As G20 leaders prepare to convene in Washington this weekend, the global business community acknowledges and accepts that, in the wake of the current global financial crisis, there is a need for better regulation of markets and a strong desire for a restructuring and consolidation of regulatory bodies, according to a survey published by international legal practice Allen & Overy.
Despite this, there is no overwhelming desire for a global regulator, with the market split on this point (42 per cent agree and 50 per cent disagree), and participants indicating that such a development would be unworkable and unachievable. The study of over 700 business leaders from around the world, ranging from CEOs and Chairmen to General Counsel, Partners and Directors, found that while there is a near universal recognition of the need for better regulation, there is confusion and conflicting views as to how this might be delivered. There are also conflicting regional views, highlighting that solutions to this global issue may be difficult to identify and implement.
There was a broad acceptance among respondents from financial institutions in Asia of greater regulation, with a strong feeling that domestic regulators should be restructured and/or consolidated (for example, the Securities and Futures Commission, Hong Kong Monetary Authority and Insurance Commissioner in Hong Kong). Asian institutions (in line with Continental Europe) appear to favour a supra-national regulator for oversight of global financial institutions, but opinion is mixed - the imposition of such a regime would almost certainly cause major regional political friction given the broad range of legal systems and political structures in Asia. An overwhelming desire for rating agencies to be regulated more tightly shone through in Asia, in line with the general support globally for the concept, as demonstrated by the survey results.
The establishment of a central counterparty for credit default swaps has significant support, the highest amongst the regions surveyed, together with an appetite for greater transparency of products and participants. There is a high degree of support for more protective depositor compensation schemes and (not surprisingly given the geographical issues in Asia) disagreement with ring-fencing of national assets in times of trouble.
Mark-to-market accounting is strongly supported, together with the need for global liquidity regulation.
Asia was also the only region to have majority support for more political oversight and regulation of bank lending practices. Overall, Asia appears broadly in line with the other regions, with a slight tendency toward acceptance of (or resignation to) greater regulation, greater transparency and the perceived advantages of, or need for, global supervision and guidance all of which, as a practical matter, would present great challenges for the industry.
Regulatory outlook: Asia
As always, it is difficult to give a "block" view of the Asian position and likely future developments, given the wide range of jurisdictions and political structures and agendas that exist across the region. However, there is no doubt that regulators in Asia will be spurred by public and political pressure to become more aggressive in regulating the markets.
In Hong Kong, the Securities and Futures Commission has faced questions over its handling of various issues, in particular the "mini-bonds" saga, in which credit default swaps in respect of Lehman (and various other institutions) were sold to retail investors. The losses to clients triggered a wave of public protests blaming the banks for mis-selling, and the regulators for allowing it to happen. This resulted in pressure being applied on the banks by the Hong Kong Government to buy back the mini bonds at market price.
This demonstrates the slightly different ways of doing business for institutions in Asia, where sales of sophisticated products to retail investors have become fairly standard. That is clearly set to change, and there is an expectation that there will be greater restrictions being placed on the distribution of products to retail investors.
Various Asian jurisdictions, including Hong Kong and Korea, have clamped down on short selling in response to the market turmoil. Derivatives have also attracted more attention, and given the current market conditions hedge funds may well find themselves being much more tightly regulated in relation to transparency, etc.
Overall, there is a likelihood, borne out by the survey responses, of a significant move toward tighter regulation across the financial markets (although given the disparities in Asia, this is likely to create potential regulatory arbitrages). Hong Kong is also expected to become more active in its implementation of Basel II, and whatever comes next.
Overview of survey results for Continental Europe
The views of respondents across Continental Europe were broadly in line with those across the USA, UK and Asia, in accepting the need for greater regulation and the restructuring and/or consolidation of domestic regulators. However, while there is no clear consensus among the global community on the need for the establishment of a supra-national regulator to oversee global financial institutions, Continental Europe was the only region where the majority agreed with this statement.
The appetite among respondents for a strong regulatory reaction to the global financial crises, relative to respondents in other regions, is marked. Europeans showed the strongest support for a comprehensive rewrite of Basel II, and gave the most favourable reaction to the suggestion of increased regulation of hedge funds.
The region also showed the highest number of respondents endorsing increased regulation, restrictions and disclosure of securitisations and other structured finance products, and also felt most strongly that off-balance sheet treatment of securitisation and structured finance arrangements should be restricted.
While Europeans agreed with the universal view that it would be wrong to prohibit short selling and other speculative trading activities, the sentiment was least strong in the region. On insolvency issues, Continental Europe follows the globally held view that there is a need for a global convention dealing with cross border insolvency.
Respondents also displayed the most favourable reaction to the suggestion that ringfencing of national assets for the benefit of local creditors should be prohibited and were the most likely to agree with the introduction by regulators of more debtor friendly bankruptcy policies.
Mark-to-market accounting is supported, as is the establishment of a global quantitative standard for liquidity regulation. Opinion across Continental Europe is divided, however, on whether there should be more political oversight and regulation of bank lending practices and volumes.
Regulatory outlook: Continental Europe
At an informal meeting of the EU Heads of State or Government on 7 November, five specific measures were put forward as possible steps to be incorporated in the rebuilding of the international financial system:
1. Submit rating agencies to registration, surveillance and rules of governance;
2. Adopt the principle of convergence of accounting standards and review the application in the financial sector of the fair value rule in order to improve its consistency with prudential rules;
3. Decide that no market segment, no territory, and no financial institution should escape proportionate and adequate regulation or at least oversight;
4. Establish codes of conduct to avoid excessive risk-taking in the financial sector, including in the area of systems of remuneration. Supervisors will have to take them into account in evaluating the risk profile of financial institutions;
5. Give the IMF the initial responsibility together with the FSF, of recommending the measures needed to restore confidence and stability. The IMF must be given the necessary resources and appropriate instruments to support countries in difficulty, and must fully exercise its role of macroeconomic surveillance.
It remains to be seen how these measures will be greeted by other countries. However, there does appear to be a desire for stronger enforcement of EU directives and a move to increasing the regulatory capital requirements of financial institutions across Europe.
Overview of survey results for the UK
Perhaps unsurprisingly given London's status as a global financial centre, the majority of respondents concluded that a global super-regulator would not be a good idea - London would have much to lose from a global regulator in terms of autonomy.
There was also widespread agreement that the UK regulatory system needs restructuring. Again, the
UK's reliance on the flows of international capital saw strong agreement that there should not be any increase in FX / country exchange controls to limit the flows of capital.
More surprising, given the central role of hedge funds and derivatives in the UK financial services industry - and the UK's historic free market culture - is the apparent acceptance that hedge funds, securitisations and derivatives deserve greater regulation.
By contrast there is a clear sense that free market principles should continue to apply in relation to remuneration, with the UK respondents giving a clear signal that controls on remuneration are not wanted. UK respondents also had a strong majority view that short selling should not be restricted.
Given recent experience with Icelandic banks it is not surprising that a clear majority of UK respondents are against ring-fencing of national assets for the benefit of local creditors.
The UK also had one of the highest levels of support for an increase in the protection conferred by depositor compensation schemes. There was also strong support in the UK for the establishment of a global quantitative standard for liquidity regulation and more political oversight and regulation of bank lending practices.
Regulatory outlook: UK
The UK has signed up to the measures agreed by EU Heads of State or Government last week. Thus far the UK authorities appear to be awaiting developments on a Europe-wide basis expected from the European Commission, rather than taking a ‘go it alone’ approach.
Early indications of the regulatory response emerging from Europe are that there are likely to be tougher conditions for off-balance sheet structures, with aggressively structured CDOs unlikely to reappear. ‘Skin in the game’, or the need to retain some portion of the originated assets - say 10 per cent - where there is a transfer of credit risk, is also likely to come to the fore for securitisation (and possibly other credit risk transfers). There is also an expectation of tougher regulatory capital requirements for trading book arrangements (including derivatives) following the recent Basel paper on the topic.
The UK regulatory response has been limited to a proposed Banking Bill (which among other things seeks to improve the system for dealing with failed banks, and make improvements to the Financial Services Compensation Scheme), and proposed changes to liquidity regulation. The FSA has also fired the first shots in a possible skirmish over executive compensation by means of an open letter to banks' management. There has also been some indication that the FSA will decide to exercise its supervision and enforcement powers more aggressively.
Overview of survey results for the USA
Respondents in the USA gave the most free market responses in the survey, including the highest majority to reject the idea of a global supra-national regulator and the highest majority to reject any increase in FX / country exchange controls to limit the flows of capital.
In terms of more regulation of participants and products, respondents in the USA were split over the need for increased regulation of hedge funds, but were only just behind Asia in terms of their overwhelming desire to see greater regulation of rating agencies. The USA also had the highest number of respondents who were against a ban on short-selling and other speculative trading activities.
On insolvency issues, the USA was the only region where there was not a clear a majority in favour of prohibiting ring-fencing of national assets for the benefit of local creditors. There was also a clear difference in the strength of opinion in the USA on regulators introducing more debtor friendly bankruptcy policies and the ability of authorities to override set-off, netting and collateral provisions to deal with failing banks, as each received the highest level of disagreement from any region.
Respondents in the USA were also most against mark-to-market accounting being abolished and were largely against the adoption of changes in capital requirements (a so-called Basel III) or additional restrictions on securitisations and off-balance sheet arrangements.
Regulatory outlook: USA
The regulatory outlook is probably most uncertain in the USA given President-elect Obama's views about how the world economy should be managed are as yet unclear, and reports suggest he will not be attending the G20 summit.
Whatever view President-elect Obama and his incoming administration develop, one thing is clear, there is going to be a huge overhaul of the regulatory framework in the United States. One obvious target is the number of regulatory bodies and what entities they regulate. But this all remains a moot point until the intentions of the incoming administration are made clear.
A supra-national regulator for oversight of global financial institutions should be established
The global community seems split over the need for a supranational regulator to be established for the oversight of global financial institutions, with 50 per cent of our global sample disagreeing and 42 per cent agreeing to this need. There are, however, clear regional differences of opinion, with 58 per cent of respondents in Continental Europe agreeing there should be a supranational regulator, and respondents in both the UK (55 per cent) and USA (56 per cent) disagreeing.
Respondents in Asia were split with 44 per cent agreeing and 41 per cent disagreeing.
There should be a restructuring and/or consolidation of domestic regulators
There is overwhelming support for a restructuring and/or consolidation of domestic regulators with 79 per cent of respondents globally agreeing, and no less than 76 per cent agreeing in any region. Half (50 per cent) of the respondents agree there needs to be a fundamental rewrite of Basel II to create a Basel III. This was felt particularly strongly in Continental Europe where 66 per cent of respondents thought this was the case. Respondents from the UK and USA are equally likely to disagree, with almost one in five (19 per cent) failing to see the need for such action.
Roughly half of the global sample (47 per cent) agrees that IMF and World Bank remits should be reviewed and expanded. This need is felt more strongly by Asia respondents (54 per cent). Globally 24 per cent disagree, but a greater proportion (28 per cent) has no opinion. There is a similar split across all regions. There is strong disagreement (74 per cent) around the world that there should be an increase in FX / country exchange controls to limit the flows of capital. The United States has the smallest proportion of respondents who agree with this statement at 5 per cent and the largest proportion who disagree at 83 per cent.
There is broad agreement (66 per cent) globally that there should be increased regulation of hedge funds, although this is felt more strongly in some regions than others. In Asia 73 per cent agree, while in the USA it is only 50 per cent. The USA is the only region that is divided on this issue, with 42 per cent of respondents there disagreeing that increased regulation of hedge funds is required.
There is a strong acceptance of the need for increased regulation, restrictions and disclosure of securitizations and other structured finance products, with 67 per cent of respondents globally agreeing. Sentiment was particularly strong in Continental Europe, with 78 per cent agreeing.
Off-balance sheet treatment of securitisation
Over three quarters (76 per cent) of respondents globally agree that greater regulation of rating agencies is necessary. This is felt most strongly by respondents in Asia (86 per cent), followed by the USA (84 per cent), Continental Europe (79 per cent), and UK (78 per cent).
There is strong agreement (65 per cent) globally that a central counter-party should be established for credit default swaps and improved reporting of exposures, For respondents in Asia this rises to 76 per cent, and 72 per cent of respondents in the USA agree. Once again, there is broad agreement globally (59 per cent) that this should apply. Those responding from Continental Europe are more likely to agree (72 per cent). Opinion is most closely split amongst USA respondents, where 53 per cent agree, but one-third (33 per cent) disagree and 13 per cent have no opinion.
Quantitative restrictions on bonuses and remuneration structures
Roughly one-quarter (27 per cent) of respondents globally agree and over half (57 per cent) disagree. Opinion is more polarised in some regions than others on this undeniably hot topic. Respondents in Asia (42 per cent disagree, 40 per cent agree) and Continental Europe (48 per cent disagree, 40 per cent agree) are fairly evenly split. Next follows the USA where 55 per cent disagree and 33 per cent agree. The UK feels most strongly about this issue with nearly three-quarters of respondents (73 per cent) disagreeing with restrictions on bonuses and remuneration and only 19 per cent agreeing.
There is strong disagreement that short-selling and other speculative trading activities should be prohibited. Over two-thirds (67 per cent) disagree globally, ranging from 62 per cent disagreement in Continental Europe to 84 per cent disagreement in the USA.
There appears to be some consensus (61 per cent globally) that a global convention dealing with cross-border insolvency should be established. While 70 per cent of respondents from Asia agree with such a convention this drops to 58 per cent from respondents in the USA.
A simplified bankruptcy regime in relation to insolvent states should be introduced
The findings for this statement are less conclusive. While only 9 per cent of respondents globally disagree with the statement, a reasonable number of respondents (30 per cent) have no opinion. However, over half the respondents (54 per cent) agree with the need for a simplified bankruptcy regime in relation to insolvent states. This rises to over two-thirds (69 per cent) in Asia compared to 39 per cent in the USA.
Ring-fencing of national assets
Over half (55 per cent) of respondents globally agree ring-fencing should be prohibited, rising to 64 per cent of respondents in agreement from Continental Europe and 63 per cent from the UK. Interestingly almost one-third (30 per cent) of respondents from the USA disagree, compared to 48 per cent who agree and 22 per cent who have no opinion. There is a mixed response to increasing the protection conferred by depositor compensation schemes. Although half (51 per cent) of global respondents agree, rising to 60 per cent for respondents in Asia, there is no majority view from respondents in the USA, with 38 per cent agreeing, 23 per cent disagreeing and the highest proportion (39 per cent) having no opinion.
Regulators should introduce more debtor friendly bankruptcy policies
Globally there is no clear majority view, with 32 per cent agreeing, 33 per cent disagreeing and 28 per cent holding no opinion on regulators introducing more debtor friendly bankruptcy policies. Respondents from the USA are most likely to disagree (53 per cent) with the introduction of such policies while respondents from Continental Europe are most likely to agree (44 per cent).
Half the sample (51 per cent) does not believe that authorities should be able to override set-off, netting and collateral provisions to deal with failing banks. However, respondents from the UK and the USA are far more likely to disagree than the rest of the sample with 59 per cent and 67 per cent opposed respectively.
Globally, over half (51 per cent) disagree with allowing failing banks to bypass shareholder consent in order to raise new capital. This was fairly consistent across Asia (51 per cent) and the UK (55 per cent) but rose to 63 per cent among USA respondents. Respondents from Continental Europe are fairly evenly split on the issue, with 45 per cent disagreeing and 40 per cent agreeing.
Half (50 per cent) of respondents globally disagree with abolishing mark-to-market accounting, rising to 63 per cent disagreeing among respondents from the USA. Respondents from Continental Europe are split in their views, with 31 per cent agreeing, 47 per cent disagreeing and 21 per cent having no opinion.
A global quantitative standard for liquidity regulation should be established
A majority (60 per cent) of global respondents agree that there should be a global quantitative standard for liquidity regulation. This hit a high of 78 per cent among respondents in Asia and 63 per cent among respondents from Continental Europe, but drops down to 53 per cent among USA respondents.
While globally there is an even split with 37 per cent agreeing and 45 per cent disagreeing that there should be more political oversight of banking lending practices, Asia is the only region where a majority (53 per cent) of respondents agree. In all other regions the majority of respondents disagree – Continental Europe (51 per cent), USA (52 per cent), rising to 56 per cent disagreeing in the UK.