Law and regulation should set the framework for efficient markets. However, law and regulation also demand compliance and put a huge burden on every aspect of business and especially on the financial and treasury functions. Yet there are fears that the current pace of regulation is threatening to outrun not only the traditional systems but also may even be going beyond the boundaries of the law itself.
Regulation affects treasurers in two ways. First, there is the direct burden in staff time and investment in technology. Second, and more insidious, are the increased costs and reduced flexibility in the financial systems (mostly banking but also insurance and investment) on which they depend. There’s a third way in which it affects everyone through national and international tax regimes.
The phenomenon of regulation is worldwide but Professor Philip Hamburger of Columbia University Law School argues that regulations – the enacting bit of political legislators – or what he defines as “administrative law” has returned the US government and society to precisely the sort of consolidated or absolute power that the US Constitution (and constitutions in general) were designed to prevent.
Hamburger’s thesis is that the use of regulation goes back a long way – long before the Roosevelt era – but has certainly increased since the global financial crisis of 2008. This had revealed a fragility in the international financial system and provoked a wave of intervention, reform and regulation. Politicians decided that something must be done. “This is something,” cried the public. And some things were done.
However, there was no coordination. The old regulators were joined by new regulators or changed their names and swapped around their functions. They came out with so many acronyms that financial markets began looking like alphabet soup. HIRE an EMIR and get your FATCA right [definitions below]. The result has been an asystemic system of regulation, self-regulation, conflicting reporting and, according to some exasperated treasurers, a plain mess.
The regulatory world may be roughly divided into three parts, a bit as Caesar observed of Gaul. The US, the EU and the rest. They overlap into hundreds of ways but the big beasts of the US and Europe have, respectively, the largest internal economies and the largest trading economies. The result for regulation, treasurers say, has been a con fusing mixture of quasi imperialism and impotence.
Few treasurers are willing to speak on the record. The reason is obvious – don’t rock the boat when the weather is looking choppy. “On regulation, I think the situation is simple. It is turning out exactly as predicted. Lots of panic, confusion, useless cost, banks covering their backs – and the crowning glory: the regulators have publicly admitted that they do not know what to do with all the data they are now gathering,” says one group treasurer.
Dodd-Frank and Emir costs
Dodd-Frank (The Wall Street Reform and Consumer Protection Act) of 2010 certainly extends powers. Its motives are excellent: “To promote the financial stability of the US by improving accountability and transparency in the financial system, to end “too big to fail”, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.”
But all that comes at a cost. Davis Polk & Wardwell (DPW), a US law firm, summed up the regulatory burden imposed by the greatest legislative change to financial supervision since the 1930s. “By our count, the Act requires 243 rulemakings and 67 studies.” That’s quite a lot but perhaps not enough. “This estimate,” they add, “only includes references to explicit rulemakings in the Act, and thus likely represents a significant underestimate.” To drive home the point, their analysis concludes with six pages of contact references to expert lawyers on each of the 16 Titles in the Act.
There is another cost: US credibility. “This legislation will affect every financial institution that operates in this country,” says the DPW team, “many that operate from outside this country and will also have a significant effect on commercial companies.” That sounds a lot like the extraterritoriality imposed by the US Foreign Account Tax Compliance Act (FATCA), part of the 2010 Hiring Incentives to Restore Employment (HIRE) Act.
It may not be the case that the European Union’s acquis communautaire – the body of, well, just about anything that makes up EU law – was inspired to avoid absolute power but it’s certainly the case that the various European organs have also been busy. The European Market Infrastructure Regulation (Regulation (EU) 648/2012 or EMIR) was designed to increase the stability of the over-the-counter (OTC) derivative markets throughout the EU states and it came into force in August 2012.
And again cost on both sides. An estimate of the cash cost can be made. According to research by Kinetic Partners, the US Securities and Exchange Commission (SEC), the UK Financial Conduct Authority (FCA) and the Securities and Futures Commission of Hong Kong (SFC) had a combined expenditure of approximately $2.4 billion in 2012/13. This was more than $900 million in excess of their total expenditure before the financial crisis (2006/07) of some $1.5 billion.
However, the research found that the scope of this increase in expenditure spanned beyond increases in staff numbers at the three regulators. The study revealed that the number of regulatory staff increased by just 36.4% from 2006/07 to 2012/13 across all three agencies.
“This disparity between expenditure and headcount could be indicative of a focus by the regulators to improve market surveillance by developing innovative technologies and hiring more experienced, specialised staff,” says Julian Korek, chief executive officer at Kinetic Partners. “For our clients across the banking, asset management and insurance sectors, we are seeing a mirroring of this investment in systems to monitor and report on transactions.”
The standard setters, who have a quasi-regulatory function, have also continued on their own way and they are not short of their own acronyms. Since 2008 the International Accounting Standards Board (IASB) has held meetings with the Financial Accounting Standards Board (FASB). The FASB is usually called the US counterpart of the IASB but the FASB is itself a creation of the federal government (the sort of delegation that Hamburger examines) while the IASB is the child of the International Accounting Standards Committee (IASC back from 1973). In general terms, FASB oversees (US) Generally Accepted Accounted Principles (GAAP) and the IASB looks after International Financial Reporting Standards (IFRS) and there are now some 120 countries which follow IFRS.
There is a belief that the IFRS and GAAP systems are fundamentally different. Scott Taub, who was a member of the IFRS Interpretations Committee, doesn’t think so. “Many believe without question that US Generally Accepted Accounting Standards is rules-based while IFRS is principles-based. Let me bust that one right away. Both IFRS and US GAAP are based on principles. Every piece of guidance in either set of standards is based on one or more principles. To suggest that significant pieces of US GAAP are just rules with no underlying principles is an insult to the FASB and the other groups that have contributed to US GAAP over the years.”
For practitioners, the new world is frightening. “Only a group of politicians could have come up with some thing so mind-blowingly stupid,” says one treasurer.
And what of treasurers?
Yet treasurers will have to deal with all this. And, of course, they and their colleagues will have to run businesses which do strange things such as produce motor cars, computers, cardboard boxes and everything else. Some are angry.
So, we have a world in which people are spending large amounts of money to comply with silly and meaningless regulations, so this can all be reported in meaningless accounting statements to investors who no longer have the faintest idea of what is really going on.”
The same treasurer adds with a degree of irony: “This sounds to me like a great way of avoiding future financial crises – presumably everyone will have spent all their money on these silly processes, and all productive activity will cease, thereby eliminating the possibility of financial manipulation.”