May 2014

REGULATION: More muscles from Brussels

EU parliamentThe European Parliament elections in mid-May could see a strong showing for anti-EU, populist parties. Could they interrupt or slow the pace of financial regulation? Don’t bet on it. George Mitton reports. Between 2008 and 2013 the proportion of Greeks who approved of their European leaders sank from a majority to less than one in five. A similar collapse was recorded by Gallup polls in Spain, Italy, Ireland and Portugal – countries which endured austerity and hardship soon after the eurozone debt crisis. Even in relatively prosperous northern Europe, faith in the European political project is at an ebb. The National Front in France, the Party For Freedom in the Netherlands and the People’s Party in Denmark – far-right parties, campaigning on a eurosceptic platform – are leading the  polls. In Greece, the far-left Syriza party is in front. With such disillusionment, the European Parliament elections in mid-May could well be remembered as the year of the protest vote – an election in which anti-EU populists and  nationalists could capture 150 of the 751 seats in  the next European Parliament. What will this mean for the financial industry? Could confusion and discord in parliament halt or slow the torrent of regulation emanating from Brussels? This can besummed up in two words: probably not. “There’s a hope that the rate of new regulatory proposals will slow down and ones in the production line will disappear,” says Tony Freeman, executive director of post-trade processing firm Omgeo. “That’s a false hope. The signals I get from Brussels are the next parliament will be just as determined as the current one.” EAGER TO REGULATE
Indeed, some of the eurosceptic parties are among the most eager to regulate financial markets and are likely to support further measures, which they see as vote winners, though some commentators are murmuring that the  exotic parties lack the expertise or experience at European council level to effectively shape policy. What the election could do is change the dynamics in the parliament. Some predict a “squeezed middle” in which the centrist parties will be forced into an alliance simply to ensure legislation is passed. Unlike in the current   parliament, where the centre-right has often allied with liberals to push through law, this arrangement could lead to a greater role for the centre-left, which could result in more hostile regulation. Meanwhile the need to court fringe parties for votes could lead to more influence for some smaller parties. This has happened before, for instance when the Greens were able to push for rules to limit fund manager pay. Regulation-weary financial services firms might take some respite from the presidency elections. For the first time, the president of the European Commission will be elected, not appointed, and many financial companies are  hoping Jean-Claude Juncker, of the European People’s Party, a former prime minister of Luxembourg, will be victorious. “His view is a little softer because he has experience of Luxembourg,” says Mario Mantrisi, chief strategy and research officer at Kneip. “He will look at another aspect which is neglected, the economic factor. What does the financial sector bring for the EU economy? He has a balance between investor protection, but also looking at opportunities linked to the industry.” Juncker has made moves to charm UK prime minister David Cameron, perhaps sensing the power of the UK to aid or hamper financial regulation. With the backing of German chancellor Angela Merkel, he is regarded as  the favourite. However, he is running against candidates who would be much less favourable to the financial industry, such as Alexis Tsipras of Syriza. Assuming, as many fear, that the next parliament will be just as militant as the last, what items will be on the regulatory agenda? WATCH THE INDICES
Horrified by abuses of Libor, and amid suspicion of manipulation in foreign exchange markets, European legislators are keen to regulate benchmarks. Their idea is to create rules that apply across the board, legislating not only  on Libor but on equity and fixed income indices. A European Commission proposal for regulation of benchmarks did not pass during this parliament but is likely to get picked up again in the next, starting from the draft at council level. This means more headaches for men such  as Alex Matturri, chief executive, S&P Dow Jones Indices. “Being regulated doesn’t bother us, but it’s a problem if you paint everyone with the same brush. Some of the rules intended to be implemented do have farreaching repercussions.” One problematic part of the proposal are the third-country rules, which seem to say an index can’t be distributed in Europe if it is not regulated in Europe, a problem for a US-based index provider. Meanwhile, proposals on liabilities could be interpreted to make an index provider liable for investors’ losses. “How could we be liable for someone who misuses a benchmark, and we don’t even know who they are?” he asks. THE FTT
Although it has faced a number  of legal challenges, the proposal to place a 0.1% tax on financial market transactions (and 0.01% on derivatives trades) is still on regulators’ minds. An agreement on the financial transaction  tax (FTT) is likely at the Council of Ministers meeting on May 6 after which the legislative machine could approve the rule in 2016. According to James Walsh, policy lead, EU and international, National Association of Pension Funds, the rule could be implemented by 2018. Although there are likely to be exemptions to buy off opposition, there is enough support to make the legislation happen.Walsh suggests the FTT will apply first to equities and equity-based derivatives, then corporate and government bonds a year or two later, then other derivatives and instruments. “Behind schedule, details unclear and no plan for implementation? Yes indeed. But still advancing inexorably down the political track? You bet,” he wrote, in a recent column for Funds Europe. HIGH FREQUENCY
Another regulatory target could be high-frequency trading, which has gained attention lately thanks to a book by journalist Michael Lewis, Flash Boys: A Wall Street Revolt. The issue is mentioned in the second draft of the Markets in Financial Instruments Directive but it may affect other regulations too. Specifically, European regulators will have more data to base decisions on thanks to the Alternative Investment Fund Managers Directive, which requires managers of alternative funds, particularly hedge funds that are often the most enthusiastic high frequency traders, to submit large amounts of data to the regulators. “Suddenly the regulators will have access to a huge amount of information they didn’t used to have,” says Cathy Pitt, funds partner with law firm CMS, who believes regulators will use this data to investigate the effect of high-frequency trading on financial markets, alongside other goals. Another trend is the move away from over-the-counter trading to regulated exchanges, a particular preoccupation of Michel Barnier, the European commissioner for internal market and services. Central clearing of derivatives  will be obligatory under the European Markets Infrastructure Regulation, however, there is scope for these regulations to be expanded, with central clearing perhaps broadened to transactions in commodities, energy and natural resource assets as well as derivatives and fixed income. WHAT DIRECTION?
Meanwhile, rules on money market funds will likely be debated once again, after opposition to the inclusion of rules about a buffer led to the last legislation being blocked. Where does this leave the financial industry? Certainly, firms should not expect a break from the regulatory burden they must bear. The European Parliament passed a series of laws in the last few weeks that must be digested and implemented, including rules governing Ucits V and rules specifically for packaged retail investment products. As asset managers and other firms implement these regulations they must keep an eye on the newer developments that are outlined above. Will the make-up of the parliament affect the pipeline of regulation that the financial markets face? Aside from causing some trivial delays, it seems unlikely to stop the tide. Public and political will to get tough on financial markets seems simply too strong. Perhaps the more general point is that financial market regulation will be influenced by a broader debate as to what exactly is the future of the European Union, in an environment where so many European citizens have fallen out of love with their masters located in Brussels. “It’s a critical year for the EU because it will be tested,” suggests David Henry Doyle, the Brussels-based head of financial services at public affairs firm Hume Brophy. “There are a lot of people questioning the direction of Europe,” he adds. ©2014 funds europe

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