I have long been a critic of the length and complexity of recent regulation and other missives from the Authorities. The worst of the global offenders are the 848 page long Dodd Frank Act and the 116 page long T2S Framework Agreement. As far as complexity goes, the former wins with its sheer opacity whilst the latter scores highly with the incredible use of difficult to follow cross referencing throughout its 7 chapters, 54 articles and 13 schedules. I am relieved that I am not alone and note that Sheila Blair, the former FDIC head, has admitted that at least the Volcker rule (itself a subset of the Dodd Frank legislation) is too complex and needs to be simplified!
Dodd Frank is the perfect example of the danger of overlegislation. The Volcker rule is intended to reduce bank risk by restricting proprietary trading and certain high risk investments. Its substance takes up just 11 pages of Dodd Frank but four of the five affected US agencies have transformed this into a 298 page proposal, including 383 questions which break down into close on 1500 sub sections. And that ignores the independent action of the fifth agency, the CFTC, which has put out its own 489 page long proposal on the same issue. It is no wonder that US legal firms are increasing their rates and the market is even more confused than it was in the past!
Of course finance is far more complicated than in the allegedly halcyon days of the last century. Then bankers had to consider the Federal Reserve Act 1913 and the Glass Steagall Act, a bargain at 69 pages in total. No wonder they had so much time to relax!
But modern legislation, and the inevitable regulation that it requires, is so complex that it is hard to implement. The Dodd Frank Act was expected to be in place within 12-18 months but several banks are expecting that it will not be enacted in its entirety before the end of the current decade. That even makes T2S (started around 2006 and scheduled for delivery in 2015) appear to operate in a reasonable time frame.
But why is it all so complex? One legal firm estimates that we have merely finalised around 90 of the expected 400 rule making requirements of Dodd Frank. Deadlines have been missed in around half the rest. And legislative challenges are starting in some areas. The derivatives, consumer protection, banking regulation, mortgage reform and systemic risk areas are the most contentious. But that overlooks concerns on rating agencies, financial sector living wills and corporate governance to name but a few.
The reality is that Sheila Blair’s comment on the Volcker rule is right and applies to many other areas governed by the growing web of regulatory bodies, often structured on a sectorspecific basis rather than a functional one. As a result a single broadly based financial organisation may find itself having to handle different interpretations of the same part of the Dodd Frank Act, for example, dependent on their areas of activity and the regulatory oversight of specific businesses. And different organisations, dependent on their operating sector, may be subject to tougher or less restrictive rules for identical risks. A world is being created that is rife with regulatory arbitrage and a growth in shadow banking entities which may obfuscate major systemic risks.
The flaws appearing in the US market as a result of Dodd Frank are multiple. From potentially huge financial inducements to whistle blowers (which could well cause a substantial number of “nuisance” cases) to the categorisation of all non US-government bonds as non-eligible under the Volcker rule, the regulation is becoming ever more dangerous, especially given the trend to extraterritoriality for financial sector legislation and regulation.
Sheila Blair is right that we need simple rules. But that overlooks the reality of a world where another financial sector bailout is an economic and political impossibility. And it is a world that has become ever more litigious and thus keen to have clear rules. It is the desire for clear rules, in the US and also in the EU, which is at the hub of the problem. We are long gone from the days where a quiet word from the Central Bank was enough to guide a financial institution to the “straight and narrow”. The banking world is mobile enough to move products and ideas from unfriendly to friendly jurisdictions (hence the danger of taxes such as the Financial Transaction Tax). It is not just a regulated environment but, as already noted, it encompasses an important, and often unregulated, shadow banking sector.
So what is to be done? In reality the market had two options. We could either have had more complexity and more regulation in an environment that defined narrowly the role and remit of the different players in financial markets. Or we could have had a general rule book with more interpretive discretion to the regulators on detail. Is the latter feasible from a commercial and even practical perspective? Unfortunately it appears not for we have moved too far down the road of a legally formulated business environment for the two prerequisites of a simple environment to prevail - trust and sound judgements across the different stakeholders.
John Gubert
Chairman Global Securities Services Executive Committee UniCredit