Winston Churchill once said “If the human race wishes to have a prolonged and indefinite period of material prosperity, they have only got to behave in a peaceful and helpful way toward one another.”
Churchill probably wasn’t referring to financial services regulation, but it nevertheless applies.
Brexit, trade wars, border walls – the current geopolitical environment breeds nationalism and regulatory protectionism. But we live in a global economy, with global financial markets. Closing off our markets from each other would devastate economic growth and increase costs for consumers and retail investors.
Yet, the European Union (EU) has proposed a multitude of financial regulations that could have the ultimate effect of discouraging other countries from doing business in the EU. Center for Capital Markets Competitiveness (CCMC) recently commissioned a research paper entitled, “The Economic Consequences of Regulatory Protection & Extraterritorial Reach,” to explore just how damaging the impact of these regulations could be.
Unfortunately, the findings confirm our concerns.
Take, for example, the EU’s proposed changes to the supervision of third-country central counterparty clearinghouses (CCPs). CCPs facilitate trade between counterparties to a derivative contract, becoming the buyer to every seller and the seller to every buyer, guaranteeing the terms of trade and providing extensive protections in the case of counterparty default. In short, they reduce risk in the marketplace.
Under the European Commission’s proposal, a U.S. CCP, already subject to U.S. rules and oversight, would also be subject to strict EU rules and oversight. Some might even have to relocate parts of their business to the EU.
The asset management industry is also under attack with potential restrictions to portfolio delegation. Portfolio delegation is a common business practice where fund management firms outsource some of the business functions to another location for efficiency and cost-saving purposes, ultimately benefiting their customers.
Under a European Commission proposal European authorities would take control over these arrangements, rather than the national authorities, and potentially restrict the use of this common practice. Which means U.S.-based asset managers would be restricted from engaging in EU business.
Understandably, the EU is concerned about the potential to circumvent the rules when outsourcing to entities outside of the EU. But the existing rules already protect against that. Moreover, the answer is not extraterritorial regulation, but rather cross-border cooperation among EU and third-country regulators to ensure adequate information flow on the oversight of funds.
We can already see the impacts of the EU’s global-reaching regulation. The updated Markets in Financial Instruments Directive (MiFID II) just took effect in January and because of the way it splits up research and execution costs, it’s already making research too expensive. Most funds are stepping up to foot the bill, but research spending is still decreasing as a whole. Smaller companies trying to make educated investment decisions to find the liquidity they need to grow will not fare well in this new environment.
Ultimately, trying to impose EU regulation on third countries will only drive business out of Europe. Financial markets move to where there is opportunity for efficiency and liquidity – that will not be the European Union if these regulations pass as proposed. Our research finds that the proposals discussed here, among others, could increase market fragmentation, decrease competition among financial services firms, decrease liquidity, slow innovation, and ultimately increase costs for consumers and businesses.
On a recent trip to Brussels, we shared these concerns with European officials. Every person we met with acknowledged the need for cross-border cooperation to keep our global markets functioning efficiently. Although, as always, the devil is in the details. We encourage third-country regulatory deference, mutual recognition, and substituted compliance whenever possible to avoid these damaging unintended consequences.
For global financial markets to continue to prosper, we must heed Churchill’s advice and be helpful toward one another, not drive each other away. We need to respect each other’s laws and the fact that while regulatory regimes may not be identical, we all share the goals of maintaining financial stability, safe and liquid markets, and economic growth. Our approaches may be different, but the world is big enough for more than one perspective.
