Natasha de Teran considers Europe’s regulatory landscape, its impact on distribution and why banks have lost faith in the ideal of a single market.
Between the EU Savings Directive, the new International Accounting Standards (IAS), Basel II and the other edicts emanating from national and international regulators, derivatives structurers and markets have had a complex task in recent years. So much so, in fact, that the French have come up with a new word for describing their method of dealing with the issues: structuration.
Even if the moniker is new, SG has had a so-called financial engineering-structuration group in place for about 15 years. The group is headed by Emmanuel Goudouneix and it deals with the mix of legal, tax, regulatory and accounting issues that equity derivatives structurers, distributors and investors increasingly need to address. The 15-strong, Paris-based group is comprised of staff with engineering and legal backgrounds that are charged with constantly researching these ever-changing issues. “We are therefore often able to identify opportunities that others will miss,” asserts Mr Goudouneix.
The group was first formed in 1991 when the vogue for granting stock options meant there was a need to address the best way to structure stock option hedging. For example, the year after the team’s institution, it was able to identify a unique fiscal opportunity in France that saved investors 17% in tax. “Because we had been looking closely at the incoming fiscal changes, we were able to offer the qualifying guaranteed fund products months before our competitors had even worked out what to do,” says Mr Goudouneix.
Insight and support
Mr Goudouneix claims that having such a service and being able to provide clients with the necessary confidence in their investments and structures is an increasingly valuable and integral part of SG’s equity derivatives business. He believes it is no longer sufficient to structure and sell in isolation – banks need to be able to provide insight and support in these areas.
Fundamentally, banks have two options: to hire in legal, fiscal, regulatory and accounting experts from elsewhere in the industry on a project- by-project basis or to build the capabilities in house.
Mr Goudouneix is a strong advocate of the latter route. He believes, for instance, that hiring IAS specialists from the large audit firms to research and advise on these issues is not the best option. Given that the standards are new and changing, there is no reason to suggest that these firms have more expertise on such matters than any other qualified individuals that have been studying the subjects, he believes.
“In fact, in our conversations with many audit practices, we have realised that we have an edge over them because we are more solid with the derivatives-related issues than they are, and we understand the products and structuring better,” he says.
The hidden costs
Besides employing specialist and dedicated staff, there are many hidden costs in running the equity derivatives that arise directly from the lack of harmonisation in Europe. Where US equity derivatives teams are able to sell similar products across the whole of North America without batting an eyelid, in Europe there are endless compliance checks and country-specific adaptations that have to be made. In some cases, products that are permitted by one regulator are banned by another. This is particularly the case in the otherwise lucrative retail market.
“Regulation is certainly a cost. The dream the industry had back in the late-1990s of a single European market with a single regulatory landscape has simply not come true,” says Joachim Willnow, head of equity derivatives at Nomura.
Hassan Houari, head of equity structuring at Barclays Capital, agrees. “If Europe did enjoy a harmonised regulatory landscape, there is no doubt that the costs of business would be far lower and economies of scale more readily achievable. It is heading in the right direction, but more work remains,” he says.
Harmonisation is absolutely key for the industry and it is in the ultimate interest of private investors because it will ensure greater competition, wider choice and cheaper products. One of the key areas on which bankers are pinning their hopes for change is the EU’s Passporting Directive, which has already come into effect but which does not need to be adopted in full until 2007. This will allow prospectuses that have already met the standards of and been approved by the appropriate authority in one EU member state to be used to market the same securities in any other member state without further review by any other authority.
Remy Frank, global head of equity and derivative sales at BNP Paribas, says the passporting directive has helped a bit but some countries are still not using it. “And because it does not yet need to be adopted in full, regulation in Europe remains very localised.”
Beyond passporting
Despite the optimistic view that passporting will make a huge difference, local fiscal differences will remain and may prevent the market from becoming truly uniform. Many argue that there will be more than just tax issues holding the market back from becoming truly harmonised.
“Everyone seems to think that passporting will be the Holy Grail but the level of investor education and tastes in each region and country remain – and are likely to remain – very different,” says Christian Kwek, global head of institutional sales at BNP Paribas. “For very simple products, the directive will make a difference, but for the more structured products, where you are tailor-making solutions, it will not make any real difference.”
Others agree that although Europe is heading towards greater harmonisation, national and regional tastes will never completely merge and banks will need to continue catering to these differences. “In some countries, investors will typically look for specialisation, in other areas they will look for simplicity; in one country they may favour debt exposure, in others they may be more familiar with equities and prefer that,” says Mr Houari.
Mr Willnow concurs, pointing out how technical complexity gets sold far faster in France, Spain and Italy, while northern European investors typically prefer to put more money into simple equity structures. “No matter how the regulation changes, these differences will remain,” he says.
Working with the status quo
How can banks overcome the differences between European countries and achieve economies of scale? Mr Frank says that economies of scale can still be achieved in the middle and back office – and even in the front office – because the traders are the same, whatever the product. On the structuring and sales side, however, he admits that there is less room to manoeuvre.
Wrappers – which are effectively the form of casing or packaging put around structured products – can contribute to helping a bank realise cost savings. “We can offer the same product in a different vehicle in different countries, according to what the regulators permit and the investors require – a product that we might offer in note form in Germany for instance, we might offer in fund or structured deposit form elsewhere,” says Mr Houari.
Other banks are leveraging off the European legislation that is in place, such as UCITS III. “That enables us to sell in several countries simultaneously and to achieve economies of scale,” says Mr Willnow.
Given that full harmonisation is far from a dead cert in the foreseeable future and that the expanding borders of the EU are likely to make the process an even lengthier one than many originally assumed, it is just as well the banks have found some ways around the problems. Before the new rules are fully adopted, they will no doubt have found a few more.
