Reg­u­la­tory ef­forts con­tinue un­abated

The global fi­nan­cial cri­sis led to an un­prece­dented re­sponse from reg­u­la­tors that re­mains a work in progress

Investment Executive - - NEWS - BY JAMES L ANGTON

a decade ago this septem­ber, the global fi­nan­cial sys­tem was on the brink of col­lapse. In the af­ter­math of the global fi­nan­cial cri­sis, pol­icy-mak­ers around the world rushed to fix fis­sures in the reg­u­la­tory sys­tem that the cri­sis ex­posed. Much of that work now is done, and the fi­nan­cial ser­vices sec­tor stands trans­formed as a re­sult. The chal­lenge ahead is to avoid com­pla­cency.

At the time, the global fi­nan­cial sys­tem ap­peared doomed as a host of the world’s largest banks teetered to­ward in­sol­vency. In re­sponse, govern­ments i n the U.S. and Europe hur­ried to bail out most of them, while Lehman Broth­ers Hold­ings Inc., a U.S.based fi­nan­cial ser­vices gi­ant, was al­lowed to im­plode.

Al­though Canada’s fi­nan­cial sys­tem avoided the worst of the global fi­nan­cial cri­sis, our coun­try cer­tainly was not im­mune. At the height of the chaos, the fed­eral gov­ern­ment took ac­tion to prop up mort­gage se­cu­ri­ties and the Bank of Canada de­ployed ex­tra­or­di­nary mon­e­tary pol­icy mea­sures de­signed to keep fi­nan­cial mar­kets liq­uid.

A to­tal sys­temic fail­ure was averted, but the tur­moil touched off a world­wide re­ces­sion and sparked an un­prece­dented global pol­icy re­sponse as reg­u­la­tors and govern­ments pur­sued re­forms to shore up the fi­nan­cial sys­tem.

At the macro level, pol­icy-mak­ers sought to re­in­force the re­silience of the global bank­ing sys­tem and to bring some over­sight to the largely un­reg­u­lated over-the-counter (OTC) deriva­tives mar­kets.

In pur­suit of these ob­jec­tives, nu­mer­ous, far-reach­ing re­form ef­forts were launched. And while the fun­da­men­tal re­quire­ments were agreed to at the global level, lo­cal reg­u­la­tors had to de­velop and im­ple­ment the ac­tual de­tailed rules. Given the scale and scope of the task, many re­forms re­main a work in progress.

The most ur­gent is­sues, such as the sol­vency of the global bank­ing sys­tem, took pri­or­ity. In those ar­eas, ma­jor changes have been ac­com­plished. Pol­icy-mak­ers have strength­ened the fi­nan­cial sys­tem by tough­en­ing bank cap­i­tal re­quire­ments and in­tro­duc­ing lever­age and liq­uid­ity lim­its — the Basel III re­quire­ments. The world’s big­gest, most in­ter­con­nected banks now must hold ex­tra cap­i­tal and sub­mit to ad­di­tional over­sight. In ad­di­tion, the ini­tial re­forms to en­hance over­sight of the global OTC deriva­tives mar­kets — such as manda­tory trade re­port­ing and more cen­tral clear­ing — also are largely in place.

Yet, the ef­fort to en­sure big banks won’t be treated as “too big to fail” still is on­go­ing. The adop­tion of mech­a­nisms to avoid fu­ture tax­payer bailouts by craft­ing regimes to “bail in” and re­solve fail­ing fi­nan­cial ser­vices in­sti­tu­tions are not fully im­ple­mented. Sim­i­larly, mea­sures to curb re­liance on the so-called “shadow bank­ing” in­dus­try are not high among pol­icy-mak­ers’ pri­or­i­ties.

Nev­er­the­less, the re­form ef­forts to date have al­tered the fi­nan­cial ser­vices sec­tor fun­da­men­tally. The im­pact goes be­yond the bot­tom line, as the cri­sis caused reg­u­la­tors to re-eval­u­ate not just what fi­nan­cial ser­vices firms do, but how they do it.

Not only did the cri­sis ex­pose weak­nesses in the struc­ture of the global fi­nan­cial sys­tem, it also shat­tered trust in the in­vest­ment in­dus­try and ex­posed a wide ar­ray of in­di­vid­ual and in­sti­tu­tional mis­con­duct. Thus, reg­u­la­tors around the world be­gan con­sid­er­ing re­forms to the in­dus­try’s con­duct stan­dards in the wake of the cri­sis.

In Canada, fun­da­men­tal con­cerns about how the in­dus­try treats its clients pre­date the global fi­nan­cial cri­sis. In 2004, the On­tario Se­cu­ri­ties Com­mis­sion pro­posed a fair-deal­ing model to ad­dress con­cerns about how the in­dus­try op­er­ates. That ini­tia­tive even­tu­ally evolved into the client-re­la­tion­ship model (CRM) re­forms, which fo­cused largely on en­hanced dis­clo­sure.

Al­though the global fi­nan­cial cri­sis didn’t spark that ini­tia­tive, the cri­sis val­i­dated reg­u­la­tors’ con­cerns and in­formed the on­go­ing pol­icy de­vel­op­ment process. Thus, Canada’s reg­u­la­tors went ahead with re­forms that re­quired the in­dus­try to pro­vide in­vestors with more ex­ten­sive dis­clo­sure, par­tic­u­larly re­gard­ing the costs of in­vest­ing and port­fo­lio per­for­mance.

At the same time, the cri­sis caused reg­u­la­tors around the world to ques­tion whether the tra­di­tional model of re­ly­ing on dis­clo­sure could pro­vide ad­e­quate in­vestor pro­tec­tion. Post­mortems on the cri­sis, such as U.S. Con­gres­sional hear­ings, and crim­i­nal and reg­u­la­tory en­force­ment cases fo­cus­ing on in­dus­try con­duct in the years lead­ing up to the cri­sis, ex­posed an in­dus­try that of­ten was preda­tory to­ward its own clients — even “so­phis­ti­cated” in­sti­tu­tional in­vestors.

As a re­sult, reg­u­la­tors be­gan to con­sider whether the cul­ture of greed per­vad­ing the in­dus­try should be ad­dressed with stricter rules re­gard­ing con­duct, com­pen­sa­tion and con­flicts of in­ter­est.

In the U.S., this pro­duced par­al­lel ini­tia­tives by the Se­cu­ri­ties and Ex­change Com­mis­sion (SEC) and the Depart­ment of La­bor (DOL) to in­tro­duce new rules re­quir­ing bro­ker-deal­ers to put clients’ in­ter­ests be­fore their own. The DOL rules re­main in limbo amid in­dus­try-led le­gal chal­lenges, while the SEC fi­nally is­sued its own pro­pos­als ear­lier this year, which re­main un­der con­sid­er­a­tion.

In Canada, the Cana­dian Se­cu­ri­ties Ad­min­is­tra­tors (CSA) pub­lished a pair of pa­pers in late 2012 rais­ing the is­sue of whether deal­ers and fi­nan­cial ad­vi­sors should be re­quired to act in their clients’ best in­ter­ests, along with whether re­forms are needed in in­vest­ment funds’ fee struc­tures.

Af­ter years of re­search, con­sul­ta­tion and study, the CSA pro­posed a series of “client-fo­cused re­forms” this past June that in­clude mea­sures to in­cor­po­rate “best in­ter­est” re­quire­ments into ex­ist­ing se­cu­ri­ties rules re­gard­ing con­flicts, suit­abil­ity and “know your clients” and “know your prod­uct” obli­ga­tions. Those pro­pos­als are out for com­ment un­til Oct. 19.

The CSA also in­di­cated in June that it plans to ban de­ferred sales charge (DSC) mu­tual fund fee struc­tures and pro­hibit the pay­ment of trailer fees to dis­count bro­ker­ages amid con­cerns about a va­ri­ety of neg­a­tive ef­fects that these mech­a­nisms can have on in­vestors — in­clud­ing wor­ries that DSCs dis­tort ad­vice and re­duce in­vestors’ re­turns, and that dis­clo­sure of­ten doesn’t work. The CSA is ex­pected to is­sue pro­pos­als on these mea­sures this month.

Both the CSA’s pro­posed client­fo­cused re­forms and its plans for mu­tual fund fee struc­tures look cer­tain to face in­tense in­dus­try push­back, as they are de­signed to al­ter how firms treat their clients fun­da­men­tally, which would also ex­pand firms’ com­pli­ance obli­ga­tions and are likely to af­fect the in­dus­try’s eco­nomics. If the process that pro­duced the CRM2 re­forms is any guide, sev­eral years are likely to elapse be­fore these pro­pos­als are fi­nal­ized — and adopt­ing any changes will take even longer.

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