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Conference report: international financiers reflect on Brexit

Chris Hamblin, Editor, London, 6 July 2017

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At a recent CompliGlobe conference in London on regulation by the US Securities and Exchange Commission outside the United States, delegates took time to mull over the regulatory implications of 'Brexit' for financiers in the UK and the wider world.

The United Kingdom has now embarked on its long-delayed negotiations with the European Union over the terms of its departure from that governmental association. It is well-known that there are two alternatives before it: either no deal at all or, in the words of one delegate: "some form of close deal with the EU which preserves some of the existing legal and regulatory framework but repatriates basic sovereignty to the UK and allows the UK to go off and do things in its own way and under its national standards on an enhanced equivalence-based relationship." HM Government is currently pursuing the latter while contemplating the former.

The conference heard the argument that 'Brexit,' far from being an impending catastrophe, is an opportunity for the City of London – one of the world's top two financial centres – to 'reboot' and rethink its regulatory environment.

Equivalence between jurisdictions

In many EU laws there is a recognised route for people from outside the EU to do business within the EU under an 'equivalence' standard. The US has availed itself of this in the context of reinsurance and central counterparties. The EU's second Markets in Financial Instruments Directive or MiFID II, which takes effect on 3rd January 2018, contains a good example of an 'equivalence' regime for the entirety of investment banking.

A speaker observed: "We can agree some sort of deal where there's a wide, enhanced version of equivalence for the UK (not difficult to start with because financial regulations in the UK and the EU are identical right now). This will allow the UK to revert to its traditional method of regulation which consists of higher standards and fewer rules.

"At the moment we are getting the worst of both worlds. We have higher standards which are 'gold plating,' while we have all the European prescriptions that can now be stripped out."

The UK and EU are bound to work together in future on various ideas in any case. Both are members of international standard-setting organisations such as the International Organisation of Securities Commissions from which so much regulation stems. The conference heard about this also.

Why the EU needs a deal

The idea of a good ‘Brexit’ deal received much approbation and was hailed as the likely outcome of the talks in some quarters of the conference. Some delegates were sure that the EU needed a deal because it needed access to London’s capital market, and indeed some were willing to bet money on that outcome.

One large reason for this is the fact that the next largest financial centre in the EU after London is Frankfurt, which according to one delegate’s estimate ranked 19th in the world, with Paris coming farther behind at 21st. Far higher up the list are Hong Kong and Singapore, which are themselves much smaller than New York and London. According to one estimate, Europe’s second and third best centres are not much larger than the Dubai International Financial Centre and Qatar.

One speaker argued: “These are tiny little centres; they are not liquid pools at all. They are very expensive places to do business and they are very expensive places to hire and fire. In fact, it’s almost impossible to hire and fire. One of my clients did a takeover of a Parisian business. They wanted to downsize. They laid off some people and then they were told when they advertised for new jobs that they had to offer the new jobs back to the people they had just laid off and, in fact, for more money. They actually ended up in a worse place than they'd started.

“So it's not an easy place to do business. In France, it's a requirement of law that you don't have to look at emails at weekends. These are unusual places to do business.”

At another point the conference was reminded that the damage that London sustained in the Second World War – about a third of London in all – did not last and the City recovered from it and retained its dominance. A delegate opined: “It takes something extraordinarily dramatic to shift a financial centre. It's a place where people come to do business. Brexit's a meaningful event but it's nothing like that in scale. So it's not going to shift that dynamic. People are going to come to the market for the expertise and liquidity that it offers.”

Beware the EU power-grab!

It is well-known that the EU is attempting to use the negotiations to pull various bits of financial business onto its own territory. It is also trying to obtain more of a say in regulation in the UK, despite the fact that the UK is leaving it. One delegate argued that the UK ought to resist these initiatives very heavily, adding that the first glimmers of the EU’s aggressive strategy were to be found in the context of Euroclearing and systemic clearing houses. He also thought that the EU wanted two further things.

“They want a bureaucratic, byzantine method of regulation – I've lived through that in the context of a European exchange client, where a college of regulators voting by committee in a highly politicised way engages in micro-decisions on each strategy. [My] client wanted a French CEO and then they wanted a French head of risk. The particular head of risk was rejected when he was submitted because he lived three days a week in Brussels with his family and a few days in Paris and that wasn't considered French even though he was French! We can't allow a situation like that because it would kill the market in this time zone, which is in no-one's interests.

“The other mischief in the Euroclearing proposition – and I think they want to magnify this out to other sectors – is the idea that they want to preserve the Euro as a currency. The Euro is half-built, as we all know. It's got no sovereign, it's got a central bank that is not under any particular sovereign control. They want to be able to control margining in the UK in the Euromarket in relation to Euro credits. There's a big concern that the London Clearing House raised its margin requirements for southern Europe in 2011 and started haircutting southern European bonds and that caused huge strains in the Eurozone.

“Well that's just an objective private-sector commentary on creditworthiness. The private sector is going to exercise its rights and beliefs in relation to required margin anyway. I think it will do it in London or it's going to take it somewhere else and do it somewhere else. It is impossible for an authority to control the absolute levels of margin.”

Regulation – a substitute for good economics?

The conference looked further at the EU’s policy of trying to prop up the Euro through regulatory measures rather than actually sorting out the problems inherent in the Eurozone. Two other examples of this presented themselves. One was the EU’s desire to ban short-selling in government bonds in the EU and on naked credit default swaps, the ultimate aim of which is to alleviate downwards pressure on valuations. The other was the regulation of credit-rating agencies, pushed assiduously by France when Moody's downgraded that country. Somebody reminded the audience: “They were very annoyed with that and they wanted to be able to go to the rating agency and say look, you're wrong and if you don't change your mind you're going to get out!”

The conference heard the Euro’s problems being likened to an explosion in a badly-built nuclear power plant with toxic waste in the reactor while the management was trying to distract attention away from the dilemma and avoid dealing with the problem for as long as possible by issuing rules.

Delegates heard the argument that the UK ought to reject all the EU’s attempts to control the Euro situation with regulation, although they also thought that it might come to some accommodation with the EU that involved the sharing of data or information. They thought, however, that interference from committee-based oversight should not continue because it could only inject systemic risk into a dynamic market in a most dangerous way.

No deal – better than a bad deal?

Having explored the 'deal' option, the conference moved on to discuss the ‘no deal’ option, which the markets still probably do not understand fully. An eloquent speaker said that this option was not a bad one in the slightest and might be even better because it would allow the UK to move further towards the very market-friendly system of regulation that the United States has always enjoyed.

He went on: “One of the things that the EU has done is to split rulemaking and supervision, which is a very dangerous thing to do. Done safely, rulemaking and supervision ought to be done by the same person and in real time, in the same language as these dynamic markets and in the same place, or very close by, so their regulations are attuned to what's going on. The UK should re-regulate, remove red tape and remove concepts that are completely unnecessary.”

Competition-based regulation

One of these bad concepts, he thought, was competition-based or a priori regulation, which he condemned in strong terms: “A lot of MiFID II is competition-based actually. I would get rid of most of it. It is intended to reach a good result [through an] a priori understanding of the perfect market, creating all sorts of rules, rather than what anti-trust law should be, which is...ex-post, waiting to identify a mischief on the basis of the facts and the evidence, having some semi-judicial process and taking action on something that has actually gone wrong.

“This EU technique of competition-based regulation came from the European Commission, because legally the commission has jurisdiction over competition law matters all the way through. They do a lot of rulemaking on competition but it seeps into the UK, through the FCA's competition powers which came in recently, and the FCA now has over 100 people who are sort of well-intentionedly researching points to make rules on to try to create some sort of competitive market. This is not possible, especially in areas where the market hasn't properly evolved. It's completely wrong-headed. To my mind that needs stripping back.”

The conference returned to the EU’s need to retain access to a capital market in the Greenwich time zone. If this were not essential for it, delegates heard, it would already have moved operations to New York or Singapore, or perhaps would have created something in Frankfurt or Paris. Its failure to do so stems from the fact that the economic effects of capital market fragmentation are punitive, which explains the existence of financial centres in the first place. Were that not to be the case, Jakarta would have a massive financial centre, Mumbai would be a global financial centre with access to 1.25 billion people, Shanghai would be already a global financial centre and Singapore, with its tiny population, would have no relevance at all. People often fail to grasp these points fully.

Creeping European paternalism...and the antidote

Delegates made more observations about the philosophical difference between the US/UK and Europe, this time in respect of listings. One opined: “As I understand it, the US regime is more based on disclosure and people being adults and being able to read stuff and rely on it. European paternalism has crept into the UK system, which is much keener to try and massage things and [impose] pre-trade restrictions. Taking an interventionist approach over and above reliance on disclosure, I think, is something that should be revisited.”

MiFID II's a priori measures were discussed, ranging from the regulation of organised trading facilities (OTFs) and fee disclosure to the extension of the systematic internaliser category and the unbundling proposition. One delegate said: "A lot of this stuff is interventionist and pro-competitive. It's an idea that's gone too far and Brexit really is an opportunity to reconsider all of this."

One American delegate whose office was in Switzerland and whose clients were in the EU raised the example of the Swiss taking on 'EU-lite' regulations in exchange for trading rights in the EU and asked whether the UK might have to follow the Swiss example. Another delegate thought this unlikely.

"I think the UK's position is different from Switzerland's. It's a global financial centre in its own right and the EU customer base comes to London in the way that everyone does from the rest of the world – from Russia, from India, from Africa, the US and elsewhere. They deal on the market by setting subsidiaries up here, which costs tuppence-ha'penny in the scheme of things. I don't believe the UK needs to follow the EU regime at all.

"Switzerland is in a different position. It's surrounded by Europe. It's a smaller market. It's not a destination market so it's had to go down an equivalence-based access route and it hasn't got the leverage not to be a rule-taker. I don't believe that that's the truth for the UK and in this context the UK isn't a G5 country so much as a G1 or 2 country because of its financial market. So it's in a very different position."

With this in mind, delegates returned to the idea that 'Brexit' is not likely to lead to a continuance of the status quo and the transformation of the UK into a mini-Europe on its own. Brexit, they were told, is much more likely to lead to a laissez-faire, free-market regulatory relaunch. Whether it does or not, only time will tell.

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