Unintended Consequences!

I admit it is easy to criticise the great and the good who are trying regulate the financial markets and the practitioners within them! see my last blog. I'm not certain that the route these bodies are taking is the most likely to get the desired results. The task to me is akin to Canute's self imposed challenge of turning back the tide but adds a couple more dimensions; firstly instead of setting a throne at the water's edge and commanding it to stop, the throne is set on a floating barge in the middle of the sea; secondly that sea is shark infested, a not too tortured analogy! The imposition of new rules and amendments to the old rules smacks of desperation to me. Whichever way you interpret it the legend of Canute is allegorical, either a self-effacing acknowledgement that Kings are mortal or a egotistical folly fuelled by the adoration of his subjects. The actions of the regulators are not allegorical they are real, imposed (admittedly after parsimonious consultation in some but not all areas) and real drivers of change. At the risk of the last sentence being interpreted as a positive it should be noted that change is not always benign it can be destructive or at least unintended and avoided at all costs just for it own sake.  Equally so, I would hope that the initial blame culture prevalent at the beginning of the crisis where governments blamed financial institutions,  regulators blamed distributors, journalists and consumers blamed everyone has been replaced by that most "illusive" of cultures, collective responsibility.

The following statements I would hope are not controversial and sum up the majority of the major issues that changes to the the regulatory environment are attempting to address.

1. The liabilities of major Financial institutions must be underwritten by assets with a surplus for sustained periods of stress.
2. Advice and remuneration for it must be transparent, fit for purpose and economically appropriate.
3. Retail consumers must be protected to a higher degree than Professionals and Institutions in their dealing in the financial markets.
4. Market practitioners must exhibit high standards of Professional integrity and accountability if they do not.
5. Consumers must be more educated in their understanding of the Financial markets and the relationship between risk and reward.

 I will be first to admit that the five statements are broad and the devil is in the detail, however if you could start again you would  not build the current models of Regulatory oversight that we see in the developed world. Stepping back my single biggest issue is that when you breakdown the value chain of most financial transactions you will identify a very real and material cost of regulation. Regulatory cost comes in various shapes and sizes whether it be Capital Adequacy ( the requirement to hold very liquid assets on balance sheet equal to a proportion of the liabilities of a business in the future, even if only to run down the business without client detriment; to the cost of armies of Compliance professionals tasked with keeping the business within the rules and the first line of protection for retail clients or the cost of reporting regularly to clients telling them how much they have made or lost in the experience. I am not advocating that the cost of regulation should be nil as this is clearly a nonsense, I am however concerned that the materiality of it is misunderstood. I work in a simple world where the measurement of the validity of a transaction or product can be assessed by the risk and reward profile inherent in the final return. Therefore if costs; manufacturing, distribution and regulatory are passed onto a client in the transaction they inevitably inhibit reward as a drag on return.

All to often the antidote to make the product or transaction more attractive will manifest itself as an increase in risk. Products and the underlying transactions in the whole are a provision of services, whether it be a combination of professional management aimed at growing or preserving wealth, matching an outcome to a need through advice or valuing, reporting and safekeeping. In the regulated world there is also an element of Fiduciary oversight and redress. As with any manufacturing industry the provision of such service comes at a cost which in turn covers the cost incurred by the service providers plus a realistic margin of profit. It is my contention that the regulatory cost and hurdles that exist before any product is launched creates a burden that influences the quality of the product and ultimately by extrapolation the choice of potential product available to the market.

Finally and at the risk of becoming a latter day Canute myself I am firmly becoming an advocate of a return to "Caveat Emptor", the principle of buyer beware! It is probably the wrong time to suggest that protection should be relaxed in Financial services given the relative excesses and failings exhibited over the last decade and frankly back to the late 80's when the regulatory framework as we know it began, however the very real cost of regulatory intervention will become prohibitive if it is not already for most consumers seeking choice. Leviathan funds may be the only choice for those seeking investment or savings products, since the sheer size does give the benefit of scale efficiencies accommodating costs at a relatively low ratio to  principal investment. All good you may think but only if the fund does what it says on the tin! As we know there is more than one FSA struggling with this issue and we certainly don't want retail investors seeking low volatility investment return and getting Horse meat instead!

HRP February 2013

If it is broken can we fix it!

I have to admit that when I posted my first Blog anticipating the Olympics I did not realise that the Games would actually contribute to to my failure to post a second Blog until now

I have to admit that the usual bile and vitriol that I call upon as my muse for my various Blogs has been hugely dissipated by watching London 2012 and a family holiday in the Basque country. Every time I have felt the need to wax lyrical on the failings of the global financial services industry I have only managed a Tweet in support or deriding the hard work of somebody else.

I have long since returned to a normality, the warm feeling of pride in the fact that we all managed to deliver a wonderful and uplifting spectacle has long since been replaced with huge personal cynicism by confronting the absurdity of the current financial services market.

Firstly and or a more positive note whether it be the often ridiculed organisation committee, the Mayoral office, the competitors, the volunteers or the spectators, all and I mean all deserve praise for delivering beyond expectation. I wish our politicians and lawmakers were not exhibiting the exact antithesis of these Olympian values!

I was recently looking at a PowerPoint slide originally produced by Pwc two or three years ago entitled the regulatory Tsunami ( see attached). I have since adapted it and in reaction to several commentators and retitled it the Regulatory Ice age. Tsunami is a misnomer because although destructive, tsunami's engulf but ultimately dissipate and things get back to normal with the obvious acknowledgement of the human and personal traumas that inevitably remain. Life however goes on. If the current set of regulatory developments, laws and directives are implemented as drafted or consulted on, God help us!

If the dinosaurs were wiped out by an Ice age caused by a huge meteorite strike somewhere in Mexico (bare with me if you don't subscribe to this particular theory as it matches a tortured analogy) then the same thing may happen to the leviathans of the financial services industry! This time the Ice age follows not a meteorite strike but a paper based onslaught of game changing laws and regulatory upheaval. It is not that any one individual text is flawed in its thinking or objectives (although some are and admittedly some I can't even bring myself to read the synopsis of, so could be anything) it is the interaction or lack of coordination whichever way you wish to look at it that gets me.

 I pride myself on trying to understand the objective behind the law or regulation before I get caught up in the individual clauses and detail. This allows me to take part in pre-implementation consultation and hopefully have influence on the eventual outcome. Even if it is only a clarification request, or more fundamental observation, in my experience the authors need practitioner help. Afterwards I get to grips with the detail.Therefore I get that; Solvency II and Basel III are about prudential standards and making sure the Dinosaurs have enough to stave off starvation; I know that MIFID II is looking to level the conduct of business playing field in European Markets; UCITS V and VI  are about saving the brand of the only truly pan-European regulated product; Volcker preventing poacher being gamekeeper in the Investment banks, and AIMFD ensuring that managers of Collective investment Schemes are subject to regulation and oversight by a third party. The UK's RDR wants to see transparency in charging for advice while challenging the advisory industry to show their worth. There's my favourite of all in FATCA which is probably the most ill conceived of the lot (forgive the simplification) whereby anybody investing in American financial instruments will have to prove to the US revenue that all Americans who have beneficial ownership of said instruments have been identified as such, the costs of this I only shudder to think. There you have it a series of single focus developments that create a barren wasteland of entrepreneurial opportunity. Outwardly there is no acknowledgement of the "law of unconsidered consequences". I am finding it difficult to believe that the large institutions are not caught in a web of regulatory impasse, having to consider structural change and adaptation at the expense of viability.

When the meteorite hit 65 million years ago it is estimated that half the species on earth were wiped out, only those that could adapt to the environmental paradigm shift did and then evolved into the present flora and fauna we have today (with the exception of the species hunted into extinction or denied environments in which they can survive). I obviously don't know that half the businesses in Financial services are going to disappear but I do know their chances are slimmer than they were now that we are entering the regulatory Ice age.

HRP 20th November 2012