Dodd-Frank Wall Street Reform and Consumer Protection Act gets a bad report from White House Financial Services Committee members

Dodd-Frank Wall Street Reform and Consumer Protection Act gets a bad report from White House Financial Services Committee members

Transaction bankers across the globe are facing unprecedented levels of regulation, from Basel III to the Single Euro Payments Area, which are potentially affecting the way they do business. The Banker looks at how concerns over this abundance of legislation differs from region to region, and what are banks doing to deal with these demands?

Regulation has been an ever-present part of the banking world since time immemorial. But now, in the wake of a global financial crisis, law makers are heaping demand upon demand, requiring institutions to comply with a mass of legislation that is unprecedented in scope, complexity and sheer scale.

The effects are being felt across the industry, and despite enhancing, rather than sullying, its reputation over the past three years, transaction banking is no exception.

Even pre-crisis, there was hardly a dearth of legislation. Europe in particular saw a number of industry-led regulatory initiatives aimed at standardising processes, and, in some cases, encouraging competition, such as the Single Euro Payments Area (SEPA). Post-2008, these were no longer anyone’s top priority, and deferred time and again, even as a wave of directives designed to reduce the possibility of future economic meltdown loomed. The net result for transaction bankers, is one enormous regulatory headache.

Red tape deluge

Indeed, the volume of regulation facing the industry is in danger of swamping it completely, and now that initial proposals are beginning to crystallise, things are likely to get worse. Just keeping pace with the latest developments can be problematic. "The amount of legislation is challenging. There is a plethora of legislative consultations as well as regulatory proposals at different development stages, and all of these initiatives need to be carefully assessed in terms of their potential impact on different types of clients as well as the overall operation of a service or even a market,” says Ruth Wandhöfer, head of regulatory and market strategy in Europe, the Middle East and Africa (EMEA) for Citi Global Transaction Services. "To keep up to speed you  need to regularly screen the various outputs of the European Commission. It is in danger of becoming unmanageable.”

In the US things are not much better according to Dan Taylor, executive director, global market infrastructure, at JPMorgan. “If there’s one thing the industry doesn’t have a lack of right now it is regulatory issues. Many of these are starting to move from proposal to implementation stage and there’s a shift now to thinking about how to comply.”

He adds that the overlapping nature of this deluge of proposed legislation raises the likelihood of unintended consequences. “When you’re putting that much regulation together all at one time, knowing and understanding how one piece of regulation impacts upon other regulations and lines of business is hard. A piece of legislation may be well directed at a single line of business but it often has a spill over into others. Figuring out all of the bits and pieces is like a very large jigsaw puzzle.”

The SEPA saga

Ask a European transaction banker what is on his or her regulatory radar, and SEPA will still rank highly. Apparent approval from banks, businesses and regulators of its goal to create a single payments zone, open up cross-border competition and make payments easier for consumers, has not translated into decisive action. Indeed, since its inception, SEPA has proven to be a saga of delays, frustrations and painfully slow progress.

This is partly due to the lack of a solid end date, without which there has been little motivation to make the investment required to comply. And in recent years, budget for anything not strictly necessary has been hard to come by. “Banks could see long-term benefits in SEPA, and were very bullish about that at a time when there were fewer questions about discretionary investment and less true regulatory change soaking up investment.” says Peter Jameson, head of financial institutions, product management, for EMEA global transaction services (GTS) with Bank of America. “Post-crisis, adoption, which would have been a key driver to success, didn’t happen, because people didn’t want to spend money on something which wasn’t absolutely essential.”

Nevertheless the general consensus is that SEPA will be finalised by the end of 2011 at the latest, including a long-awaited concrete end-date, which is broadly expected to be 2014. And this ought to help get laggards on board, says Ms Wandhöfer. "Solid dates should act as a catalyst for banks. For some time a number of local and regional banks, from my perspective, didn’t think SEPA was really going to happen. Now the question is how far will the upcoming regulation help the market towards actual harmonisation and therefore competition.”

No guarantees

However, she cautions that even if that is the case, SEPA’s overall success is far from guaranteed, not least because in the cold light of the post-crisis day, more competition might not seem like a particularly attractive political proposition. “I think the biggest problem here is that once small countries realise that harmonisation could be regulated and that implementation and standards are going to come with a stick, they may hide behind their governments and say ‘we don’t really need this, it’s going to increase costs...' The whole idea of a single market is to give up a sovereign view and get the best price and service, but that could mean some countries having to come to terms with the fact that their banks are not the most competitive.”

For governments with protectionist tendencies, the Additional Optional Services (AOSs) built into the SEPA rulebook – which allow countries to add functionalities and implement certain local variations – could prove to be a tempting, and a completely legal method to stand in the way of cross-border competition by making changes so comprehensive that interoperability is no longer possible.

The industry is aware of the risks, however, and has been hard at work lobbying for stricter rules on AOSs. The powers that be are listening, says Simon Newstead head of financial institutions market and business strategy for GTS with RBS. “There has been significant progress in the SEPA draft,” he says. “Both the European parliament and the European payments council have targeted [improved] wording to increase the chances of the regulation delivering a harmonised outcome as opposed to a more fragmented one.”

All encompassing

SEPA obviously weighs heavily on the minds of European transaction bankers, but it is but one of a substantial laundry list of regulatory and legislative demands. In the US, regulation is packaged quite differently. Instead of overwhelming by sheer force of numbers, the danger comes from one enormously complex behemoth: the Dodd-Frank Wall Street Reform and Consumer Protection Act. The statute may be inspired in parts by European law makers, but instead of being divided into separate chunks, a variety of resolutions have been crammed together to create a 2000-page whole.

Its magnitude could cause some serious problems for bankers. Bank of America’s Mr Jameson says the firm currently has more than 100 sub-groups looking at the bill’s potential impact. “One of the challenges of Dodd-Frank is that it’s so enormous and is a bit all encompassing. Clearly on the US-side of our operations, it will have a huge impact on the way we do business,” he says.

Much of the act is focused on addressing potential weaknesses in the US financial system exposed by the crisis, via increased balance sheet liquidity, for example. It is the kind of regulation that will impact upon a bank’s entire operations, rather than transaction banking specifically, but additional clauses have been added which could have a direct effect. These include attempts to regulate overseas remittances, and better protect consumers when moving money internationally.

These provisions are an attempt to create predictability in foreign exchange deductions and the like right up to the beneficiary, something which is “virtually impossible” in an international transaction, says Mr Jameson. “There are a lot of specifications over what banks will be able to and need to do to meet those demands. The worst case is that if there isn’t broad clarity over these requirements, some may decide that they don’t want to offer a particular service anymore.”

These add-ons may risk Dodd-Frank’s core goals, he adds. “What often happens with broad-ranging regulators is the important stuff gets diluted and then other things which get slipped in go unnoticed... It’s very difficult to disagree with what’s at the heart of the bill, but the more you build around it the more it takes the focus away from the things which are critically important.”

Global concerns

Look east, and the regional-specific regulatory demands are less overwhelming, though they are present. Standard Chartered's managing director and global head of trade product management, Ashutosh Kumar, for example, complains that the growth of open account trade financing in Asia is being held back by regulatory constraints on credit insurance markets.

But Mr Kumar’s main regulatory worries are shared across the globe, namely the impact of the third iteration of the Basel Committee on Banking Supervision's Basel Accords.

Like Dodd-Frank, much of the content of Basel III is a product of the crisis, and therefore designed to force banks to shore up balance sheets. However, Mr Jameson cautions, that while it may not have an immediate impact on transaction banking customers, any regulation which will impact on how banks operate and result in increased collateral or balance sheet costs will ultimately be passed on to the customer via increased costs or reduction in services. “The necessity of maintaining sufficient liquidity, for example, is not something which a corporation would necessarily be aware of, but all end clients could eventually end up being impacted by it,” he says.

For Ms Wandhöfer, the biggest repercussion of Basel III will be its impact on balance sheets, and for transaction services in particular, there are implications for how different balances are treated, she says. “As part of the proposed liquidity rules financial institution balances are being considered of far less value than retail balances, which is likely to create an imbalance between wholesale and retail banking.”

Priced out?

On top of this are the well-publicised fears that Basel III’s stringent capital requirements and planned global standards for leverage and liquidity may result in trade financing becoming prohibitively expensive. Under the new rules, a leverage conversion factor of 100% is assumed, meaning banks would be required to hold capital against the entire value of a trade finance lending commitment, up from the current prerequisite of 20% under Basel II – itself an increase of 10% from Basel I.

The principle is that off-balance-sheet (OBS) instruments could be a significant source of leverage for banks, and should be considered in an institution's overall list of obligations and therefore limited. But planned leverage ratios will not account for the risk profile of a loan, so lower-risk trade obligations – such as bonding or letters of credit – may be caught up with other, riskier, OBS instruments, and bankers argue that holding adequate capital reserves to cover every trade obligation is not necessary. “Under Basel III, trade finance is treated similar to other asset classes, such as a long-tenor syndicated loan or a derivative or any other exposure on the bank’s balance sheet,” says Mr Kumar. “But we all know it is very different, it’s short term and it is self liquidating, but that did not get factored into the Basel regulations when they were being crafted.”

If implemented as it currently stands, Mr Kumar predicts Basel III could lead to a 6% reduction in global trade finance capacity, as well as an increase in pricing of as much as 40%. And the true damage could be even worse, because demand will continue to increase.

An increase in the amount of capital that banks have to set aside for trade finance would make it a far less attractive business proposition, he adds. “If trade finance has the same treatment as derivatives, then people will probably ask themselves whether it even makes sense to do trade finance when you can make much more money on derivatives.”

Reworking regulation

The potential ramifications may be serious, but the banking industry does appear to have pulled together on the issue. The International Chamber of Commerce (ICC) together with the Asian Development Bank, for example, has created a register of 5.22 million trade finance transactions conducted around the world by nine international banks over the past five years. For the first time, the industry has empirical data to present to regulators on the average duration (115 days) of a trade finance deal and on total default rates (which amounted to just 1140).

RBS’s Mr Newstead is confident that the right people are paying attention. “We are positive that the regulators are listening to the recent arguments,” he says. “Clearly we don’t yet know the outcome, because nothing has changed so far in the regulation proposals, but we’re encouraged by the audience we’re getting that they’re listening at the Basel III and EU level to those arguments, and clearly they understand where we’re coming from as an industry on this point.”

A more basic worry about Basel III is simply how consistent implementation will actually be. Global banks are keen to see consistent implantation to ensure the fabled level playing field across the globe, but that is far from certain. “When you have different regulations in different places, it becomes very difficult from a compliance standpoint. A standardised approach is clearly what we would prefer in terms of implementation,” says JPMorgan’s Mr Taylor

He adds that while the Basel committee has been very supportive of standardised implementation, the accord is, of course, just a recommendation, so individual regulations must be implemented in different jurisdictions. “Many countries have already said they will implement it, but when it comes to being put down in actual regulation, things tend to change.”

The transaction banking industry then, is facing a veritable flood of regulation in every territory, and is in many cases at risk of falling foul of legislation which is not necessarily intended to impact upon its business. As the combined industry reaction to the threat posed by Basel III to trade financing will hopefully show, however, a unified response in engaging with regulatory bodies can help safeguard transaction banking against legislation, which was never designed to affect its operations, and to better cope with that which is.

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