Capital market harmonisation: how to align market liberalisation and regulatory supervision?

“The financial industry and financial regulators need to find the right balance of regulatory action and response in order to foster investor confidence. There is still a great degree of fine-tuning that regulators and institutions have to do in order to restore investor confidence in the markets.”

By Sylvie Clerbout, Head of Compliance, SGSS

The securities industry faces a dilemma: following the financial crisis there is a need for growth, particularly in Europe where unemployment rates remain high and small and medium sized enterprises (SMEs) are struggling to access to financing. This growth needs diversified funding, which can be sustained only by financial markets as traditional banking channels (loans, monetary policy) are no longer enough to do so. However, the financial institutions, which are the main actors in the financial markets have lost the confidence of investors and the public.

There is now a strong regulatory trend towards rebuilding public support and confidence in the markets. Despite the many regulations being imposed on the market, there has been a dramatic increase in cross-border transactions, although SMEs tend to resort mainly to their domestic markets when seeking financing.

At the same time, there has also arisen a more complex structure of financial products such as derivatives that are handled and processed by a complex, multi-country network of institutions, particularly in Europe.

Given these characteristics of the markets, the regulatory tendency has been to foster harmonisation and improve transparency in cross-border transactions to thus restore investor confidence. In Europe, regulatory initiatives such as Target2 Securities and Mifid II will provide transparency. The AIFMD and UCITS initiatives will provide the basis of a harmonised funds industry at the European level.

However, the recent regulatory ‘hyperactivity’ has been branded by many financial institutions as a regulatory tsunami. Regulators should be careful not to add to the burden of financial actors, who already face many regulatory obligations. Rather, regulators should choose carefully the areas that still require regulatory action and should also wait to assess the impact of regulations before bringing in amendments.

Regulations come with a cost attached: some financial markets actors could well disengage from certain activities altogether if they feel that the cost of compliance, coupled with the cost reductions sought by investors, is too high a cost.

Given the amount of regulation, it is no surprise that there is overlap between different regulatory initiatives. European directives, combined with the extra-territoriality of many US laws such as Volcker, FATCA, etc have led to uncertainty in interpretations. Financial institutions are struggling to deal with the overlap and satisfy all of the regulatory bodies involved.

The Single Supervisory Mechanism, which came into effect in November 2014, will foster harmonisation and compatibility of regulations across countries in Europe, but there are still two risks that financial institutions face. First, national rules and standards are still very much present in the implementation of such laws. For example, the implementation of AIFMD and EMIR differs across countries. Second, the ever-growing international sanctions regime is not harmonised. Recent examples show that a firm can be sanctioned under different regulations that vary across countries. The value of penalties imposed for violating sanctions also vary from one country to another and also sometimes can differ from one institution to another. The sanctions environment is difficult for financial institutions to navigate and regulators should be careful not to impose sanctions policies that inhibit the restoration of investor confidence.