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The term “tsunami of regulation” came into common parlance sometime in the last five years as the institutions that were tasked with keeping financial markets safe attempted to make amends. Around the world, governments, regulators, and central banks scrambled to put measures in place to stop what had just happened from happening again. Everyone was in the firing line.
On January 5, 2010, the United States Congress was presented with an 848-page document. In this hefty legislative work–the “Dodd–Frank Wall Street Reform and Consumer Protection Act” (aka Dodd–Frank)—the word “bank” appeared 1,577 times; “protect,” 596 times; and “investor,” 269 times.
Three and half years later, this act has bourgeoned into a 14,000-page-long opus, and just 39% of the rules it proposes have so far been enshrined into law. The rest are being busily worked on by armies of government wonks and should come into force in the next three years.
Across the Atlantic, the announcement of the Alternative Investment Fund Managers’ Directive hit traditional and alternative asset managers’ desks in 2009 and took until August this year—and several hundred meetings in Brussels, Frankfurt, and beyond—to be passed to European Union member states to be written into each country’s own domestic laws.
Add in several more major rules on collateral, central clearing, trading agreements, and tax—without mentioning the Basel III capital requirements and an enhanced Solvency II for insurers—and the “tsunami” label does not sound too extreme.
So, do we all feel protected?
“I feed my family on regulation, but does it help? Almost certainly not,” says Robin Ellison, former chairman of the National Association of Pension Funds (NAPF) and partner at law firm Pinsent Masons. “The crisis was partly caused by regulation, as it gave a false belief that the regulators were in control. And, with more regulations, there are more ways of getting through them.”
Think about the headlines over the last five years: “Bloodbath on Wall Street,” “Retailer Collapse Triggers Thousands of Job Losses,” and the like. But does anyone remember “Legal Firms Shed Staff”? Not so much.
“We need regulation, but in finance and pensions it becomes very complex—and what it has spawned most recently is a huge industry called ‘compliance,’” says Penny Green, CEO of the £3.8 billion Superannuation Arrangements of the University of London. Apart from employing a lot of people—and charging clients for their work—“compliance” has removed some of the effectiveness of regulation, Green says. “The trouble with regulation is that it reduces everything to tick boxes. It limits your ability to be innovative and flexible,” she says. “In 2008, the Data Protection Act was produced in the UK. It contained 38 pages and had eight principles. It works.
“Dodd–Frank was made in haste and was poorly drafted. If you want effective and clear regulation, you need to take your time and think clearly about it,” Green says.
Strict rules in large quantities are frowned upon elsewhere in Europe, too. “What you see right now is a tsunami of regulation, and it’s piling up on itself,” says Bob Rädecker, public markets CIO of Dutch pension manager PGGM. “I think regulation should be principle-based, not rule-based. If you have financial institutions that are faced with huge amounts of specific rules, risk management is being downgraded to compliance. You can tick all the boxes, but still in banking things go wrong. And excessive regulation leads to people no longer thinking for themselves.”
Yet, not all regulation is bad regulation, Rädecker believes. He commends the action taken to strengthen banks’ balance sheets, for example. These large institutions are some of his trading partners, and reducing any risk in that sector is welcome.
Andrew Clare, professor of asset management at London’s Cass Business School, is also pleased with some of the measures: “Some of the new regulations are important—the European Market Infrastructure Regulation, for example, and the new reporting requirements for investors.”
But his next remark is a refrain sounded time and again by investors and other financial professionals: “It’s possible that these new regulations will stop a repeat of the Lehman Brothers collapse, but they won’t stop the next crisis.”
Some are less critical of regulators. “It is hard to gauge the adequacy of regulations in place at the time because the market, as a whole, had not experienced the magnitude of crisis such as that of 2008 since the Great Depression,” says Anne Sheehan, director of corporate governance at the California State Teachers’ Retirement System (CalSTRS). She adds that regulators, like the rest of the financial markets, had to figure out what was going on—and how to adapt to it—as they went along. Ultimately, she says, market participants themselves have to take responsibility for their own actions, and they should think in terms of “empowerment” rather than “protection.”
“I don’t believe strict regulation is the answer to anything,” she says. “Regulators play a role in our markets, but they are only one aspect of it. Equally important for healthy markets are companies that act responsibly and investors and shareholders who take an active role. That is why we at CalSTRS have long been supporters of good corporate governance.”
For former-NAPF head Ellison, though, the system of self-governing has been lost. Banks are too big to offer genuine competitive value to their clients, and justice—which he believes is the only way of stopping financial institutions from misbehaving—is open only to the very few who are rich and powerful enough to access it.
One thing is certain: Regulators and other governing bodies have felt the criticism and learned the lesson of what happens when “light-touch” regulation goes wrong. Maybe they feel it is better to be accused of doing too much of the wrong thing than to be accused of doing nothing at all.