FS Regulation: Plotting a new direction for FS Regulation

Transcription

1 FS Regulation: Plotting a new direction for FS Regulation A truly sustainable system of regulation, which can be responsive to its economic impacts, needs greater transparency and accountability for achieving outcomes. March 2017

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3 PwC FS Regulation: Plotting a new direction for FS Regulation 3 Regulation of the Financial Services industry is at a crossroads. Policymakers in the G20 demanded sweeping changes to improve industry regulation following the financial crisis, and massive changes have been conceived and implemented as a result. According to William Coen, Secretary General of the Basel Committee on Banking Supervision, there has been a dramatic transformation in the operating environment for financial institutions and a significant improvement in financial strength of global banks since the financial crisis. 1 The Financial Stability Board (FSB) has driven as much global consistency of implementation as possible: systemically important firms and activities have been identified; new, much tougher capital standards introduced; more intrusive supervision mandated with a focus on risk management processes, enhanced reporting and transparency of risk information. And if all this improved resilience and supervision fails, living wills have introduced protections to try to avoid future public bailouts. Additional reforms have also included a range of new protections for investors and consumers, reinforced with much larger and painful penalties for poor sales practices and market conduct infractions. International policy measures to end too-big-to-fail are now largely complete for banks G20 financial reforms have achieved a substantial strengthening of the resilience of the global banking system Mark Carney Letter from FSB Chair to G20 Finance Ministers and Central Bank Governors, 5 October Looking at the big picture, these changes have improved the resilience of individual firms. There is no doubt that reforms have been challenging for firms to deal with: PwC analysis suggests that very few global banks have earned their cost of equity since the crisis 2. In effect, regulation has brought about a lower risk, lower return financial system. 1 William Coen - pg xi, Foreword for A Practitioner s Guide to Banking Regulation Mastering the New Regulatory Landscape, Sweet & Maxwell, Thomson Reuters, PricewaterhouseCoopers LLP, Polk, Pontiki, Raina - pg 34, A Practitioner s Guide to Banking Regulation Mastering the New Regulatory Landscape, Sweet & Maxwell, Thomson Reuters, PricewaterhouseCoopers LLP, FSB Chair s Letter to G20 on Financial Reforms Progress on the Work Plan for the Antalya Summit, 5 October 2015

4 4 PwC FS Regulation: Plotting a new direction for FS Regulation So what comes now? If victory has been (mostly) achieved, where does regulation go from here? Much recent attention has turned to the migration of risk within the financial system. Additional efforts are underway to improve international consistency and deal with risks within the adjacent shadow banking and insurance sectors, within Financial Market Infrastructures, and within the activities of investment firms. Other new efforts have been suggested to improve the analysis of and focus on emergent risks; and to ensure future regulations are accompanied by improved impact assessments (so that legislative decisions can be betterjustified by evidence. 4 ) The FSB suggests that it has an essential role [to play in the latter], including through a more intense focus on the implementation and effects of reforms 5 The business case for any regulation lies in effectively serving the public interest. Post crisis regulation identifies the public interest as avoiding future crisis: managing risks to prevent financial market failures, and by so doing, also overturning the policy trend for deregulation which had originated in the 1990 s (itself a response to the unintended consequences of previous policymaking), and which had been seen to fail. The critical test for regulation is always the public interest test: on balance, does regulation serve the public interest? No system of regulation can survive if it does not achieve ends which enjoy public confidence. The fundamental current public interest issue in western economies is slow growth. Jacques de Larosière, in his concluding Eurofi remarks in 2015, suggested that the thing that is missing [from industry regulation] is not competence, it is leadership the name of the game is restarting investment growth in Europe. If investors are really convinced that regulation is so punitive that they are not going to [invest], we should listen and try something more friendly. And if we err on the side of being too bold, we can correct that but if we err on the side of being too prudent, we cannot correct it because by definition nothing will have happened. 6 His point was that regulation needs to be more responsive, more dynamic. Periods of deregulation have tended to follow periods of regulation, precisely because the perception of public interest changes and because new popular arguments are made that better public outcomes can only be achieved by removal of red tape that inhibits growth. Following the crisis, regulators made powerful arguments that the costs of new regulation were far outweighed by the costs of the crisis. But a decade later, others are now arguing that the slow growth experienced in the US and Europe since the crisis may have been largely due to excessive regulation that long-term trend levels of growth can only be achieved again by rolling back some reforms. To many, the costs of a decade of sub-trend growth can be compared unfavourably to the risks of crisis, inviting the conclusion that the policy response should be different. A truly sustainable system of regulation, one which can enjoy sustained public support, needs to be seen as responsive to the economic challenges of the day. 4 European Commission press release: Better Regulation Agenda: Enhancing transparency and scrutiny for better EU law-making, 19 May Mark Carney, FSB Chairman s Letter to G20 Finance Ministers and Central Bank Governors, 10 March J. de Larosière, President, EUROFI speech: Making the Euro area viable, 10 September 2015

5 PwC FS Regulation: Plotting a new direction for FS Regulation 5 So is the regulatory pendulum about to swing? Should we expect a bonfire of regulation? In the US, Jeb Hensarling (Republican, Texas), the new Chairman of the House Financial Services Committee, argues that if we want strong economic growth and more freedom, we must empower Americans, not Washington bureaucrats. He has proposed a new Financial Choice Act, offering relief from the complexities of the Dodd-Frank Act for firms, in return for higher capital and reduced leverage 7. In the UK, the new Chancellor, Philip Hammond, has said that the UK government would not lie down in the event of Brexit difficulties, but would do whatever we have to do to remain competitive 8. Many in the press have interpreted this as an indication that tax and regulation would be changed substantially, to deal with any post-brexit crisis. In 2015, the European Commission, under the Capital Markets Union policy umbrella, issued a Call for Evidence regarding the EU framework for regulation of financial services. Its summary report indicated that only some minor examples and descriptions had been produced of where rules are perceived to be inconsistent, overlapping or duplicative (e.g. reporting and disclosure requirements, definitions). It also noted limited specific information was provided as regards the compliance costs or wider market impacts. The Commission speculated, apparently without irony given the inherent transfer of responsibility for producing evidence from the Commission itself to industry, that the lack of evidence could reflect the difficulties inherent in isolating the impact of EU rules from other factors (e.g. monetary policy, national policy changes, macroeconomic developments) that may also play a significant role. 9 In 2016, the European Commission launched a review of the EU macroprudential framework, with the aim of examining the balance between national and central control over the use of macroprudential tools and the process for activating them, looking at the role of the European Systemic Risk Board (ESRB), the European Central Bank (ECB) supervisors, and national central banks. This review has yet to to be published. The Commission has also launched a review of the European Supervisory Authorities (ESAs) as well

6 6 PwC FS Regulation: Plotting a new direction for FS Regulation But is this enough? What should regulators do? This paper maintains that we need to focus the next phase of reforms explicitly on making regulation more responsive to economic challenges. This is not to argue for suddenly removing hard-won protections for savers, investors or consumers; sustainable growth nor societal good is created, for example, by allowing the sale of high risk investment products to pensioners desperate for higher returns. The focus now needs to be on creating the regulatory output measures, as well as a new culture of regulatory transparency and accountability. In the same way that the US Fed s Federal Open Market Committee (FOMC) or the Bank of England s (BoE s) Monetary Policy Committee (MPC) report publicly on deliberations that result in decisions about monetary policy and justify these based on inflation and growth targets, the BoE s Financial Policy Committee (FPC), the ECB s Single Supervisory Mechanism (SSM) and the Fed s Board of Governors should all be responsible for developing and communicating transparent, output-linked policies for the setting of buffers to deal with risks. Determinations of Pillar 2 and total loss absorbing capacity (TLAC) and of minimum own funds and eligible liabilities (MREL) buffers should also be more transparent, so that banks can in turn be more accountable to their shareholders for the decisions about business model and risk appetite that drive these outcomes. But many regulators regularly deploy the argument that too much transparency leads sophisticated firms to game the system. The OECD s 2014 book, Best Practice Principles for Regulatory Policy: The Governance of Regulators, suggests that where disclosure would likely lead to gaming of the regulatory system by regulated entities, it would be appropriate for the regulator to be permitted to limit transparency. 11 This exception seems too widely utilised amongst financial services regulators. Where changes of regulation represent material risks to investors, in financial firms greater transparency of decision-making is required. To its credit, the FSB has been open about the global framework for identifying SIFIs, and the bands in which each fits, for the purposes of determining the SIFI buffer. And in the Chairman s recent letter to G20 Finance Ministers, he calls for reforms to also be dynamic. That is, we must learn by doing and make adjustments, as necessary, to optimise our efforts 12. The FSB will deliver to the G20 Summit [Hamburg, June 2017] a structured framework for evaluating the postimplementation effects of the G20 financial regulatory reforms. This framework will be subject to public consultation. It will be used to guide analyses of whether G20 reforms are achieving their intended outcomes, identify any regulatory gaps, remaining or emerging risks, or potential material unintended consequences. The development of and consultation on this framework shows the FSB s policy review process places the highest priority on effective evaluation and transparency. 13 There are some examples of good practice. In the days immediately following the Brexit vote in the UK, the Bank s Financial Policy Committee publicly reported its meeting and ruling that the UK countercyclical capital buffer should be reduced from 0.5% to 0% with immediate effect 10 to deal with the expected challenges of Brexit OECD, pg 83, Best Practice Principles for Regulatory Policy: The Governance of Regulators, Chapter 4 Accountability and Transparency 12 Mark Carney, FSB Chairman s Letter to G20 Finance Ministers and Central Bank Governors, 10 March ibid

7 PwC FS Regulation: Plotting a new direction for FS Regulation 7 Regulators and policymakers should grasp this promised advance by the FSB, and re-examine opportunities within their own systems to drive increased transparency and accountability for outputs, with a view to communicating decisions in an open and disciplined way. Greater transparency and regulatory accountability will allow management of firms and investors to make better decisions about investments and business models which align to regulatory objectives. And regulatory objectives which are explicitly aligned to publicly agreed target outcomes and measures can be more responsive to the wider public interest, as conditions change. This is the system of regulation we need for the future. Contacts: William J. Lewis Global FS Regulation Leader PwC US bill.lewis@us.pwc.com Brian Polk EMEA FS Regulation Director PwC UK +44 (0) brian.polk@uk.pwc.com

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