Trump, Brexit and the Financial Regulation Conundrum – MiFID II Edition
Ahhh, MiFID 2. You’ve been the dull throbbing headache in my professional existence for several years now. 10 days ago, the European Union’s flagship piece of financial regulation, 2nd edition went live after being delayed for a year. However it has not been without incident. Unsurprising given the better part of a decade long design and consultation process for coming up with the 30,000 pages of new rules for financial markets in the European Union, thought to have cost billions for the industry to implement and intended to make finance more transparent and provide better value for the end investor, whether it's your pension or your brokerage account.
Unsurprisingly, Brexit and non-EU Switzerland have featured heavily in the issues which have arisen thus far with the rulebook effectively handing a competitive advantage to the Swiss national exchange for trading increments on Swiss stocks, a rule which European Union markets like Aquis (my employer) and Cboe Europe have chosen to ignore in the letter of the regulation so as to ensure adherence to the spirit of the law.
Meanwhile, Brexit also takes its toll with British and German regulators granting last minute reprieves to some of their regulated entities on some aspects of the MiFID II regulation implementation to their respective markets. Initiatives which would strengthen links (and competition) between the UK and its continental counterparts at a time when the future shape of the relationship is yet to be defined.
In another blow to the landmark regulation, one of the key pieces aimed at promoting transparency in the market and limiting the amount of trading which can take place on dark pools known as the Double Volume Cap has also been effectively delayed until March with the EU regulator saying that the quality and completeness of the data they have received to determine the point at which dark trading is suspended is insufficient to calculate the limits.
Implementation issues aside, much of the Markets in Financial Instruments Directive II is now in force and my LinkedIn feed was awash with colleagues and connections wishing each other luck on the 3rd of January, but other factors are starting to come into play here.
Brexit in the Wings
Financial services are obviously a significantly important part of the UK economy. Estimates put it at employing over 7% of the working population and contributing almost 11% of UK GDP, it’s the UK’s largest export industry running a surplus of over £70bn as well as being the largest tax paying sector in the country with over 11% of total tax receipts.
As such, Brexit is weighing heavily on the minds of those in the industry both here in the UK and abroad. European finance hub cities such as Frankfurt, Paris and Amsterdam among others, used to playing second fiddle to The City of London are eyeing up the huge swathes of the European financial business occurring in the City. They’ll struggle in the short term to match the deep talent pool both in finance and the surrounding industries it relies on that London has, but it’s a sign of intent when the head of the largest international school in Frankfurt said one bank tried to reserve 100 places in the school and that they have had to limit institutions to 10 new students per year saying they won’t be a “Brexit school”.
At the end of last year, the UK and EU finally managed to make a breakthrough in negotiations for Brexit and are now moving on from the “divorce” settlement part of the talks to discuss interim transitional arrangements. Adhering with the EU's primary financial regulation is of course to continue through the likely 2 year transitional period. The key to this however is what shape the final trade deal will take and those talks have still not been started.
The trouble is, there is another agitator itching to get in on any new carve up of the global financial services industry…
Trump/Republicans Continuing Deregulation Push
While Europe is caught in the throes of trying to implement MiFID 2 and Brexit, the US is perhaps unsurprisingly pushing with its deregulation mantra. As I wrote at the end of 2016 (here), one of President Trump’s big arguments was against governmental overreach in many areas of US life. Despite campaigning on behalf of “the little guy”, steel workers in the rust belt and such, the President is clearly in love with Wall Street, appointing long time Goldman Sachs banker Steven Mnuchin as his Treasury Secretary.
Wall Street itself has continuously chafed with the financial regulation introduced in the US in the wake of the financial crisis, particularly with the Volcker Rule restricting banks which the government guarantees from trading riskier instruments with their own capital. In the wake of the election, US bank stocks jumped anticipating Trump would look to remove some of the restrictions placed on them in the wake of the sub-prime scandal and the resulting financial meltdown. That hasn’t particularly happened yet but it’s certainly something that is on the agenda.
The concern however is that much of Dodd-Frank was aimed at consumer protection, economy protection and preventing the too big to fail scenario from arising again. Certainly it was not perfect, no regulation is but its aims at least were appropriate. Simply removing these protections is unlikely to destroy the US or global economy again immediately as the doomsayers predict, but it would undoubtedly introduce additional elements of risk which the average consumer on the street is ill equipped to understand. Risks which would ultimately lead to an increased likelihood of another financial crisis.
There is an argument that the global financial system is simply too complex to regulate to avoid crises entirely and this is completely accurate. The causes of the next economic downturn are out there and can be guessed at but are largely unknown. What is known is that (currently) it’s unlikely to be a US based sub-prime CDO with a high rating stamp that causes it.
This Complex Web We Weave
A couple of years ago, I was slightly surprised to find that Deutsche Bank was the bank the IMF had deemed to pose the greatest systemic risk to the global financial system, illustrating this with a nice picture of the systemic risk amongst GSIBs (globally systemic important banks). Not overly surprising considering that a few years before that, Deutsche was ranked as the bank with the biggest total derivatives exposure in the world at over €55 trillion (for comparison, the total economic output of the Germany economy at the time was under €3 trillion).
It’s important to give a sense of scale to the scenario we’re talking about. At the moment, the EU and UK are discussing a relatively binary scenario and somewhat considering things as a zero sum game between the two parties. Unfortunately it’s not that straightforward and the UK has started laying out its game plan this week arguing that if London loses its financial crown, it’s not the EU that will win, but neither party with the winnings likely to be diluted by the US, Japan and China getting in on the gold rush that will be the effective reorganisation of the global financial system.
Major financial institutions were recently invited to talks with the UK Prime Minister and Chancellor, with some of them allegedly pushing for the UK not to simply be a “rule taker” of European financial regulation, along with a lighter regulatory burden signalling the beginning of a potential deregulatory race to the bottom in the attempt to attract business. Progress is being made, but the stakes are getting higher.