Shoots...Scores! Finally, After All These Years, It's A Goal!
The long awaited curse is over.
No, not England’s win on penalties (yes, I was as amazed as the next person) - it’s the wait for a decent regulation that might actually make things better for everyone.
Senior Manager’s and Certification Regime (SM&CR) is coming to all FCA registered firms on December 9th, 2019 (and the insurance industry is a year earlier on Dec 10th, 2018). The FCA plans have been agreed upon as necessary, beneficial, outweigh the cost of implementation many times over and as such will need to be in place next year.
SM&CR will oblige all firms to put people in positions of responsibility and make them liable for their actions, making them attest to the control and evidence that they have done so. For those of who do not know this regulation, it has been in place for a while, targeted at firms that have significant industry presence or deemed to be significant on an infrastructure level. These have included any Bank, Building Society, Credit Union, large investment bank or insurance company but this still only represented around 5% of total regulated firms, many of which have been dual regulated by both the FCA and the PRA (i.e the very big firms). Now, it is coming to all. Eyestorm Advisors sees this as a common-sense development for the industry, improving its culture and making sure that its officers are fit and proper, and we are happy to see it being expanded to encompass all regulated firms.
Not All Regulations Are Equal
Over the past decade, we have seen just about everything challenged, every business practice, process and operational workflow monitored, changed and adapted to suit an ever-burgeoning book of regulation, most of which seems to have been designed by and thought up by politicians and civil servants that have no idea how the markets work, or what the markets do, and just how the business has evolved and why.
The law of unintended consequences is something that I speak of a great deal in these articles. Let’s take capital requirements, for example. No one can make an argument that asking banks to hold more capital is a bad idea, right? Except as a consequence of asking them to hold more capital we get the following:
1. Outsourcing of risk to investment firms, that hold almost no capital themselves. Mostly, they have only their client’s money.
2. Less liquidity in the market as banks retract from market making, so therefore over time spreads will widen, and the cost of transacting will eventually go up as the number of players lessen.
3. Less access to new or evolving products, and more restrictive lending practice.
So the end result is:
1. If someone makes a mistake there is little or no balance sheet to protect the losses.
2. Higher costs for the industry, sucking out liquidity and detracting from returns to end customers.
3. Less access to capital for new projects for end customers.
This is at a time when governments are demanding more lending and more consumer transparency, thus bearing down on costs; this is at a time when people are pouring in to get 2.5% on US Treasuries because they can’t get yield anywhere. Government is saying they want an outcome that helps to boost tax revenues and growth but have established and are maintaining rules that can only lead to the opposite outcome. Why do we not hear this from the industry players? Why are the directors and shareholders not speaking out? Because to do so would be considered heresy by the regulators, media and governments who have tried the industry in the court of public opinion. And until someone comes along with a bigger bogeyman to blame for the world’s ills, then it’s 'toe the line' time.
Light At The End Of The Tunnel?
Repeal of Dodd-Frank in the US started to look like it may be the market’s saviour and that some common sense might start to be in fashion again. If one governemnt can start rolling back on this type of legislation maybe the others may follow suit. But the “repeal” has been a classic fudge with the Choice Act (something that truly would have replaced Dodd Frank) being rejected by the senate and being sent back as a replacement of existing law. In the end, the changes were small:
1. Bank SIFI regulation was amended so the Fed would be able to set more lenient terms for organisations by removing the unindexed $50bn cap and making it $250bn indexed for growth (though for most organisations in institutional business would be far above this weight anyway).
2. Some obtuse rules and procedures around lending to mobile home owners and not profiling race on mortgages were changed.
3. Credit agencies were given a much lower level of liability for errors, despite the fact that 1 in 4 credit ratings checks have errors, according to a study by the US Govt (am I the only one who thinks this is staggeringly high?)
The changes made were a start by the Trump administration but in no way do they effect the mainstream of lending activity or do little to improve the book of regulation that needs to be adhered to; frankly, they are more about the tone of repeal than the effect of it. Most of the actual change has been by directing appointments to the top of bodies such as the FDIC. That can be reversed by a different administration very quickly. However, in changing the tone, it has inspired activity.
The Market Rides To The Rescue
Despite the lack of true repeal, something has stirred in the US. Local bank lending in the US has been rising four-fold versus major bank lending. This is where we are seeing the real difference to the US as lending is driving the economy forward, with interest rate rises seen as a given. Real wage growth in the US is now running at 0.3% and unemployment is down to 3.8% and averaged across a basket of counties in states from the rust belt to the prairies of 2.0%. That is realistically zero unemployment, as a number at 2.0% is normally considered as being a churn of existing labour markets.
What I believe we are seeing in the USA is the normalisation of business and the 'big means good' model being challenged by fresh players, growing adaptable smaller businesses that can compete. The question for the rest of the world is going to be, “at what point do you try and do the same?”
This may be a long time coming. Put simply, they don’t have the means, wherewithal or the desire to do so in Government or Supra- National Government. Where are the smaller lenders to plug these gaps in the EU for example? It is no surprise that across Europe there are a plethora of new hedge funds opening to fill the ever-widening gap between what corporate lending in the major banks is allowed to lend under tightening risk profiles and what the market requires to start projects/achieve growth. PE lending is continuing to grow, companies are de-listing as they see less and less benefit in offering to the public, with ever greater legislation on what they can and cannot do. This is the market trying to plug gaps for the established businesses that need access to lending, but it wont help start-ups and retail lending at all and that’s where the economy is getting its fillip in the US.
SM&CR Shows The Way
The situation in the US has come about in spite of regulation and not because of it. Perhaps this ought to be shouted from the rooftops a bit more often. The constriction of industry through often needless and over-bearing legislation has formed the opportunity for others to fill the gap and they have taken the opportunity to do so. These new players need to be monitored and controlled appropriately but in a constructive way and that is what SM&CR does. It sets out to make sure that people in senior roles are appropriate and have the necessary skills and background. It makes them responsible for their actions. It doesn’t hector and it doesn’t tell people how to do their jobs and it doesn’t set out prescriptive rules about how and what must be done by an organisation to the point where compliance removes differentiation. This is an example of what good regulation looks like. It treats the industry and the end customer as adults and not children that must be ordered about or molly-coddled.
The long and short of it is we now have good regulation and bad regulation. The good is that which enables business to function, achieve its goals, makes sure that customers are appropriate for the products they are offered and that market practices are not abused. The prescriptive regulation that tells all how to do every tiny little thing - like most of MIFIR/MiFID II) - is a burden that carries no real benefit. A stripped-out version that captures the essence of what was needed to protect consumers always made more sense. I still can’t work out who it was that determined that this was beneficial; I only know one hedge fund manager that speaks up for enforcing it (most likely because barriers to entry are the only way they would get any business in the first place). I still can’t see how any of it is going to make a catastrophic failure at one business not fall on the next (perhaps someone could write to me, if they know, because I would love a debate about this).
Good is SM&CR and MAR. Bad is MiFIR/MIFID II and Dodd Frank/Volcker. It's time for there to be a realisation of this, and a debate about how to stop the nanny state and start business again for the benefit of everyone. After all, the end consumer always ends up paying the price and restrictive practice is what we have now, with little or no value to the people it is supposed to be done on behalf of.
Iain Bonner-Fomes is the CEO of Eyestorm Advisors.