This article first appeared in the December 2016 - January 2017 issue of Funds Europe.
After John Maynard Keynes lost a fortune speculating on currencies, he made a famous quotation about “irrational” markets. Paul North, of BNY Mellon, puts Keynes’ wry witticism in a modern context.
“Markets can remain irrational longer than you can remain solvent.”
This quote from John Maynard Keynes perhaps nicely summarises some of the motivation behind the accumulation of regulations we have been and will continue to be working on through 2018. This quote is attributed to Keynes after he was nearly wiped out in 1920 from trading in currencies by leveraging an investment of £4,000 via a margin account to trade positions worth £40,000. Be it currencies, securities, funds, property or any other asset class, it is this type of loss for a retail investor that many regulations are seeking to avoid.
No one would argue with the motives, but the volume of change and cost of achieving this and other regulatory objectives are increasing year on year. For example, our survey of clients attending our annual EMEA Tax and Regulatory Forum shows that the number of clients who believe their costs will increase has increased from 41% in 2014 to 61% in 2016.
Looking at the volume of regulations to come in 2017 and 2018, this trend is unlikely to reverse in the short term.
At the start of 2016, the priorities were clearly FATCA/CRS, MiFID II and UCITS V. Looking forward to 2017, MiFID II is clearly the priority for many firms. The EMIR regulation on variation margins for FX Forwards and FX Swaps, coming in March 2017, is an immediate priority for some and for others Brexit is beginning to shape plans and product developments in 2017. But it is perhaps harder to establish priorities for the coming year as there are other changes that could come forward as priorities. On one hand, we have seen the start date for PRIIPs delayed for one year whilst on the other, we have seen further discussions on the EU Financial Transaction Tax (FTT), with suggestions there could be an agreed text soon.
From my perspective, I would suggest the following regulations are going to be priorities for investment firms for the next 12 -18 months: MiFID II, EMIR, CRS, BEPS and GDPR. The other regulations that we believe will have impacts on firms, to one degree or another, would include IORP II, Revised German Investment Tax Reporting, Shareholders Rights Directive, Payment Services Directive II and tax developments such as the FTT, if agreed as suggested in some recent press releases. Beyond this list, there are other proposals in development covering topics such as the Capital Markets Union, Capital Requirements and EU Bank Structural Reform, Money Market Fund Reform and the European Deposit Insurance Scheme. Further to these, there may be developments on key topics of Asset Segregation, papers on Distributed Ledger Technology and a final report from the FCA on their Asset Management Market Study.
So, if the cost of implementing regulatory change and maintaining compliance is rising, what impact is this having on firms? When asked if these regulations would have a material impact on their firm, 82% of delegates polled agreed this would be the case over the next 12 to 36 months. This is consistent with results from 2015. But slightly more firms are saying they are delaying other projects because of regulations, up from 42% in 2015 to 48.5% in 2016.
When asked about the impact on end investors, respondents to the survey were somewhat doubtful. The majority felt that investors would have less choice, and less value as a result of these regulations. They did recognise that they would be better protected. These views, sceptical at face value, are similar to the results in 2015. However, they seem inconsistent when taking a wider perspective of the market for investment products. For example, EFAMA reports that the number of UCITS funds increased in Q2 2016 to 30,274 and the number of AIFs was 27,544. With MiFID II leading to a ban on commissions for non-independent sales, in theory investors may see a reduction in their investment costs in funds. And with the focus on passive funds, investors will get more choice of lower-cost funds.
Regulations, whilst often seen as a reaction to previous crisis or change, are themselves change and so have the potential to create opportunities and value for business. However, views on this question have grown more pessimistic since 2014. Then approximately 40% of respondents thought there are some material new opportunities for our business. This year, this has dropped to only 21%, the majority seeing no short-term or material opportunities arising from regulations.
I mentioned above that MiFID II is one of, if not the, top priority regulation for financial firms for 2016 and this reflects its scope, complexity, costs and impacts. With one year left to implement changes, we asked when firms would start making changes to their business and systems. One-third said they had already started, with a further 16% planning to start before the end of 2016, leaving just over 50% starting to implement change in 2017. One-fifth said they are still planning. On the face of it, this could be considered worrisome. However, I believe this reflects the reality of business today with constraints on budgets and resources, the complexity of MiFID II both in terms of its requirements and the implementation as both directive and regulation.
I believe, hope, that 2017 and 2018 will represent the peak in terms of work on regulations. I will not take on bets on this, simply remain optimistic. I also believe there will be shift in terms of themes and intent around regulations beyond 2018. Themes such as growth, further expansion of the single market in the EU, and new forms of funding for investment will create new regulations and, I believe, new opportunities. We are also seeing regulators engage with Fintechs, looking to encourage innovation, including in the area of regulations and compliance. To that end we asked the attendees at our conference if they believed Fintechs would materially disrupt their business model. One-third said ‘No, not all’; 40% said ‘Yes, but not materially, perhaps adding new capabilities or options.’ Only 7% thought there would be material disruption in the next three years. Which brings me back to John Maynard Keynes and his quote that “the difficulty lies not so much in developing new ideas as in escaping from old ones”.
Source: Regulations and priorities for investment firms in 2017, Funds Europe / Funds-europe.com, Dec 2016-Jan 2017. Used under licence from the Funds Europe.
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