Regulators in the United States and Europe are poised to make deep and lasting changes intended to improve global financial markets and decrease systemic risk. How these changes are structured, and to what extent various market participants will be affected, is still being worked out. However, both detractors and supporters of financial markets regulatory change agree that in seeking a new balance between free markets and containing systemic risk, the cost of doing business is likely to rise for many institutional investors.
“There is a tight rope that regulators need to walk, on the one hand limiting systemic risk, but on the other hand if regulators impose capital requirements and compliance costs that are too high it could have a negative impact on the economy,” says James Roselle, associate general counsel at Northern Trust, Chicago.
Pension funds, endowments and foundations are watching the evolution of several major regulatory initiatives, including:
- The Dodd-Frank Wall Street Reform and Consumer Protection Act
- Proposed rules in the United States and Eurozone to govern the over-the-counter (OTC) derivatives markets
- The Undertakings for Collective Investment in Transferable Securities (UCITS) directive
At more than 2,300 pages, the Dodd-Frank Act is considered the largest and most far-reaching piece of financial legislation since the Great Depression. It requires 11 government agencies to write the details for more than 300 proposed rules. The effort required is so large that many deadlines for regulators have been postponed or extended until the end of the year.
The proposed regulations will have sweeping impact. Included in the new law are new rules for mortgage lending and debit card charges by banks, a definition of a “systematically important financial institution” and increases in the amount of capital financial and nonfinancial institutions are required to hold. (For a deeper at look at Dodd-Frank and its likely impact on institutional investors, see “The Evolution of Dodd-Frank.”)
Achieving regulatory balance and transparency in the OTC derivatives markets is another massive undertaking. Regulators in both the European Union and the United States are working out rules that would attempt to standardize the contracts, centralize them on exchanges or “swaps execution facilities” and clear them.
Harmonizing those rules, so as to not create opportunities for regulatory arbitrage or push business overseas, is a high stakes effort that will affect the way institutional investors balance increased capital requirements and risk. (For a deeper look at OTC derivatives and how proposed changes are likely to affect institutional investors, see “OTC Derivatives Regulations a Mixed Bag for Investors.”)
One new and seemingly successful effort at transnational regulatory harmonization is UCITS, the European-based directive that enables a single management company to “passport” funds from country to country.
Although UCITS has already been in place for retail entities, the latest update, UCITS IV, scheduled for rollout in July 2011, will include financial institutions. If fully implemented, UCITS IV could result in substantial savings for funds providers and institutional investors. (For a deeper at look at UCITS IV and its potential impact on institutional investors, see “UCITS Upgrade Brings Competition, Cost Savings.”)
Funds and market participants are looking closely at all of these proposals and lobbying for fairness, both in terms of compliance costs as well as how and for whom the rules are implemented. With some of these proposals spanning continents, multiple regulators and a dizzying array of products and services, achieving regulatory fairness is a high-stakes balancing act.