth". The international standards that have been set by IOSCO are a major step forward, but they have come about through compromises and by trying to figure out the level with which everybody is comfortable. The issue is that this does not force people and regulators to put forward the best practices or to avoid agreeing on the almost lowest denominator. This is true for example in the case of data standards. We need to put in place an international governance structure "with teeth" that people will respond to, listen to and be held accountable to. Otherwise, fragmentation will continue.
It is the natural tendency for national regulators to always protect their home market, that is their job, the industry speaker stated. However, given the global dimension of markets, they have to have a second role which is to think of rules in the global context, the panellist believed. The only way to do that is by having governing bodies at the international level. There is already the FSB, IOSCO, and CPMI, but they have to have sharper teeth. This is essential because market players are being affected tremendously by the inconsistency of rules at the global level and the implications are huge. For example, probably about US$600 million a year, if not more, are being spent on Trade Repositories and they are not meeting the global mandate that they were set out to have. So the international regulatory bodies are in place, but they should be given much more authority and "push" to allow the implementation of global standards to happen.
Ultimately, the focus of IOSCO is to allow capital to flow freely around the world to fund the real economy, a regulator noted. Improving global coordination is "more about evolution than revolution". There are good examples of working together as standard-setters, such as the work done with regard to LIBOR and credit rating agencies. Regulators know how to work together and how to work with policy-makers. Progress is also being made at the bilateral level. Around the world there are many examples of countries cooperating on debt equity capital markets and fund management. What Australia is trying to do with the United States at the moment on mutual recognition with retail debt capital markets is an example. The Asian Funds Passport that exists on a regional basis to allow funds to flow across the region is another good example. Having a vision and measuring where the industry is going is important for the next 10/20 years, there is a need to keep moving towards that long-term vision.
How to improve the global enforcement of financial regulations is a "huge question", an industry representative stated. Obviously it is hard to put in place the idea that was proposed a few years ago, to have a kind of a World Trade Organisation (WTO)-style dispute settlement system for financial regulations. This is a useful proposal to put on the table, but a hard one to implement
The premise that underpins the question about having a stronger multilateral coordination of regulation is interesting, another industry representative noted, because the market is already evolving into a more fragmented, subsidiarised model with an increased allocation of localised capital pools in different geographies. That is only relevant, of course, when looking at certain aspects of the regulatory reform agenda such as resolution, robustness and resilience in particular; it is less relevant for others such as customer protection or transparency. Nonetheless it is a reality. As the environment moves into increased subsidiarisation, the nature of the issues that some aspects of the G20 reforms are looking to fix evolves. How that comes together is important.
Regarding supranational entities, people should try to be a little more upbeat, the industry speaker suggested. There has been tremendous success in terms of international cooperation in those areas where there has been the political will to achieve it. There are difficulties, but in the context of benchmarks and credit rating agencies and in some aspects of the resolution agenda, quite an effective capacity has been seen in terms of delivering close to coherent outcomes.
The base case for global coordination is problematic, when considering the example given by a previous panellist of introducing a speed limit without the means for enforcement, a regulator believed. At the same time, it is important to realise that since the catalyst of the financial crisis there has been significant and substantial progress made. Further improvement is nevertheless still needed.
The rules that might be put in place with a more coordinated approach at the global level might not be the rules that everyone likes, the regulator warned. There should also be recognition that there are important elements of European legislation which are a response to European situations. Europe has exemptions for pensions for central clearing because that is Europe’s preference. These types of exemptions, tailor-made elements in this kind of legislation, might disappear once there is a worldwide standard-setter.
4. The need for increased flexibility and more systematic impact assessment
Addressing the possible unintended consequences and cumulative effects of legislations
What is important when laws or solutions are being drafted is that sufficient thought is given to what the unintended outcomes might be, or what the cumulative effect of regulation could be, a regulator stressed. A lesson from the financial crisis is that some solutions may seem appropriate when taken individually, but cumulatively they can have a very adverse outcome. Sometimes there is not the luxury of time and such evaluations cannot be done beforehand, but in an ideal world, these effects should be taken into account. Moreover, transparency is needed; if new regulations are being drafted there has to be a consultation with industry and if it is something that affects consumers there needs to be a wider consultation with the public. There is now the opportunity through social media to potentially do that more effectively in terms of engaging with the broader community. Implementing regulation is about outcomes. When a problem has been identified and a solution found, then it is necessary to make sure that the implementation of the solutions is assessed and that the outcomes are identified and communicated.
An industry representative agreed that the unintended consequences of regulations are a particularly important issue. It is essential that there should be a commitment to explore the unintended consequences of regulations both at the domestic and at the global (G20) levels. "No one has any idea" how this "myriad" of rules and prudential requirements will all ultimately interact.
Moreover there needs to be some flexibility in the regulatory system, the industry speaker believed, because having a consistent implementation is not sufficient, if at the same time a very rigid system makes it difficult to move when unintended consequences arise. If the regulatory and supervisory system is so "static" that the regulators cannot go back and recognise that adjustments are necessary, this will eventually lead to real risks. Industry players may complain about market impacts and impacts on their own business, but what is more important from a policy perspective is the degree to which regulations may ultimately have systemic implications, create inefficiency and potentially damage the ability of the capital markets to service the end user. It is an important issue but it requires "consistent pressure" to get it right.
Another industry representative emphasized that one of the key tools that ESMA does not have at present is the ability to change or to not implement certain parts of primary legislation when they raise issues. Doing so is possible in the US, e.g. with the no-action letters that can be used by the CFTC. This could have helped to avoid many issues with the frontloading procedure in EMIR1 in particular and there may be other frontloading problems with MiFID II. Globally, regulators need to be empowered to be able to not implement sections of primary level legislation when it is discovered that they are problematic. There will always be some problems. This is going to cause significant issues going forward, particularly with respect to the global implementation of regulation.
A regulator agreed that flexibility is very important and is one of the problems that makes international harmonisation and standardisation difficult. During the EMIR evaluation the suggestion was made not to make the frontloading requirement more flexible but to completely remove it, because it is a very complex issue that does not help to implement the rules. Ultimately there was not much support for the frontloading requirement when it had to be used. It would be preferable in the future not to have it anymore. It is right that there should be more flexibility on the central clearing requirements. If liquidity dries up for a particular instrument and withdrawing the central clearing requirement has to be considered, it would take nine months to do so under the current system. That is too long from a supervisory perspective. Another area where there should be more flexibility is the recognition system; currently, if there is an equivalence decision and a third country CCP registers with ESMA, there is no discretion. Some CCPs outside Europe might however pose specific risks that should be addressed. Regarding the liquidity issue, there is now a consultation on the possibility for a one-day liquidation period for gross accounts2. That was inspired by other regulators around the world and it might prove to be a better system. Hopefully other regulators can also be inspired by this idea and there can be a joint move towards a more harmonised system.
The possible modalities for introducing more flexibility in the regulatory process
In Australia, the regulator has the power to modify the law if it appears that implementing it would place an undue burden on the industry and if this modification is not detrimental for consumers, a regulator explained. Every year, the regulator uses these modification or waiver powers and this saves hundreds of millions of dollars in red tape. Flexibility should be possible so long as the spirit of the law is followed and no undue detriment is caused. Flexibility and agility are necessary in the regulation of the "modern" financial system because the world is not standing still and you cannot afford to have "clunky" rules that are not adapted to the way the financial system operates. Those two words of flexibility and agility really have to "frame the way" in which the industry moves forward in terms of regulation.
As was mentioned previously, the CFTC and the SEC have a number of helpful tools, an official confirmed. One is a general exemptive authority, which is an option not to implement part of the law, if it is in the public interest to do so. Another tool is what is known as No Action Letters, which are much more specific to a particular market participant who may bring to the regulator any problems that would be caused by applying the law in the way it is set out. A No Action Letter issued by the regulator means that the regulator would not pursue any enforcement case against that particular participant or accuse it of violating the law.
One issue however is that the processes can be somewhat rigid in the US at present, the official believed. With the Dodd Frank Wall Street Reform Act, it has not been possible to make any modifications. With "normal" relations with the Congress, there would at least have been the possibility to pass a technical corrections bill at this point and some changes would have been made to points that people had figured out did not work as expected. A new indemnification rule has just been issued that will hopefully help on that particular aspect with MOUs. Everyone needs to keep thinking of ways to build in flexibility because international bodies, national bodies and regulators have "a lot on their plates" already. They tend not to go back to something that they have already done unless there is a really big problem. So, as the way to increase transparency, accountability and enforceability is being thought through, we also need to reflect on how to help these regulatory and supervisory bodies to keep working together.
It is crucial that the regulatory agencies should have the capacity and the leeway to be able to make equivalence or substitute compliance determinations, whatever the nomenclature in a particular jurisdiction might be, an industry representative emphasized. There must be adequate flexibility to be able to deal with the real world issues that emerge when trying in practice to deal with outcomes-based equivalence determinations. This is far more difficult to deliver in practice than it might sound conceptually when looked at through the G20 lens. Market practices are evolving in the derivatives market for example with different market participants engaging in trade reporting and clearing, increasingly moving into trading venues and providing uncleared margin. The way that this is being done in different regions may not in fact be "hugely different", but it does not take much of a difference before there is a real sticking point from a regulatory standpoint which is often difficult to understand for market participants and their clients.
Improving the impact assessment of regulation
An element that has been very useful for the US SEC, in addition to public comment, is an internal analysis function with an Economics Department analysing the intended and unintended consequences of making certain policy choices and the related costs and benefits, an official explained. That is good because it is about making active choices about what the likely consequences of regulation are going to be. It is clear however that no one is going to understand all the consequences of a given rule, for example how a requirement implemented in the US could affect business in Japan or Europe, unless someone tells the regulator. If a firm cannot hold margin in yen, this is going to be a problem. So there is a need to think through how industry participants and regulators can help each other. Market participants need to tell the US regulators how their rules are going to affect the foreign markets in which they operate, as US regulators will not necessarily naturally be thinking that through; their primary focus will indeed normally be how it affects business in the United States. It will help immensely to keep thinking through mechanisms that allow an understanding of those consequences on the global level.
Australia has a very similar approach, a regulator pointed out. Before the regulator issues any guidance it has to go to an independent government agency called the Office of Best Practice Regulation, which assesses whether it would produce undue red tape for the industry. This is an independent cross-check.
There is a need for a cost/benefit analysis of regulations not only at the national level but also at the global one, an industry representative emphasized. It is critical for policy-makers to make active decisions based on real information. Often there will be outcomes or impacts of regulations that the industry will not like, which is why it is essential that regulators should fully reflect beforehand on the impact that could potentially arise from a particular area of regulation. This is a critical area of reform.
Improving the assessment of systemic risks and emerging risks
An industry representative highlighted three points. A first point is the concern that although much effort has been made to make individual institutions much stronger, the system as a whole may have become weaker at the same time with fragmentation, liquidity drops, etc. Secondly, what is needed in the financial industry is that interests should be aligned. After this financial crisis, the firms, the regulators, the legislators, all want well-regulated, transparent and strong financial systems. There is a very strong alignment and agreement across the industry, whether public or private, to get these things done. Lastly, care must be taken of excessive hubris. There has been much discussion during the Eurofi Forum about how the possible causes of the next crisis could be spotted, provided the data to do so is available. But currently, no one knows where the next crisis might come from. The present focus is still on tools that may be appropriate for solving the previous crisis. These are important as they have yet to be put in place but no one should think that the industry will be able to see where the next crisis is going to come from with these tools. In addition nobody has ever done that in the past, and this group is no smarter than its predecessors, the speaker believed. It is important to have a little modesty in terms of "how the industry looks at the world".
To be a good regulator what is important is to be proactive and forward-looking in order to identify emerging risks, a regulator indicated. That is the best form of regulation. When a problem has been identified the regulator should first engage with the industry, because many issues can be solved that way if the industry is alerted in a timely fashion. If it cannot be solved by the industry, then a regulatory solution might be needed.
Everyone needs to cooperate, to be practical and respectful of one another and action-oriented, an official claimed. A key lesson from the 2008 crisis was interconnectedness. Geographic boundaries have not contained markets and financial firms for over a century. The problem has been there for a long time but it is becoming more complicated because all the players are more interconnected with computers and that has to be recognised and dealt with. New bodies have been created such as the FSB at the international level and the Financial Stability Oversight Counsel and the Office of Financial Research in the US. There is now a group of people focused proactively towards the future and trying to predict potential risks. Many questions need to be addressed. Is there a huge number of new products that have not yet been heard of, are there issues that are not yet understood? Why is the data showing or not showing decreasing liquidity, are there factors that could be decreasing liquidity, does it make sense to pool liquidity on an international level in some cases and where does it make sense to have regional liquidity that is available to capital formation in that region? Ultimately, regulators and the industry need to keep interacting and to learn lessons from each other. Business players are on the frontline trying to implement many of those reforms. That is why feedback is so important.
5. Closing remarks
The Chair closed the session with two remarks. First, there could be somewhat of a disconnect between the discussion on financial stability in Europe and what stability means in many other parts of the world, the Middle East or Africa, which is simply trying to survive. Maybe the debate in Europe is slightly too technical. To really think globally, we must stop looking from the perspective of stable western countries benefiting from prosperity. That has to be kept in mind. The second point is on flexibility, which was a key word of the discussion. Inside the Eurozone there are huge cultural differences in the perception of what a rule is and what flexibility can mean. For some, "the rule is the rule" – a dry common rule. Others sign treaties but do not worry unduly about them and see the rules as flexible. Inside Europe and in the Eurozone, no one should be under the illusion that simply calling for more flexibility can be the solution.
1 Frontloading is a term that refers to the clearing obligation under EMIR, which will oblige counterparties to centrally clear certain derivative trades through clearing houses (CCP). ESMA believes that the frontloading procedure creates uncertainties for derivatives end-users while the exact terms of the clearing obligation has not been defined which could have adverse impacts on risk hedging and financial stability. Therefore, ESMA has informed the European Commission that it intends to establish the frontloading requirement in a manner that will minimise uncertainty. Source ESMA May 2014
2 ESMA published in August 2015 a public consultation on the review of Article 26 of its Regulatory Technical Standards under the EMIR regulation which deals with the liquidation period (margin period of risk - MPOR) that clearing houses (CCPs) need to apply to client accounts. ESMA is investigating whether it would be appropriate to revise the current regulatory standard in Article 26 with respect to client accounts in order to allow CCPs authorised under EMIR to apply a one-day liquidation period for financial instruments other than OTC. https://www.esma.europa.eu/news/ESMA-consults-review-EMIR-standards-relating-CCP-client-accounts
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