Getting Financial Regulation Right- ICMA
I’d like to thank the ICMA for inviting me to speak here in Dublin today.
In the immediate aftermath of the financial crisis in 2008-2009 regulators went into overdrive.
This was because although there were many different and diverse contributors and causes of the crisis, as the many PhD theses and commentaries that have been produced since will attest.
The behaviour of regulators was definitely part of the mix.
Light touch regulation
A principles based approach
Lack of enforcement mechanisms
Mandates to encourage the growth of the financial services sector
All of these have been cited as contributors to the excesses that took place prior to the crisis.
It is therefore unsurprising that the immediate response of different jurisdictions was to look at reforming their financial supervisors as well as their regulation.
To put it plainly, the regulatory system went into over-drive as so many were accused of having been asleep at the wheel in 2008.
Every politician, financial regulator, supervisor and central banker saw it as their responsibility to spot and prevent the next financial crisis.
No regulator would ever get in trouble for calling for higher capital requirements.
No supervisor would be called into question if they imposed a draconian fine upon a large institution
And no politician would be voted out of office for calling for a clamp down on bankers’ bonuses.
This was the back drop for the 40 pieces of regulation that were negotiated in the EU over the past 6 years.
This is why ESMA, EIOPA and the EBA were established in 2010.
The regulation and restructuring the followed were all aimed at facing up to past mistakes and ensuring that there were no regulatory gaps that the next crisis could emerge from.
If that meant duplication and overly burdensome administrative costs; that was considered a small price to pay for a more stable financial system.
Stability, resilience, systemic risk
These were the buzz words across global financial capitals, including Brussels, as the chosen way of implementing new financial regulations across the single market.
All three of which are important, and essential for a fully functioning financial system.
However, we must not lose sight of what the financial system is supposed to do.
It is supposed to finance the economy
It is supposed to manage risk
To put it in political language - it is all about growth and jobs.
How do we match those in business who are prepared to take risk with those in finance who are prepared to take the financial risk funding it?
And in the regulatory zeal of the past 6 or 7 years, it is economic growth that we are now seeing as having suffered.
We have succeeded in preventing the entire financial system collapsing
Now we need to get it running again and financing a growing economy for the future of Europe.
At an EU level, that is why Jean Claude Juncker and the Lord Hill in particular have placed Capital Markets Union at the heart of this growth strategy.
I know you have already heard a lot about that from other speakers during the conference so I will not go into detail on it
Needless to say the CMU is the forward looking agenda, which I hope will reap the benefits of the EU’s single market in financial services for companies across the breadth and depth of the EU in its entirety
But even before the building blocks of the CMU are put on the table, the Parliament was calling for a cumulative impact assessment of the past 5 years of regulation.
What has been the effect of the multiple Capital Requirements Directives and Regulation on the ability of banks to fund businesses?
Did all of those complaints from banks about the effect of specific rules on beneficial activities like trade financing and the securitisation market actually appear?
What behaviour has been encouraged or supressed by the interactions between the markets regulations and the prudential regulations?
More fundamentally, in our haste to fix things, where did we perhaps over reach or where did the outcome not match the original expectation?
I am proud that the Commission, as one of its first acts as the newly incorporated DG FISMA was to launch the call for evidence on the cumulative impact of regulation.
And for the European Commission to commit to changing things that are demonstrated to have been detrimental to the market.
This is not the Dodd-Frank Trap.
We are not stuck in some political deadlock that means we can’t work together to achieve the common objective of ensuring that the primary regulation is fit for purpose.
The EU has multiple methods and mechanisms for fixing things when they don’t work.
The first, is to build reviews directly into the legislation.
We don’t have to rely on an expose or on trade bodies going into overdrive in the Financial Times,
It has become a routine tool.
Typically three years after implementation the Commission or ESMA will be called upon to specifically review certain aspects of how the regulation has functioned, or provide a report on the regulation as a whole.
This is currently being undertaken on EMIR.
Even though clearing obligations may not have been implemented yet, there are many other aspects of EMIR that have been in place for a few years that may require fine tuning.
We expect a report from the Commission on where they think the legislation should be changed shortly, followed by a legislative proposal in the summer.
So the review is the first method of correction then the second method of changing things is the “Quick fix”.
I am always surprised by how often this method is used for solving blatant omissions or mistakes in the legislation that are often identified by ESMA as part of their level 2 rule making process, or alerted by the national regulators or even the market participants as unworkable.
The three changes that were agreed between the Parliament and Council to MiFID 2 last week are an example of this.
While MiFID 2 was passed nearly 18 months ago, it was only when the full extent of the level 2 was extrapolated by ESMA and the high level of IT resource intensity was made clear – for both supervisors and market participants, that the time lines laid out in the legislation were laid bare and declared unworkable.
So instead of simply telling the supervisors and the market to get on with it, and risk having a failed and costly implementation by keeping to the original schedule, the Commission recognised this was impossible and brought forwards legislation that would postpone the adoption for a year.
This provided the Parliament and Council, as co-legislators, with an opportunity to fix a small number of other issues that had been identified prior to the regulation taking effect.
Instead of waiting for the damage to be done, and fix it in three years’ time, we have taken the bold step of admitting mistakes and acting now to correct them.
On Parliament’s side we worked together across all active political groups to jointly draft and table amendments only on those specific issues that we agreed on.
Meaning we reached political agreement in the EP within the negotiating team in record time.
Just to put this in context, when MiFID 2 was first proposed by the Commission in 2011 there were 2145 amendments from the all members of the ECON committee
For the Quick Fix – there were 5.
All co-signed and pre agreed.
We then met with Commission and Council for 1 single trilogue to agree exactly how to solve these issues.
For those of you who know the EU legislative process, you will know how long and painful it usually is.
Yet in this case we were able to address the issues raised by corporates, accidently caught by an anti-HFT provision and solve it.
We were able to identify and solve the issue raised by ESMA and multiple market participants of asymmetric transparency provisions for packaged products that would have caused a huge discrepancy between the US and EU requirements on derivatives trading.
Importantly, we were able to remove the uncertainty around how MiFID would apply to securities financing transactions, preventing huge interpretation discrepancies between different competent authorities in the EU.
The errors were identified and we fixed them whilst lengthening the time period for MiFID 2 to come into force.
The final method of improving the regulation is at arm’s length to the politicians.
Hence I have struggled to find an example of it.
Yet it is the method we put in place when designing ESMA, the EBA and EIOPA in answer to those who said that the EU legislative process was too slow and cumbersome to respond to market developments.
We gave those financial supervisory agencies the power to rescind and adopt new regulatory technical standards as they saw fit.
These still have to be accepted or rejected by the Parliament and Council – but it is a process that can be done in 3 months.
Faster if they pick up the phone to us to say why it is necessary and secure a non-objection.
The detailed level 2 rules written by ESMA are often based on a broad legislative mandate that they are able to interpret and implement with a degree of freedom to find the most efficient way of achieving what the co-legislators asked for.
For example, they are asked to write detailed rules on reporting of derivatives trades.
The level of granularity that they saw as appropriate to the market in 2011 may have changed since then, there may have been more international convergence over the best way to aggregate data, new data standards may have been agreed by industry in that time.
ESMA is able to re-issue those standards to reflect such changes
I would argue that they are duty bound to do so.
This can be extended to many of the provisions in those many level 2 rules that were spawned by those 40 pieces of EU legislation.
The call for evidence by the Commission is not a PR exercise.
It has full political support across the European Parliament and majority of Council.
If you identify where things have gone wrong, there are ways of fixing it.
To be clear, some of the painful consequences of the regulation are intentional, you may not like them, but they were planned and intended as a result of behaviour that was unsuited to a modern, efficient and resilient financial system.
But genuine unintended consequences can and will be fixed – if you provide the evidence and data to support a change.
I got reprimanded by a German Green MEP earlier this week at the Commission hearing on their call for evidence, for being too much of a British empiricist;
calling for evidence and data to justify changes.
I didn’t apologise to him, and I won’t apologise now.
I am scientist turned banker, turned politician and I believe that the only way to answer to my constituents about how to return growth to the economies of the EU is to analyse where mistakes and have been made and identify how to fix them.
Your industry is run on statistical models, analysis and data.
I fully believe you are up to challenge of providing the evidence that makes the financial system more resilient and stable while still being fit for purpose.
More efficient markets, best practice and well regulated markets are in everyone’s interests and as we move towards a more effective Capital Markets Union in Europe, identifying the good and the bad in our policy decisions becomes even more important.