The cost of more severe and intensely supervised capital, business conduct and market integrity requirements will largely be born by the institutional and corporate buy side, either directly or as a pass-through cost.
Some will restrict their risk management strategies to core risks, which cannot be passed on, while others may look to add a risk buffer to the prices and fees charged to their own customers. Others yet may have sufficient knowledge and experience to forgo the increased cost of risk management.
The markets are increasingly being standardised and shaped by the regulatory authorities. It is the institutional and corporate customers who are having to do the work around and deal with the loss of execution choice resulting from the significantly higher cost being placed on the use of over-the-counter markets.
Stamping down on certain types of legitimate order flow, particularly bank proprietary trading, short-selling, position-trading and, because of the increased costs faced by them from end-users, could damage market liquidity and functionality. That could be a particular problem for smaller, more specialist markets.
Some of the key post-crisis public policy objectives included enhancing risk management capability, facilitating business recovery and ensuring liquidity at times of market stress. Yet the impact of the changes introduced since the crisis could have the opposite effect. Risk management capability is scarcely enhanced if order flow into the markets is compressed, users are incentivised to use standardised contracts to manage uniquely individual underlying risk (exacerbating basis risk) and the cost of managing risks goes up (and, potentially, taxed through the proposed financial transaction tax).
The first Markets in Financial Instruments Directive (Mifid) was beset with tight timetables that underestimated the cost and complexity of implementing changes. Many were unable to meet the requirements.
History has repeated itself with the implementation of European Market Infrastructure Regulation, particularly in trade reporting and, potentially, introducing models of individual segregation.
In the case of trade reporting, the overarching requirements relevant to exchange-traded contracts were not fit for purpose and data overload resulted in confusion that was foreshadowed not just by the industry, but by the European Securities and Markets Authority itself (whose application for an extension to the deadline was refused by the EU Commission).
Firms will have to be in a position to offer individually segregated accounts to their customers on the date of central counterparties authorisation.
They are making real efforts to comply with the timetable, but the lack of information, certainty and time required to introduce all the necessary changes will make this difficult. This points to the need for much closer industry consultation on implementation timetables with regard to the forthcoming Mifid II.
Another consequence of change is the morass into which the regulation of cross-border business has fallen, with disputes between regulators regarding the primacy of the application of their rules to cross-border business and growing compliance complexity, legal risk and cost for markets, intermediaries and their customers.
The intention by the new IOSCO Task Force to cut through the swathe of conflicting and/or duplicative rules governing cross-border business is welcomed. But scaling back on this regulatory mess is unlikely to happen soon – and the trench warfare over whose rules apply to what categories of business will continue largely unabated, despite the policy assurances of many international standard-setters. The G20 needs to energise the dialogue on regulatory recognition and underpin the role and primacy of IOSCO as it seeks to address this issue.
Policy makers and regulators need to better understand the potential for adverse economic consequences and/or a migration of business to less well-regulated and less-transparent jurisdictions is real.
Anthony Belchambers FIA Europe, a European industry association for those in the futures, options and other derivatives industries
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