Benefits and unintended consequences of financial markets reform

Sponsored by:

Benefits

and

unintended

consequences

of financial

markets

reforminsights

from an

executive

survey

© The Economist Intelligence Unit Limited 2012

Benefits and unintended consequences of financial markets reform

1

Executive summary 2

Introduction 4

Regulation on the radar 6

1 Regulatory pros and cons 9

2 Overall expectations of regulatory impact vary 11

OTC derivatives overhauled 17

3 Corporate responses 19

4 The bottom line 21

5 Potential consequences 23

Appendix: survey results 24

Contents

1

2

3

4

5

6

7



2

In response to the 2008 financial crisis and the world recession that followed, central bankers, regulators and governments have drafted numerous regulatory reforms and measures designed to minimise risk and maximise consumer protection in the global financial system.

In order to investigate the potential impact of these new regulations on businesses, the Economist Intelligence Unit, on behalf of Lloyds Bank Wholesale Banking & Markets, surveyed over 450 senior executives from different companies and also conducted interviews with experts.

Key findings include:

Companies are aware of and worried about regulatory changes—but are not prepared One-half of respondents cite regulation as one of their main concerns, alongside the global economic crisis (58%) and the euro zone crisis (54%)—far ahead of other issues such as availability of finance. More than three-quarters (77%) of respondents believe that their boards are aware of the impact of changes in regulation on their company, but only 61% feel prepared.

Executive summary

In June and July 2012 the Economist Intelligence Unit, on behalf of Lloyds Bank Wholesale Banking & Markets, surveyed 454 senior executives in order to explore what companies think about the current regulatory landscape as well as how these firms are planning ahead to handle the impact of future regulation.

Respondents were drawn from Europe (60%), Asia-Pacific (20%) and North America (20%), and were divided into financial services (44%) and non-financial services companies (56%).

In addition, in-depth interviews were

conducted with three experts from leading financial companies. Our thanks are due to the following for their time and insight (listed alphabetically):

Jessica Ground, UK bank analyst at Schroders Ricky Maloney, head of treasury processing

at Ignis Asset ManagementMark Stancombe, head of client management

at Insight InvestmentThe report was written by Faith Glasgow and

edited by Monica Woodley of the Economist Intelligence Unit.

About this report



3

There is concern that new regulation will hinder growth and innovationMore than one-half (51%) are concerned that planned financial regulation will impact on growth in their industry, while 44% expect it to affect innovation. UK and US companies are somewhat more anxious (54 and 53% respectively) about the negative impact of the new regulations than either European or Asia-Pacific companies (46 and 48% respectively).

Companies expect a significant impact on profitability Overall, two-thirds (68%) of respondents anticipate a significant or fundamental impact on the profitability of their financing and risk-management models, although some regulations cause notably more concern than others. Almost three-fifths (58%) expect at least significant effects as a result of Basel III, compared with only 35% as a consequence of the Vickers Report.

The cost of compliance is the greatest worry Almost three-fifths (59%) of respondents see the increased costs of complying with the new regulations as the biggest threat, but the rising costs of obtaining funding (39%) and implementing information technology systems (25%) are also concerns.

Companies are contemplating a range of responses The most popular plan, selected by 42% of respondents, is to change their company’s corporate finance or risk-management model. But significant numbers are also thinking of relocating or changing their legal structure (26%), looking for alternative funding (27%), reducing their use of derivatives (25%) or seeking alternative service providers (24%).



4

Introduction

As a result of the 2008 financial crisis and consequent world recession, central bankers, regulators and governments have drafted a raft of new regulations to better protect and stabilise the global financial system.

The reforms have several broad aims, but include (among others) measures to boost surveillance, raise bank capital adequacy standards, reduce risk in over-the-counter (OTC) derivative activity and remove opportunities for regulatory arbitrage among non-bank lenders (known as “shadow banking”).

Some of the reforms, such as Basel III and the

International Financial Reporting Standards (IFRS), will be implemented globally. Others are regional directives; thus, the Markets in Financial Instruments Directive II (MiFID II), the European Market Infrastructure Regulation (EMIR) and Solvency II affect the EU, while the US financial landscape will be reshaped by the Dodd-Frank reforms and the Foreign Account Tax Compliance Act (FATCA). Then there are national reforms; for example, the UK is introducing its own regulatory banking requirements as a result of the Vickers Report. (See box below for a brief explanation of each regulation.)

Basel III: global agreement on bank capital adequacy and market liquidity risk

IFRS: creating a single set of enforceable and globally accepted international financial reporting standards

MiFID II: far-reaching legislation designed to modernise, make more transparent and harmonise the EU securities markets; it is likely to affect everyone involved in the EU industry

EMIR: an EU directive providing for a harmonised regulatory framework for OTC derivatives

Solvency II: EU directive requiring greater capitalisation for insurance companies, which is expected to push them towards more risk-averse investment strategies

Dodd-Frank: wide-ranging US reforms, including bank and insurance company capital requirements but also regulation of hedge funds

FATCA: US legislation requiring US taxpayers to report to the Internal Revenue System (IRS) specific foreign financial assets over a certain threshold. It also requires foreign financial institutions to report similar information to the IRS on companies operating in the US.

Independent Commission on Banking (ICB, known as the Vickers Report): UK banking reform proposals including ring-fencing of personal and SME deposits from wholesale and institutional operations

Financial regulation definitions:



5

Although companies have always had to take into account the changing requirements of the regulators, both the pace and the scale of these overhauls is unprecedented. Moreover, they have major implications for non-financial as well as financial corporations. For example, the cost of borrowing will rise as banks’ lending spreads to customers are pushed up by the banks’ obligation to provide greater capital adequacy. In addition, the introduction of reporting obligations and central clearing for OTC derivatives will increase

transactional costs for both financial and non-financial firms that use derivatives to hedge their costs or for other purposes.

This report examines the views on new regulations of financial and non-financial companies around the world, including how important these firms think regulatory reform is in the current global economic climate, in addition to how prepared they are for those changes that will affect them directly and others that may have an indirect impact on their bottom line.



6

It is clear that the regulatory overhaul is a major source of uncertainty for companies worldwide. When asked to identify up to three macro issues currently giving their business most cause for concern, one-half of them cite regulatory changes, with only the global economy (58%) and the euro zone crisis (54%) scoring higher.

Responses vary regionally, however. European companies are primarily focused on regional problems and are less troubled by the impact of regulation (only 41% cite it)—perhaps also because they are already well used to a steady stream of EU directives. By contrast, regulatory change is the single biggest headache for North

American corporates, with 61% identifying it as a concern.

As might be expected, there are also clear differences in perspective between financial services (FS) companies and non-financials. Only 36% of non-FS respondents see regulation as a major issue. For them, sales-driven considerations such as lack of consumer demand (30%) is well over twice as significant as it is for financials (12%).

By contrast, regulatory change tops the list of worries for FS respondents, cited by over two-thirds (68%).

Regulation on the radar1

QChart 1

FS Non FS

What do you see as the biggest issues facing your company today?(% of respondents, by sector)

Category 1 Category 2 Category 3 Category 4 Category 5 Category 6

Source: Economist Intelligence Unit survey, July 2012.

Lack of industrial/economic growth/investment

Eurozone crisis

Lack of confidence

Availability of finance

Regulatory changes

Lack of (consumer) demand

Global economic uncertainty

23 26

62 47

24 27

15 25

68 36

12 31

58 58



7

Ricky Maloney, head of treasury processing at the UK-based Ignis Asset Management, foresees “severe difficulties” in regard to the OTC derivatives market changes, in the current economic climate. “Governments and regulators have contradictory strategic goals, in that they are removing liquidity from the markets by way of increased margin and capital requirements, while at the same time trying to stimulate economic growth,” he notes.

At the corporate level, there seems to be reasonable confidence that senior directors at least

understand the implications of the regulations: more than three-quarters (77%) of respondents say that their board of directors is up to speed with the impact of the new regulations on their company. But that does not necessarily translate into confidence that they are actually taking action, with only 61% believing that most or all of the necessary preparations have been made, and almost one in ten (8%) of respondents perceiving their company as unprepared.

Q

North America Mainland Europe UK Asia-Pacific

What do you see as the most important issues facing your company today?% of respondents, by region





Regulatory changes


Lack of confidence

Eurozone crisis


Other

55 55 56 66

27 24 21 19

61 41 53 48

21 26 19 17

23 27 27 26

44 57 60 48

27 21 25 27

3 3 31

QChart 2

QStrongly/somewhat agree Neutral Somewhat/strongly disagree

My company is prepared for the impact of planned financial regulations.

Our board is aware of how planned financial regulations will impact our company.

Do you agree or disagree with the following statements? (% respondents)



61 31 8

77 18 6

QChart 3



8

Although companies have little choice but to take some kind of action in response to the changes, most—and especially FS companies—have serious misgivings about the wider impact on economic growth and innovation. One in two companies (51%) overall, and 64% of FS respondents, expect growth in their industry to be inhibited as a result of reduced market liquidity and increased trading costs.

Again, there is some regional differentiation, with European firms notably less fretful than those based in other areas about the impact of regulations on growth—again perhaps reflecting the fact that regulatory issues are to some extent eclipsed by the fragility of the euro zone economy and the need for far-reaching political and economic solutions.

It is also rather more worrisome for UK and US companies than for those based in Europe or Asia: 54% of UK firms are downbeat about prospects for growth, compared with 46% of European firms. Jessica Ground, UK bank analyst at the London-headquartered Schroders, makes the point that unilateral regulation is a real worry for the City.

“For global markets such as financial services, human capital is very transferable. The system did need substantial reform but with international consensus; the danger is of jurisdictions acting independently of each other and capital just moving away.” She points to the UK’s unilateral plans for bank ring-fencing and France’s proposed transaction tax as examples of regulation that could leave countries seriously vulnerable to lost business.

QQChart 4

Strongly/somewhat agree Neutral Somewhat/strongly disagree

Asia-Pacific

UK

Mainland Europe

North America

Do you agree or disagree with the following statement?“I worry that planned financial regulations will inhibit growth in my industry”(% respondents, by region)



48 36 16

54 33 13

46 26 28

53 33 15



9

Only 5% of respondents see no threat to their company as a result of the new regulatory regime; most are troubled by the various costs of implementation. The biggest issue by far is the impact of increased compliance costs, which concerns 59% of respondents overall and more than 70% of large companies with annual revenue of more than US$10bn (see chart 4). However, rising funding costs (39%) and information technology

(IT) costs (25%) are also concerns. FS companies are even more focused on compliance costs (see chart 5).

“The FS industry is underestimating the long-term costs of compliance—there will be problems down the line with the amount of work for compliance departments and the extent of reporting involved,” comments Schroders’s Ms Ground. “The trouble is that additional regulation is

Regulatory pros and cons2

Q

Between $500m and $1bn Between $1bn and $10bn More than $10bn

What are the biggest potential threats to your company from planned financial regulations?(% of respondents, by company size in USD revenue)



Increased costof funding

Increased costof compliance

Increased costof hedging risk

Increased IT costs

Difficulty in securing bankingproducts or services we need

Restrictions on wherewe can operate

I don’t see anypotential threats

Don’t know

39 37 39

70 57 52

17 16 16

23 29 23

12 12 13

10 22 26

6 5 4

1 21

QChart 5



10

absorbing firms’ profits, yet they don’t feel they’re getting better regulation because the regulators’ focus has been on volume rather than quality.”

Almost one-quarter of companies based in North America (24%) and Asia-Pacific (24%) are also anxious that the regulatory changes will restrict their freedom to operate in other jurisdictions.

When asked about the likely positive consequences of the changes, most respondents see some sign of a silver lining to the regulatory cloud hanging over them. At the top of the list of

potential benefits are improved transparency with regards to risk (42%) and greater stability for financial markets (41%), with a further 30% also looking forward to greater pricing transparency and reduced counterparty risk (for differences between FS and non-FS respondents, see chart 6).

But there is less consensus among respondents over the potential downsides to the new regime; indeed, 13% take a somewhat sceptical view, claiming that they do not envisage any benefits for their company at all.

QQChart 6

FS Non FS

What are the biggest potential threats to your company from planned financial regulations?(% of respondents, by sector)



Increased costof funding

Increased costof compliance

Increased costof hedging risk

Increased IT costs

Difficulty in securing banking products or services we need

Restrictions on wherewe can operate

I don’t see anypotential threats

Don’t know

37 40

74 48

12 20

29 22

9 16

20 19

3 7

1 2

QFS Non FS

What are the biggest potential benefits to your company from planned financial regulations?(% of respondents, by sector)



Reduced counter-party/credit risk

Better transparencyof risk

Increased market(pricing) transparency

More stable financial markets

I don’t see any benefits

Don’t know

33 27

42 41

30 31

38 43

14 11

1 3

QChart 7



11

Most respondents (68%) are bracing themselves for significant or even game-changing effects on their financial and risk-management strategies as a consequence of the new regulatory landscape, with UK companies expecting to be hardest hit (76%).

Unsurprisingly, FS companies are also predicting a higher impact than their non-FS counterparts. FS respondents are particularly worried about the regulations (such as Basel III, MiFID II and Solvency II) that are likely to make their investment business more complex or restrict their ability to issue corporate debt, as well as

those affecting the derivatives market. For non-FS firms, the survey suggests that the rising cost of borrowing from banks is the biggest problem, although they are less concerned than FS companies about this issue.

However, the FS interviewees point out that what affects their clients ultimately affects them as well.

“The big thing for us will be MiFID, though there will also be some fallout from Dodd-Frank,” according to Ms Ground at Schroders. She adds, however: “Basel III and banks’ increased capital adequacy requirements will also impact on our

Overall expectations of regulatory impact vary3

Q


Please assess the compound impact of all regulatory change(% of respondents, by region)



Low impact (impacts profit of ourfinancing and risk management model)

Medium impact (Significantly impacts profit of our financing and risk management model)

High impact (Fundamentally challenges viability of our financing and risk management model)

Don’t know

Not applicable

18 19 24 11

46 42 41 39

22 34 21 30

7 3 9 15

8 2 5 6

QChart 8



12

Overall, three-fifths (58%) expect a significant or fundamental impact on their finance and risk-management models from the Basel III banking reforms. Financials (69%) are expecting markedly more fallout than non-financials (50%), despite the fact that widening bank lending spreads are set to push up the latter’s borrowing costs. Indeed, Basel III is the single piece of regulation expected by FS respondents to have the greatest impact on their business.

QQChart 9

FS Non FS

Please assess the compound impact of all regulatory change(% of respondents, by sector)



7 29

38 44

46 12

5 10

4 6




Don’t know

Not applicable

clients, and therefore our business.”EMIR is the biggest headache for Mark

Stancombe, head of client management at Insight Investment of the UK. “It has the potential to have a very large detrimental effect on our underlying pension fund clients’ ability to mange the risks associated with funding their pension obligations,

and indeed on European pension and insurance funds generally,” he explains.

It is unsurprising that concerns over specific regulations vary with significant differences in the primary areas of concern for FS and for non-FS corporates. The differences for each regulation are detailed in the boxes below.

Basel IIIGlobal agreement on bank capital adequacy and market liquidity risk

QFS Non FS

Please assess the impact of Basel III on your company(% of respondents, by sector)



20 30

29 39

40 11

1 10

10 10




Don’t know

Not applicable

QChart 10



13

Unsurprisingly, North American respondents expect to be most significantly affected (36% of US companies expect a fundamental impact, while a further 32% predict a significant impact, compared with 14% and 30% overall). By contrast, around one-fifth of European (23%), Asian (20%) and UK (18%) companies do not see Dodd-Frank as relevant to them.

Dodd-FrankWide-ranging US reforms, including bank and insurance company capital requirements, as well as regulation of hedge funds, among other issues

Q


Please assess the impact of Dodd-Frank on your company(% of respondents, by region)






Don’t know

Not applicable

QChart 11

27 26 33 15

30 36 23 36

12 13 5 32

10 7 17 11

20 18 23 7



14

Just 38% of respondents overall expect to be significantly or fundamentally affected by the new regulations. Surprisingly, that number falls to 35% for European firms—although it rises to 43% for UK businesses. Non-financials (45%) anticipate more fallout than financials (32%).

QFS Non FS

Please assess the impact of EMIR on your company(% of respondents, by sector)



26 33

28 25

17 7

15 17

14 18




Don’t know

Not applicable

QChart 12

Again, despite the fact that this is EU legislation, it appears to be of much greater concern to UK businesses across the board. Over three-fifths (63%) of UK respondents anticipate significant or fundamental fallout from the reforms, compared with only 44% of European firms. This may reflect the fact that the insurance industry in Europe is skewed towards small mutual specialists serving a local community, which may not even be large enough to qualify for Solvency II, rather than the major one-stop-shop insurers that dominate the UK market.

Solvency IIEU directive requiring greater capitalisation for insurance companies, which is expected to push them towards more risk-averse investment strategies

QFS Non FS

Please assess the impact of Solvency II on your company (% of respondents, by sector)



QChart 13

18 29

29 34

31 7

10 15

12 15




Don’t know

Not applicable

EMIR (European Market Infrastructure Regulation)An EU directive providing for a harmonised regulatory framework for OTC derivatives trading



15

Just under one-half (47%) of respondents foresee a significant or greater impact; once again, Europe is fairly in line with the rest of the world, while in contrast UK respondents (58%) are expecting to feel much more heat from the reforms. Comparing FS and non-FS responses, more than four times the proportion of FS firms see the regulation as likely to have a fundamental impact on their business (23%, compared with just 5% for non-FS companies).

However, 15% of respondents overall (including a worrying 13% of FS firms) have no idea how the impending MiFID II regulations will affect their business.

MiFID IIFar-reaching legislation designed to modernise, make more transparent and harmonise the EU securities markets; it is likely to affect any firm involved in the EU industry

QFS Non FS

Please assess the impact of MiFID II on your company(% of respondents, by sector)



18 28

37 32

23 5

13 18

10 17




Don’t know

Not applicable

QChart 14



16

Across the board, 35% of companies (rising to 43% among UK respondents) anticipate significant implications as a result of the ICB recommendations, which are due to become law in 2015. But again there is widespread uncertainty among firms. One-third of respondents in both the US and Europe do not know whether they will be affected. Q


Please assess the impact of the Vickers Report on your company(% of respondents, by region)






Don’t know

Not applicable

28 34 25 16

30 27 21 25

7 17 4 13

14 7 32 32

22 16 18 15

QChart 15

ICB (Vickers Report)UK banking-reform proposals including ring-fencing of personal and SME deposits from wholesale and institutional operations



17

OTC derivatives overhauled4Looking specifically at the potential impact of the EMIR and Dodd-Frank regulations governing OTC derivatives trading, one clear conclusion from the survey is that companies do not fully understand how the new regime will affect them. That problem is echoed by Ms Ground at Schroders, who observes: “Companies don’t have a good grip on what’s involved, beyond the headlines.”

Thus, less than one-half (47%) of respondents consider themselves reasonably au fait with the impact of the new rules, although the biggest corporates (with annual revenue of US$10bn or more) are more up to speed, with 55% stating that they understand the impact of the new rules. Interestingly, the smallest category of firms surveyed ($500m-1bn in annual revenue) is close behind them at 53%—it is the medium-sized businesses that seem to be lagging most.

However, many companies are clearly taking measures to get a better grasp on the likely

implications. Around 44% of respondents are taking advice from external institutions such as banks or clearing houses as to how their business will be affected, while some, including Ignis Asset Management, are going further and recruiting expert staff to deal with the changes.

Overall, there is little difference between financials and non-financials in terms of understanding. But those top-line figures mask disparities between different subgroups. For example, asset managers are likely to be well aware of the implications for their institutional clients.

Insight Investment, for example, uses interest rate and inflation derivatives markets to manage the solvency risk of its pension fund clients, enabling them to reduce the volatility and protect the solvency of their pension schemes. “The centralised clearing proposals, combined with the current market-standard clearing mechanisms, would significantly raise the long-term cost of

QQChart 16


Do you agree or disagree with the following statement? “We understand what will be required of our company under Dodd-Frank/EMIR”(% of respondents, by company size in USD revenue)



Strongly/somewhatagree

Neutral

Somewhat/stronglydisagree

55 37 53

30 36 21

15 27 26



18

providing pension benefits,” Insight’s Mr Stancombe warns.

There is some disagreement as to how far the OTC derivatives market reforms will make it more costly or difficult to hedge risk. Almost one-half (48%) of respondents think that there will be some negative impact. North American respondents are most pessimistic: almost two-thirds (63%) believe that their ability to hedge will suffer as a consequence of the Dodd-Frank reforms.

Against that, almost one-fifth (18%) of those surveyed think that there will be little impact on costs or access to the market, with smaller companies (23%) feeling markedly more positive than businesses of US$15bn or more in revenue (12%).

Although there is significant unhappiness about

the Dodd-Frank and EMIR proposals, just under one-third (30%) of respondents (or 42% of North American firms) are campaigning or consulting with politicians, trade bodies or regulators to try and get the regulations modified. Interestingly, 36% are not interested in further change.

One particular concern is the difficulty of extending the reach of these derivatives reforms beyond their home jurisdiction, such as to overseas offices of domestic companies. “Extra-territoriality or crossborder application of Dodd-Frank and EMIR is a real sticking point and regulators on both sides of the Atlantic have really struggled to come up with an appropriate framework thus far,” comments Mr Maloney from Ignis Asset Management.

QQChart 17

Do you agree or disagree with the following statement?“We have assessed the regulatory impact and this will makes it more expensive and/or difficult to hedge risk.”(% of respondents, by region)




Neutral



37 45 41 63

44 38 34 28

20 17 25 9

QQChart 18

Do you agree or disagree with the following statement?“We are consulting politicians/regulators/trade bodies (either nationally and/or EU) for changes to Dodd-Frank/EMIR”(% of respondents)




Neutral



30

34

36



19

Corporate responses 5What kind of action are companies taking, or considering, in response to the regulatory changes? The most popular option by some way is to adapt their existing finance or risk-management

strategy to the requirements of the new regime. Over two-fifths (42%) of respondents intend to make such changes. However, a number of alternatives have significant support, including

QQChart 19

Are you actively considering or progressing with any of the following to mitigate the impact of upcoming financial services regulation?(% of respondents, by region)



Changing/ reducing use of derivatives

Centrally clearing derivatives

Changing my financing and/or risk management model

Becoming part of a co-operative bank with other corporates

Seeking funding from different providers

Changing service providers

Re-locating or changing the legal/ regulatory structure of my organisation

None of the above


34 29 17 24 13 21 23 20

40 39 43 44

8 10 7 12

22 29 24 30

26 33 12 27

17 33 20 33

26 20 29 19



20

finding other sources of funding (27%), physically relocating (26%), reducing the use of derivatives (25%) and changing service providers (24%).

Interestingly, European companies seem reluctant to consider any of these alternatives, particularly a switch of service providers (12%) and changes to the way they use derivatives (17%). Almost three in ten (29%) of European respondents claim that they would take “none of the above” measures. By contrast, both UK and US firms appear much more prepared to vote with their feet: one-third of British companies are ready to switch to new service providers, while physical relocation and switching funding are also high on the list for both countries.

Looking at the difference between FS and non-FS companies, it seems that financials are

considerably more willing than their non-FS counterparts to reduce the use of derivatives (30% versus 21%); indeed, this is the second most popular option among FS respondents. Similarly, FS firms are more prepared to make use of centralised derivatives clearing: 26% of financials said that they have taken or are considering this option, compared with 15% of non-financials.

However, notes Mr Maloney at Ignis Asset Management, regulation is likely to stimulate innovation in financial products. “It is widely expected that the market in general will move away from such heavy OTC use…We expect to see new products entering the market which, while having the same risk-management characteristics as clearable swaps, are neither clearing eligible nor subject to higher capital charges.”

QQChart 20

Are you actively considering or progressing with any of the following to mitigate the impact of upcoming financial services regulation?(% of respondents, by sector)










None of the above

30

21

26

15

48

36

8

9

23

30

24

24

28

24

21

26

FS Non FS



21

The bottom line6The survey makes clear that different companies expect to be spending very different amounts on the costs of implementation, although as might be expected there is some correlation between expenditure and company size. Thus, 20% of respondents overall anticipate bills of less than £500,000 (approx. USD$810,000) over the next 12 months as a result of the regulatory changes, but in the smallest category (US$500m-1bn in annual revenue) that proportion rises to 37%.

At the other end of the spectrum, another 20% of respondents, and one-third (31%) of firms worth over US$10bn, expect to spend more than £10m

(approx. USD$16m) to cover the cost of increased financial regulation. It also becomes more difficult to quantify the total anticipated spend for the biggest companies: a further 31% said that they could not put a figure on the likely cost of moving into line with the new regime.

“I have already seen eye-watering sums, running to many millions, spent by the big banks—and over the medium term those figures are likely to become really massive,” says Ms Ground of Schroders.

How will these costs be dealt with? It is hard to escape the conclusion that, in most cases, clients

QQChart 21


Approximately how much will you be spending in the next 12 months to cover the cost of increasing financial regulation (e.g IT, people, loss of sales, management time)?(% of respondents, by company size in USD revenue)



£0 to 0.5m

£0.5 to 1m

£1m to 5m

£5m to 10m

£10m+

Cannot quantify

Don’t know

7 16 37

8 15 17

11 16 15

7 9 6

31 6 5

30 29 19

7 9 2



22

will ultimately pick up the tab for increased regulation. Mr Stancombe at Insight Investment says that his company “would not expect to pass on the implementation costs to establish the infrastructure to support the new regulatory requirements,” although he points out that clients will see costs such as transaction charges rise as a consequence of the changes, and these are passed directly on to investment clients.

But for other commentators, all costs are bound to be shouldered by end users. “Either consumers will pay in the end, or firms will stop offering products that involve increased compliance,”

asserts Ms Ground.Looking at the derivatives landscape, Mr

Maloney at Ignis Asset Management suggests that the costs will be so great that a significant shift is likely to occur within the FS industry, as asset managers have to re-evaluate how far the increased costs of hedging using derivatives offset the benefits of the hedge. “One would expect end users to take comfort in having their assets in a well-regulated product—but at what cost? I expect there to be further public discomfort once the true costs of these reforms trickle down into end-user returns,” he adds.



23

Potential consequences7The 2008-09 global financial crisis and subsequent serious failures of the banking system to regulate itself have resulted in general consensus that far-reaching reforms are both necessary and inevitable.

As Ms Ground from Schroders observes: “There has been a culture of excessive risk-taking and poor financial products, and substantial reform had to take place. And a lot of this regulation is good: it means more capital is backing the system, leverage ratios are controlled and there is greater transparency and regulation of counterparty contracts.”

Mr Stancombe at Insight Investment agrees that the fundamental principles underpinning derivatives market reform are laudable. “Increased market transparency to regulators and systemic risk reduction have the potential to deliver greater security for market participants and wider stakeholders,” he notes.

But there is widespread concern over authorities’ swift moves to regulate in many areas at once. Says Ms Ground: “They have tightened all the regulations at once, without a clear understanding of the unintended consequences and costs.”

One of those unintended consequences may be that asset managers decide that it is no longer financially viable to use derivatives to hedge risk. “The underlying risk will clearly continue to exist, but will be borne by a group of people less equipped to manage it,” Mr Stancombe warns.

Even if that does not happen, adds Ignis Asset Management’s Mr Maloney, “the market consensus is that performance returns will be compromised as a result of the tremendous additional costs

involved.” Moreover, there is a further risk that the derivatives market will become concentrated within a handful of the biggest clearing houses. “If a major crisis occurs and banks begin to fail again, how will this huge concentration of risk be managed without systemic impact?”

Two-thirds (68%) of those surveyed anticipate a significant or fundamental impact on the profitability of their financing and risk-management models, while more than one-half (51%) of respondents are concerned that planned financial regulation will impact on growth in their industry and 44% expect it to affect innovation.

That effect could be made worse for some countries if there is not sufficient regulatory collaboration and consensus between jurisdictions—in the face of regulatory threats, capital may well migrate to other relatively “light-touch” jurisdictions. As the survey shows, that is clearly an option being considered by both financial and non-financial companies of all sizes. It is particularly attractive to the biggest corporates, one-third of which would seriously consider relocating.

In short, it is very difficult to say whether the benefits of the forthcoming regulatory overhauls will outweigh the negatives, as we have not been here before. The regulators are keen to close the many loopholes and skewed systems that led to previous systemic failures—but neither they nor anyone else can anticipate what the full consequences of the new regulatory regime will be in terms of its impact on companies and economies.



24

Appendix: survey results

Percentages may not add to 100% owing to rounding or the ability of respondents to choose multiple responses.


Eurozone crisis

Regulatory changes

Lack of confidence




Other

What do you see as the most important issues facing your company today? Select up to three(% respondents)

58

54

50

25

24

23

20

3

1 Strongly agree

2 3 4 5 Strongly disagree

Our board is aware of how planned financial regulations will impact our company.

My company is prepared for the impact of planned financial regulations.

I worry that planned financial regulations will inhibit growth in my industry.

I worry that planned financial regulations will inhibit innovation in my industry.

Do you agree or disagree with the following statements? Rate on a scale of 1 to 5 where 1 is strongly agree and 5 is strongly disagree (% respondents)


33 43 18 5 0

18 43 31 7 1

21 30 30 14 4

17 27 31 19 5



25

Better transparency of risk

More stable financial markets

Increased market (pricing) transparency

Reduced counter-party/credit risk

I don’t see any benefits

Don’t know

What are the biggest potential benefits to your company from planned financial regulations? Select up to two (% respondents)

42

41

30

29

13

2

Increased cost of compliance

Increased cost of funding

Increased IT costs

Restrictions on where we can operate

Increased cost of hedging risk

Difficulty in securing banking products or services we need

I don’t see any potential threats

Don’t know

What are the biggest potential threats to your company from planned financial regulations? Select up to two (% respondents)

59

38

25

19

16

13

5

1

Low impact (impacts profit of our financing and risk management model)



Don’t know Not applicable

Basel III

Dodd-Frank (OTC)

EMIR (OTC)

MIFID II

Solvency II

Vickers Report (ICB)

Compound Impact of all Regulatory Change

Please assess the impact of the below regulations on your company. (% respondents)

26 35 24 6 10

26 30 14 11 18

30 27 11 16 16

24 34 13 15 14

24 32 18 13 14

27 25 10 20 18

19 41 27 8 5



26

1Strongly agree

2 3 4 5 Strongly disagree

We understand what will be required of our company under Dodd-Frank/EMIR.

We are speaking with appropriate institutions (e.g service providers, banks and clearing houses) to assess the impact of Dodd-Frank/EMIR on our company.

We have assessed the regulatory impact and this will makes it more expensive and/or difficult to hedge risk.

We are consulting politicians/regulators/trade bodies (either nationally and/or EU) for changes to Dodd-Frank/EMIR.

Do you agree or disagree with the following statements on the regulatory impact on the use of derivatives? Rate on a scale of 1 to 5 where 1 is strongly agree and 5 is strongly disagree (% respondents)

12 35 30 16 7

13 31 33 15 8

12 35 35 11 7

12 18 34 20 16








None of the above

Are you actively considering or progressing with any of the following to mitigate the impact of upcoming financial services regulation? Select all that apply (% respondents)

42

27

26

25

24

20

9

24

Less available No change More available Don’t know

Risk Management

Funding Solutions

Cash Management

Trade Finance

How has the the availability of the following services changed since the introduction of new financial regulations post-financial crisis? (% respondents)

15 38 42 5

42 39 12 7

22 51 18 9

27 46 12 15

More expensive No change Less expensive Don’t know

Risk Management

Funding Solutions

Cash Management

Trade Finance

How has the shift in pricing (and therefore attractiveness) of the following services changed since the introduction of new financial regulations post-financial crisis? (% respondents)

56 30 4 10

58 29 4 9

38 45 5 12

36 39 6 18



27

£0 to .5m

£0.5m to 1m

£1m to 5m

£5m to 10m

£10m+

Cannot quantify

Don’t know

Approximately how much will you be spending in the next 12 months to cover the cost of increasing financial regulation (e.g IT, people, loss of sales, management time)? (% respondents)

20

13

14

7

13

26

6

Western Europe

Asia-Pacific

North America

Eastern Europe

Latin America

Middle East and Africa

In which region are you personally located?(% respondents)

54

20

20

6

0

0

0

32

27

10

5

25

Less than $500m

Between $500m and $1bn

Between $1bn and $5bn



More than $15bn

What are your company’s annual global revenues in US dollars?(% respondents)

Board member

CEO/President/Managing director

CFO/Treasurer/Comptroller

CIO/Technology director

Other C-level executive

SVP/VP/Director

Head of Business Unit

Head of Department

Manager

Other

What is your job title?(% respondents)

3

9

18

2

13

24

6

9

14

2



28

United Kingdom

United States of America

India

Canada

Australia

Netherlands

Switzerland

France

Singapore

Germany

Italy

Austria

Belgium

China

Spain

Poland

Denmark

Finland

Hong Kong

Ireland

Sweden

Turkey

Indonesia

Luxembourg

New Zealand

Russia

Ukraine

In which country are you personally located?(% respondents)

34

16

6

4

3

3

3

2

2

2

2

2

2

2

2

1

1

1

1

1

1

1

1

1

1

1

1

Finance

Strategy and business development

General management

Risk

Marketing and sales

IT

Operations and production

Customer service

Information and research

Supply-chain management

Legal

R&D

Human resources

Procurement

Other

What is your primary job function? (% respondents)

31

14

12

12

7

6

4

2

2

2

2

2

1

1

3



29

Agriculture and agribusiness

Automotive

Chemicals

Construction and real estate

Consumer goods (excluding retail)

Education

Energy and natural resources

Financial services: Bank

Financial services: Insurance company

Financial services: Asset manager

Financial services: Other financial services

Healthcare services

IT and technology

Logistics and distribution

Manufacturing

Media and entertainment

Pharmaceuticals and biotechnology

Professional services

Retail

What is your primary industry? (% respondents)

2

1

2

2

4

1

5

22

8

6

8

2

12

2

7

2

2

9

3



30

Whilst every effort has been taken to verify the accuracy of this

information, neither The Economist Intelligence Unit Ltd. nor the

sponsor of this report can accept any responsibility or liability

for reliance by any person on this white paper or any of the

information, opinions or conclusions set out in the white paper.

Cove

r: S

hutt

erst

ock

London26 Red Lion SquareLondon WC1R 4HQUnited KingdomTel: (44.20) 7576 8000Fax: (44.20) 7576 8476E-mail: [email protected]

New York750 Third Avenue5th FloorNew York, NY 10017United StatesTel: (1.212) 554 0600Fax: (1.212) 586 0248E-mail: [email protected]

Hong Kong6001, Central Plaza18 Harbour RoadWanchai Hong KongTel: (852) 2585 3888Fax: (852) 2802 7638E-mail: [email protected]

GenevaBoulevard des Tranchées 161206 GenevaSwitzerlandTel: (41) 22 566 2470Fax: (41) 22 346 93 47E-mail: [email protected]

Benefits and unintended consequences of financial markets reform

Documents

Transcript of Benefits and unintended consequences of financial markets reform