According to a recent study, diverging regulatory frameworks across the world are costing financial institutions $780bn a year – and the bad news is this could get worse. By Justin Pugsley.
What is happening?
The International Federation of Accountants and Business at the Organisation for Economic Co-operation and Development have published a report called ‘Regulatory divergence: costs, risks, impacts’, which revealed that regulatory divergence across jurisdictions costs financial institutions about 5% to 10% of their annual turnover, or $780bn a year in total.
To give that some context, the amount of fines levied on banks in the decade to 2017 totalled about $350bn, while the capital shortfall as a result of finalising Basel III in December 2017 is estimated by the Basel Committee on Banking Supervision to be €90.7bn.
The report says much of this comes down to the way regulatory reforms have been implemented since the 2007-09 global financial crisis. Among the most costly areas of regulatory divergence are competition law, market regulation, consumer protection rules and corporate governance. The most heavily impacted sector is capital markets, followed by bank deposit taking.
Why is it happening?
Regulatory fragmentation has come about because of a focus on national priorities and also because there are many more rules to implement, some of which are very complex and detailed. National interpretations merely exacerbate those complications.
Meanwhile, the US is aggressively pursuing an economic growth agenda and wants to deregulate as far as its political structures will allow. The EU wants to free up capital for households and small businesses but still distrusts capital markets, so tends to veer towards stricter regulation. Then there is Brexit, which could see the UK diverge from EU norms – besides which, the EU seems minded to erect some barriers between the two jurisdictions once the separation is complete, if indeed it ever happens.
What do the bankers say?
Global bankers are understandably worried about different jurisdictions making their own often-nationalist interpretations of global rules. This also leads to a balkanisation of capital, which lowers its mobility and returns.
Meanwhile, some jurisdictions are inventing their own rules. The UK, for example, came up with the Senior Managers and Certification Regime (SM&CR), which does not derive from global or EU norms. Some global banks with UK operations have implemented SM&CR across their entire operations, for the sake of consistency, which has come at a cost.
It is estimated that there are some 200 amendments or new rules made in the financial sector every day that global banks need to stay on top of.
Another area that concerns bankers is that every jurisdiction seems to want its rules to have an extraterritorial dimension. The US is notorious for this with any dollar-related business, but the EU is fast catching up and it may not be long before others want their supervisors to reach beyond their national borders. Banks often respond to these challenges by implementing the strictest rules across their operations so they do not fall foul of any rules.
Two other issues are regulatory uncertainty and, closely allied to that, judgement-based regulation, which is literally rule interpretation by individuals within regulatory bodies. This latter point is particularly unnerving because it can produce unpredictable outcomes for banks and is a move away from a rules-based approach.
This has been seen in the US via the annual stress-testing exercises that regulators have used to impose new requirements via the back door.
Will it provide the incentives?
Some regulatory divergence is inevitable, and arguably even desirable if particular local circumstances apply – few would argue with that. The other factor is that complex regulation partly mirrors an increasingly complex financial system.
However, the scale of regulatory fragmentation is clearly a problem for financial institutions and the global economy, and peak convergence has probably passed. It is from that vantage point that the International Federation of Accountants and Business at the Organisation for Economic Co-operation and Development is calling for international regulatory co-operation to reduce these divergences.
Unfortunately, policy-makers seem unlikely to head the calls. The 2007-09 global financial crisis is an increasingly distant memory, and the global order is itself fragmenting. This is being manifested through Brexit, EU/US ruckuses, the EU’s own internal divisions and the US versus the rest of the world.
But there are a few slivers of hope. National regulators now work across borders more closely than before. There is also an appetite to tidy up post-crisis rules that were rushed. The Financial Stability Board is committed to assessing them, the European Commission does periodic reviews and the US is pursuing a deregulation agenda, but is so far respecting internationally agreed standards for global banks.
When the tectonic plates stop shifting, national regulatory regimes will settle down, and although they will be divergent, hopefully they will at least be fairly static. That will make it far easier for banks to manage their global compliance.
