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Benefits and unintended consequences of financial markets reform

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In response to the 2008 financial crisis and the world recession that followed, central bankers, regulators and governments have drafted numerous regulatory reforms and measures designed to minimise …

In response to the 2008 financial crisis and the world recession that followed, central bankers, regulators and governments have drafted numerous regulatory reforms and measures designed to minimise risk and maximise consumer protection in the global financial system.

In order to investigate the potential impact of these new regulations on businesses, the Economist Intelligence Unit, on behalf of LloydsBank Wholesale Banking & Markets, surveyed over 450 senior executives from different companies and also conducted interviews with experts.

Key findings include:
• Companies are aware of and worried about regulatory changes—but are not prepared.
• There is concern that new regulation will hinder growth and innovation.
• Companies expect a significant impact on profitability.
• The cost of compliance is the greatest worry.
• Companies are contemplating a range of responses.

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  • 1. Sponsored by: an Be co un d ne o in ns t fi m f f eq e ts re ar in u nd su fo ke an enc e ex r fr e v In o c e rm ts ci es d si m ut y g a iv ht n e al s
  • 2. Benefits and unintended consequences of financial markets reform Contents Executive summary 2 Introduction 4 1 Regulation on the radar 6 1 2 Regulatory pros and cons 9 2 3 Overall expectations of regulatory impact vary 11 4 OTC derivatives overhauled 17 3 5 Corporate responses 19 4 6 The bottom line 21 5 7 Potential consequences 23 Appendix: survey results 241 © The Economist Intelligence Unit Limited 2012
  • 3. Benefits and unintended consequences of financial markets reform Executive summary In response to the 2008 financial crisis and the Key findings include: world recession that followed, central bankers, regulators and governments have drafted Companies are aware of and worried about numerous regulatory reforms and measures regulatory changes—but are not prepared designed to minimise risk and maximise consumer One-half of respondents cite regulation as one of protection in the global financial system. their main concerns, alongside the global In order to investigate the potential impact of economic crisis (58%) and the euro zone crisis these new regulations on businesses, the (54%)—far ahead of other issues such as Economist Intelligence Unit, on behalf of Lloyds availability of finance. More than three-quarters Bank Wholesale Banking & Markets, surveyed over (77%) of respondents believe that their boards are 450 senior executives from different companies aware of the impact of changes in regulation on and also conducted interviews with experts. their company, but only 61% feel prepared. About this report In June and July 2012 the Economist Intelligence conducted with three experts from leading Unit, on behalf of Lloyds Bank Wholesale Banking financial companies. Our thanks are due to the & Markets, surveyed 454 senior executives in following for their time and insight (listed order to explore what companies think about the alphabetically): current regulatory landscape as well as how these Jessica Ground, UK bank analyst at Schroders firms are planning ahead to handle the impact of Ricky Maloney, head of treasury processing future regulation. at Ignis Asset Management Respondents were drawn from Europe (60%), Mark Stancombe, head of client management Asia-Pacific (20%) and North America (20%), at Insight Investment and were divided into financial services (44%) The report was written by Faith Glasgow and and non-financial services companies (56%). edited by Monica Woodley of the Economist In addition, in-depth interviews were Intelligence Unit.2 © The Economist Intelligence Unit Limited 2012
  • 4. Benefits and unintended consequences of financial markets reform There is concern that new regulation will hinder The cost of compliance is the greatest worry growth and innovation Almost three-fifths (59%) of respondents see the More than one-half (51%) are concerned that increased costs of complying with the new planned financial regulation will impact on growth regulations as the biggest threat, but the rising in their industry, while 44% expect it to affect costs of obtaining funding (39%) and innovation. UK and US companies are somewhat implementing information technology systems more anxious (54 and 53% respectively) about the (25%) are also concerns. negative impact of the new regulations than either European or Asia-Pacific companies (46 and 48% Companies are contemplating a range of respectively). responses The most popular plan, selected by 42% of Companies expect a significant impact on respondents, is to change their company’s profitability corporate finance or risk-management model. But Overall, two-thirds (68%) of respondents significant numbers are also thinking of relocating anticipate a significant or fundamental impact on or changing their legal structure (26%), looking the profitability of their financing and risk- for alternative funding (27%), reducing their use management models, although some regulations of derivatives (25%) or seeking alternative service cause notably more concern than others. Almost providers (24%). three-fifths (58%) expect at least significant effects as a result of Basel III, compared with only 35% as a consequence of the Vickers Report.3 © The Economist Intelligence Unit Limited 2012
  • 5. Benefits and unintended consequences of financial markets reform Introduction As a result of the 2008 financial crisis and International Financial Reporting Standards consequent world recession, central bankers, (IFRS), will be implemented globally. Others are regulators and governments have drafted a raft of regional directives; thus, the Markets in Financial new regulations to better protect and stabilise the Instruments Directive II (MiFID II), the European global financial system. Market Infrastructure Regulation (EMIR) and The reforms have several broad aims, but Solvency II affect the EU, while the US financial include (among others) measures to boost landscape will be reshaped by the Dodd-Frank surveillance, raise bank capital adequacy reforms and the Foreign Account Tax Compliance standards, reduce risk in over-the-counter (OTC) Act (FATCA). Then there are national reforms; for derivative activity and remove opportunities for example, the UK is introducing its own regulatory regulatory arbitrage among non-bank lenders banking requirements as a result of the Vickers (known as “shadow banking”). Report. (See box below for a brief explanation of Some of the reforms, such as Basel III and the each regulation.)Financial regulation definitions:Basel III: global agreement on bank capital adequacy and Dodd-Frank: wide-ranging US reforms, including bank andmarket liquidity risk insurance company capital requirements but also regulation of hedge fundsIFRS: creating a single set of enforceable and globally acceptedinternational financial reporting standards FATCA: US legislation requiring US taxpayers to report to theMiFID II: far-reaching legislation designed to modernise, make Internal Revenue System (IRS) specific foreign financial assetsmore transparent and harmonise the EU securities markets; it is over a certain threshold. It also requires foreign financiallikely to affect everyone involved in the EU industry institutions to report similar information to the IRS on companies operating in the US.EMIR: an EU directive providing for a harmonised regulatoryframework for OTC derivatives Independent Commission on Banking (ICB, known as theSolvency II: EU directive requiring greater capitalisation for Vickers Report): UK banking reform proposals including ring-insurance companies, which is expected to push them towards fencing of personal and SME deposits from wholesale andmore risk-averse investment strategies institutional operations4 © The Economist Intelligence Unit Limited 2012
  • 6. Benefits and unintended consequences of financial markets reform Although companies have always had to take transactional costs for both financial and non- into account the changing requirements of the financial firms that use derivatives to hedge their regulators, both the pace and the scale of these costs or for other purposes. overhauls is unprecedented. Moreover, they have This report examines the views on new major implications for non-financial as well as regulations of financial and non-financial financial corporations. For example, the cost of companies around the world, including how borrowing will rise as banks’ lending spreads to important these firms think regulatory reform is in customers are pushed up by the banks’ obligation the current global economic climate, in addition to to provide greater capital adequacy. In addition, how prepared they are for those changes that will the introduction of reporting obligations and affect them directly and others that may have an central clearing for OTC derivatives will increase indirect impact on their bottom line.5 © The Economist Intelligence Unit Limited 2012
  • 7. Benefits and unintended consequences of financial markets reform 1 Regulation on the radar It is clear that the regulatory overhaul is a major American corporates, with 61% identifying it as a source of uncertainty for companies worldwide. concern. When asked to identify up to three macro issues As might be expected, there are also clear currently giving their business most cause for differences in perspective between financial concern, one-half of them cite regulatory changes, services (FS) companies and non-financials. Only with only the global economy (58%) and the euro 36% of non-FS respondents see regulation as a zone crisis (54%) scoring higher. major issue. For them, sales-driven considerations Responses vary regionally, however. European such as lack of consumer demand (30%) is well companies are primarily focused on regional over twice as significant as it is for financials problems and are less troubled by the impact of (12%). regulation (only 41% cite it)—perhaps also By contrast, regulatory change tops the list of because they are already well used to a steady worries for FS respondents, cited by over two- stream of EU directives. By contrast, regulatory thirds (68%). change is the single biggest headache for North Chart 1 Q What do you see as the biggest issues facing your company today? (% of respondents, by sector) FS Non FS Lack of industrial/economic 23 growth/investment 26 Eurozone crisis 62 47 Lack of confidence 24 27 Availability of finance 15 25 Regulatory changes 68 36 Lack of (consumer) demand 12 31 Global economic uncertainty 58 58 Source: Economist Intelligence Unit survey, July 2012.6 © The Economist Intelligence Unit Limited 2012
  • 8. Benefits and unintended consequences of financial markets reform Chart 2 Q What do you see as the most important issues facing your company today? % of respondents, by region North America Mainland Europe UK Asia-Pacific Global economic uncertainty 55 55 56 66 Lack of (consumer) demand 27 24 21 19 Regulatory changes 61 41 53 48 Availability of finance 21 26 19 17 Lack of confidence 23 27 27 26 Eurozone crisis 44 57 60 48 Lack of industrial/economic 27 21 growth/investment 25 27 Other 3 3 3 1 Source: Economist Intelligence Unit survey, July 2012. Ricky Maloney, head of treasury processing at understand the implications of the regulations: the UK-based Ignis Asset Management, foresees more than three-quarters (77%) of respondents Category 1 Category 2 “severe difficulties” in regard to the OTC derivatives say that their board of directors is5up toCategory 6 with Category 3 Category 4 Category speed market changes, in the current economic climate. the impact of the new regulations on their “Governments and regulators have contradictory company. But that does not necessarily translate strategic goals, in that they are removing liquidity into confidence that they are actually taking from the markets by way of increased margin and action, with only 61% believing that most or all of capital requirements, while at the same time trying the necessary preparations have been made, and to stimulate economic growth,” he notes. almost one in ten (8%) of respondents perceiving At the corporate level, there seems to be their company as unprepared. reasonable confidence that senior directors at least Chart 3 Q Do you agree or disagree with the following statements? (% respondents) Strongly/somewhat agree Neutral Somewhat/strongly disagree My company is prepared for the impact of planned financial regulations. 61 31 8 Our board is aware of how planned financial regulations will impact our company. 77 18 6 Source: Economist Intelligence Unit survey, July 2012. Category 1 Category 2 Category 3 Category 4 Category 5 Category 67 © The Economist Intelligence Unit Limited 2012
  • 9. Benefits and unintended consequences of financial markets reform Although companies have little choice but to It is also rather more worrisome for UK and US take some kind of action in response to the companies than for those based in Europe or Asia: changes, most—and especially FS companies—have 54% of UK firms are downbeat about prospects for serious misgivings about the wider impact on growth, compared with 46% of European firms. economic growth and innovation. One in two Jessica Ground, UK bank analyst at the London- companies (51%) overall, and 64% of FS headquartered Schroders, makes the point that respondents, expect growth in their industry to be unilateral regulation is a real worry for the City. inhibited as a result of reduced market liquidity “For global markets such as financial services, and increased trading costs. human capital is very transferable. The system did Again, there is some regional differentiation, need substantial reform but with international with European firms notably less fretful than those consensus; the danger is of jurisdictions acting based in other areas about the impact of independently of each other and capital just regulations on growth—again perhaps reflecting moving away.” She points to the UK’s unilateral the fact that regulatory issues are to some extent plans for bank ring-fencing and France’s proposed eclipsed by the fragility of the euro zone economy transaction tax as examples of regulation that and the need for far-reaching political and could leave countries seriously vulnerable to lost economic solutions. business. Chart 4 Q Do you agree or disagree with the following statement? “I worry that planned financial regulations will inhibit growth in my industry” (% respondents, by region) Strongly/somewhat agree Neutral Somewhat/strongly disagree Asia-Pacific 48 36 16 UK 54 33 13 Mainland Europe 46 26 28 North America 53 33 15 Source: Economist Intelligence Unit survey, July 2012. Category 1 Category 2 Category 3 Category 4 Category 5 Category 68 © The Economist Intelligence Unit Limited 2012
  • 10. Benefits and unintended consequences of financial markets reform 2 Regulatory pros and cons Only 5% of respondents see no threat to their (IT) costs (25%) are also concerns. FS companies company as a result of the new regulatory regime; are even more focused on compliance costs (see most are troubled by the various costs of chart 5). implementation. The biggest issue by far is the “The FS industry is underestimating the long- impact of increased compliance costs, which term costs of compliance—there will be problems concerns 59% of respondents overall and more than down the line with the amount of work for 70% of large companies with annual revenue of compliance departments and the extent of more than US$10bn (see chart 4). However, rising reporting involved,” comments Schroders’s Ms funding costs (39%) and information technology Ground. “The trouble is that additional regulation is Chart 5 Q What are the biggest potential threats to your company from planned financial regulations? (% of respondents, by company size in USD revenue) Between $500m and $1bn Between $1bn and $10bn More than $10bn Increased cost 39 of funding 37 39 Increased cost 70 of compliance 57 52 Increased cost 17 of hedging risk 16 16 Increased IT costs 23 29 23 Difficulty in securing banking 12 products or services we need 12 13 Restrictions on where 10 we can operate 22 26 I don’t see any 6 potential threats 5 4 Don’t know 1 2 1 Source: Economist Intelligence Unit survey, July 2012. Category 1 Category 2 Category 3 Category 4 Category 5 Category 69 © The Economist Intelligence Unit Limited 2012
  • 11. Benefits and unintended consequences of financial markets reform Chart 6 Q What are the biggest potential threats to your company from planned financial regulations? (% of respondents, by sector) FS Non FS Increased cost 37 of funding 40 Increased cost 74 of compliance 48 Increased cost 12 of hedging risk 20 Increased IT costs 29 22 Difficulty in securing banking 9 products or services we need 16 Restrictions on where 20 we can operate 19 I don’t see any 3 potential threats 7 Don’t know 1 2 Source: Economist Intelligence Unit survey, July 2012. absorbing firms’ profits, yet they don’t feel they’re potential benefits are improved transparency with getting better regulation because the regulators’ regards to risk (42%) and greater stability for focus has been on volume rather than quality.” financial markets (41%), with a further 30% also Almost one-quarter of companies based in North looking forward to greater pricing transparency and America (24%) and Asia-Pacific (24%) are also reduced counterparty risk (for differences between anxious that the regulatory changes will restrict Category 1 FS andCategory 3 respondents, see chart 6). Category 2 non-FS Category 4 Category 5 Category 6 their freedom to operate in other jurisdictions. But there is less consensus among respondents When asked about the likely positive over the potential downsides to the new regime; consequences of the changes, most respondents indeed, 13% take a somewhat sceptical view, see some sign of a silver lining to the regulatory claiming that they do not envisage any benefits for cloud hanging over them. At the top of the list of their company at all. Chart 7 Q What are the biggest potential benefits to your company from planned financial regulations? (% of respondents, by sector) FS Non FS Reduced counter-party/ 33 credit risk 27 Better transparency 42 of risk 41 Increased market 30 (pricing) transparency 31 More stable financial 38 markets 43 I don’t see any benefits 14 11 Don’t know 1 3 Source: Economist Intelligence Unit survey, July 2012.10 © The Economist Intelligence Unit Limited 2012
  • 12. Benefits and unintended consequences of financial markets reform 3 Overall expectations of regulatory impact vary Most respondents (68%) are bracing themselves those affecting the derivatives market. For non-FS for significant or even game-changing effects on firms, the survey suggests that the rising cost of their financial and risk-management strategies as a borrowing from banks is the biggest problem, consequence of the new regulatory landscape, with although they are less concerned than FS UK companies expecting to be hardest hit (76%). companies about this issue. Unsurprisingly, FS companies are also However, the FS interviewees point out that what predicting a higher impact than their non-FS affects their clients ultimately affects them as well. counterparts. FS respondents are particularly “The big thing for us will be MiFID, though there worried about the regulations (such as Basel III, will also be some fallout from Dodd-Frank,” MiFID II and Solvency II) that are likely to make according to Ms Ground at Schroders. She adds, their investment business more complex or restrict however: “Basel III and banks’ increased capital their ability to issue corporate debt, as well as adequacy requirements will also impact on our Chart 8 Q Please assess the compound impact of all regulatory change (% of respondents, by region) North America Mainland Europe UK Asia-Pacific Low impact (impacts profit of our 18 financing and risk management model) 19 24 11 Medium impact (Significantly impacts profit of 46 our financing and risk management model) 42 41 39 High impact (Fundamentally challenges viability 22 of our financing and risk management model) 34 21 30 Don’t know 7 3 9 15 Not applicable 8 2 5 6 Source: Economist Intelligence Unit survey, July 2012.11 © The Economist Intelligence Unit Limited 2012 Category 1 Category 2 Category 3 Category 4 Category 5 Category 6
  • 13. Benefits and unintended consequences of financial markets reform Chart 9 Q Please assess the compound impact of all regulatory change (% of respondents, by sector) FS Non FS Low impact (impacts profit of our 7 financing and risk management model) 29 Medium impact (Significantly impacts profit of 38 our financing and risk management model) 44 High impact (Fundamentally challenges viability 46 of our financing and risk management model) 12 Don’t know 5 10 Not applicable 4 6 Source: Economist Intelligence Unit survey, July 2012. clients, and therefore our business.” and indeed on European pension and insurance EMIR is the biggest headache for Mark funds generally,” he explains. Stancombe, head of client management at Insight It is unsurprising that concerns over specific Investment of the UK. “It has the potential to have regulations vary with significant differences in the a very large detrimental effect on our underlying primary areas of concern for FS and for non-FS pension fund clients’ ability to mange the risks corporates. The differences for each regulation are associated with funding their pension obligations, detailed in the boxes below. Basel III Global agreement on bank capital adequacy and market liquidity risk Category 1 Category 2 Category 3 Category 4 Category 5 Category 6 Overall, three-fifths (58%) expect a significant or fundamental impact on their finance and risk- management models from the Basel III banking reforms. Financials (69%) are expecting markedly more fallout than non-financials (50%), despite the fact that widening bank lending spreads are set to push up the latter’s borrowing costs. Indeed, Basel III is the single piece of regulation expected by FS respondents to have the greatest impact on their business. Chart 10 Q Q Please assess the impact of Basel III on your company (% of respondents, by sector) FS Non FS Low impact (impacts profit of our 20 financing and risk management model) 30 Medium impact (Significantly impacts profit of 29 our financing and risk management model) 39 High impact (Fundamentally challenges viability 40 of our financing and risk management model) 11 Don’t know 1 10 Not applicable 10 10 Source: Economist Intelligence Unit survey, July 2012.12 © The Economist Intelligence Unit Limited 2012
  • 14. Benefits and unintended consequences of financial markets reform Dodd-Frank Wide-ranging US reforms, including bank and insurance company capital requirements, as well as regulation of hedge funds, among other issues Unsurprisingly, North American respondents expect to be most significantly affected (36% of US companies expect a fundamental impact, while a further 32% predict a significant impact, compared with 14% and 30% overall). By contrast, around one-fifth of European (23%), Asian (20%) and UK (18%) companies do not see Dodd-Frank as relevant to them. Chart 11 Q Please assess the impact of Dodd-Frank on your company (% of respondents, by region) North America Mainland Europe UK Asia-Pacific Low impact (impacts profit of our 27 financing and risk management model) 26 33 15 Medium impact (Significantly impacts profit of 30 our financing and risk management model) 36 23 36 High impact (Fundamentally challenges viability 12 of our financing and risk management model) 13 5 32 Don’t know 10 7 17 11 Not applicable 20 18 23 7 Source: Economist Intelligence Unit survey, July 2012. Category 1 Category 2 Category 3 Category 4 Category 5 Category 613 © The Economist Intelligence Unit Limited 2012
  • 15. Benefits and unintended consequences of financial markets reform EMIR (European Market Infrastructure Regulation) An EU directive providing for a harmonised regulatory framework for OTC derivatives trading Just 38% of respondents overall expect to be significantly or fundamentally affected by the new regulations. Surprisingly, that number falls to 35% for European firms—although it rises to 43% for UK businesses. Non-financials (45%) anticipate more fallout than financials (32%). Chart 12 Q Please assess the impact of EMIR on your company (% of respondents, by sector) FS Non FS Low impact (impacts profit of our 26 financing and risk management model) 33 Medium impact (Significantly impacts profit of 28 our financing and risk management model) 25 High impact (Fundamentally challenges viability 17 of our financing and risk management model) 7 Don’t know 15 17 Not applicable 14 18 Source: Economist Intelligence Unit survey, July 2012. Solvency II EU directive requiring greater capitalisation for insurance companies, which is expected to push them towards more risk-averse investment strategies Again, despite the fact that this is EU legislation, it appears to be of much greater concern to UK businesses across the board. Over three-fifths (63%) of UK respondents anticipate significant or fundamental fallout from the reforms, compared with only 44% of European firms. This may reflect the fact that the insurance industry in Europe is skewed towards small mutual specialists serving a local community, which may not even be large enough to qualify for Solvency II, rather than the major one-stop-shop insurers that dominate the UK market. 3 Category 1 Category 2 Category Category 4 Category 5 Category 6 Chart 13 Q Please assess the impact of Solvency II on your company (% of respondents, by sector) FS Non FS Low impact (impacts profit of our 18 financing and risk management model) 29 Medium impact (Significantly impacts profit of 29 our financing and risk management model) 34 High impact (Fundamentally challenges viability 31 of our financing and risk management model) 7 Don’t know 10 15 Not applicable 12 15 Source: Economist Intelligence Unit survey, July 2012.14 © The Economist Intelligence Unit Limited 2012
  • 16. Benefits and unintended consequences of financial markets reform MiFID II Far-reaching legislation designed to modernise, make more transparent and harmonise the EU securities markets; it is likely to affect any firm involved in the EU industry Just under one-half (47%) of respondents foresee a significant or greater impact; once again, Europe is fairly in line with the rest of the world, while in contrast UK respondents (58%) are expecting to feel much more heat from the reforms. Comparing FS and non-FS responses, more than four times the proportion of FS firms see the regulation as likely to have a fundamental impact on their business (23%, compared with just 5% for non-FS companies). However, 15% of respondents overall (including a worrying 13% of FS firms) have no idea how the impending MiFID II regulations will affect their business. Chart 14 Q Please assess the impact of MiFID II on your company (% of respondents, by sector) FS Non FS Low impact (impacts profit of our 18 financing and risk management model) 28 Medium impact (Significantly impacts profit of 37 our financing and risk management model) 32 High impact (Fundamentally challenges viability 23 of our financing and risk management model) 5 Don’t know 13 18 Not applicable 10 17 Source: Economist Intelligence Unit survey, July 2012. Category 1 Category 2 Category 3 Category 4 Category 5 Category 615 © The Economist Intelligence Unit Limited 2012
  • 17. Benefits and unintended consequences of financial markets reform ICB (Vickers Report) UK banking-reform proposals including ring-fencing of personal and SME deposits from wholesale and institutional operations Across the board, 35% of companies (rising to 43% among UK respondents) anticipate significant implications as a result of the ICB recommendations, which are due to become law in 2015. But again there is widespread uncertainty among firms. One-third of respondents in both the US and Europe do not know whether they will be affected. Chart 15 Q Please assess the impact of the Vickers Report on your company (% of respondents, by region) North America Mainland Europe UK Asia-Pacific Low impact (impacts profit of our 28 financing and risk management model) 34 25 16 Medium impact (Significantly impacts profit of 30 our financing and risk management model) 27 21 25 High impact (Fundamentally challenges viability 7 of our financing and risk management model) 17 4 13 Don’t know 14 7 32 32 Not applicable 22 16 18 15 Source: Economist Intelligence Unit survey, July 2012. Category 1 Category 2 Category 3 Category 4 Category 5 Category 616 © The Economist Intelligence Unit Limited 2012
  • 18. Benefits and unintended consequences of financial markets reform 4 OTC derivatives overhauled Looking specifically at the potential impact of the implications. Around 44% of respondents are EMIR and Dodd-Frank regulations governing OTC taking advice from external institutions such as derivatives trading, one clear conclusion from the banks or clearing houses as to how their business survey is that companies do not fully understand will be affected, while some, including Ignis Asset how the new regime will affect them. That problem Management, are going further and recruiting is echoed by Ms Ground at Schroders, who expert staff to deal with the changes. observes: “Companies don’t have a good grip on Overall, there is little difference between what’s involved, beyond the headlines.” financials and non-financials in terms of Thus, less than one-half (47%) of respondents understanding. But those top-line figures mask consider themselves reasonably au fait with the disparities between different subgroups. For impact of the new rules, although the biggest example, asset managers are likely to be well aware corporates (with annual revenue of US$10bn or of the implications for their institutional clients. more) are more up to speed, with 55% stating that Insight Investment, for example, uses interest they understand the impact of the new rules. rate and inflation derivatives markets to manage Interestingly, the smallest category of firms the solvency risk of its pension fund clients, surveyed ($500m-1bn in annual revenue) is close enabling them to reduce the volatility and protect behind them at 53%—it is the medium-sized the solvency of their pension schemes. “The businesses that seem to be lagging most. centralised clearing proposals, combined with the However, many companies are clearly taking current market-standard clearing mechanisms, measures to get a better grasp on the likely would significantly raise the long-term cost of Chart 16 Q Do you agree or disagree with the following statement? “We understand what will be required of our company under Dodd-Frank/EMIR” (% of respondents, by company size in USD revenue) Between $500m and $1bn Between $1bn and $10bn More than $10bn Strongly/somewhat 55 agree 37 53 Neutral 30 36 21 Somewhat/strongly 15 disagree 27 26 Source: Economist Intelligence Unit survey, July 2012.17 © The Economist Intelligence Unit Limited 2012
  • 19. Benefits and unintended consequences of financial markets reform Chart 17 Q Do you agree or disagree with the following statement? “We have assessed the regulatory impact and this will makes it more expensive and/or difficult to hedge risk.” (% of respondents, by region) North America Mainland Europe UK Asia-Pacific Strongly/somewhat 37 agree 45 41 63 Neutral 44 38 34 28 Somewhat/strongly 20 disagree 17 25 9 Source: Economist Intelligence Unit survey, July 2012. providing pension benefits,” Insight’s Mr the Dodd-Frank and EMIR proposals, just under Stancombe warns. one-third (30%) of respondents (or 42% of North There is some disagreement as to how far the American firms) are campaigning or consulting OTC derivatives market reforms will make it more with politicians, trade bodies or regulators to try costly or difficult to hedge risk. Almost one-half and get the regulations modified. Interestingly, (48%) of respondents think that there will be some 36% are not interested in further change. negative impact. North American respondents1are Category 2 OneCategory 3 Category particular Category 4 is the difficulty of 6 concern Category 5 Category most pessimistic: almost two-thirds (63%) believe extending the reach of these derivatives reforms that their ability to hedge will suffer as a beyond their home jurisdiction, such as to overseas consequence of the Dodd-Frank reforms. offices of domestic companies. “Extra-territoriality Against that, almost one-fifth (18%) of those or crossborder application of Dodd-Frank and EMIR surveyed think that there will be little impact on is a real sticking point and regulators on both sides costs or access to the market, with smaller companies of the Atlantic have really struggled to come up (23%) feeling markedly more positive than with an appropriate framework thus far,” businesses of US$15bn or more in revenue (12%). comments Mr Maloney from Ignis Asset Although there is significant unhappiness about Management. Chart 18 Q Do you agree or disagree with the following statement? “We are consulting politicians/regulators/trade bodies (either nationally and/or EU) for changes to Dodd-Frank/EMIR” (% of respondents) Strongly/somewhat 30 agree Neutral 34 Somewhat/strongly 36 disagree Source: Economist Intelligence Unit survey, July 2012.18 © The Economist Intelligence Unit Limited 2012
  • 20. Benefits and unintended consequences of financial markets reform 5 Corporate responses What kind of action are companies taking, or strategy to the requirements of the new regime. considering, in response to the regulatory Over two-fifths (42%) of respondents intend to changes? The most popular option by some way is make such changes. However, a number of to adapt their existing finance or risk-management alternatives have significant support, including Chart 19 Q Are you actively considering or progressing with any of the following to mitigate the impact of upcoming financial services regulation? (% of respondents, by region) North America Mainland Europe UK Asia-Pacific Changing/ reducing use of derivatives 34 29 17 24 Centrally clearing derivatives 13 21 23 20 Changing my financing and/or risk 40 management model 39 43 44 Becoming part of a co-operative bank 8 with other corporates 10 7 12 Seeking funding from different providers 22 29 24 30 Changing service providers 26 33 12 27 Re-locating or changing the legal/ 17 regulatory structure of my organisation 33 20 33 None of the above 26 20 29 19 Source: Economist Intelligence Unit survey, July 2012.19 © The Economist Intelligence Unit Limited 2012
  • 21. Benefits and unintended consequences of financial markets reform finding other sources of funding (27%), physically considerably more willing than their non-FS relocating (26%), reducing the use of derivatives counterparts to reduce the use of derivatives (30% (25%) and changing service providers (24%). versus 21%); indeed, this is the second most Interestingly, European companies seem popular option among FS respondents. Similarly, reluctant to consider any of these alternatives, FS firms are more prepared to make use of particularly a switch of service providers (12%) and centralised derivatives clearing: 26% of financials changes to the way they use derivatives (17%). said that they have taken or are considering this Almost three in ten (29%) of European option, compared with 15% of non-financials. respondents claim that they would take “none of However, notes Mr Maloney at Ignis Asset the above” measures. By contrast, both UK and US Management, regulation is likely to stimulate firms appear much more prepared to vote with their innovation in financial products. “It is widely feet: one-third of British companies are ready to expected that the market in general will move away switch to new service providers, while physical from such heavy OTC use…We expect to see new relocation and switching funding are also high on products entering the market which, while having the list for both countries. the same risk-management characteristics as Looking at the difference between FS and non- clearable swaps, are neither clearing eligible nor FS companies, it seems that financials are subject to higher capital charges.” Chart 20 Q Are you actively considering or progressing with any of the following to mitigate the impact of upcoming financial services regulation? (% of respondents, by sector) FS Non FS Changing/ reducing use of derivatives 30 21 Centrally clearing derivatives 26 15 Changing my financing and/or risk 48 management model 36 Becoming part of a co-operative bank 8 with other corporates 9 Seeking funding from different providers 23 30 Changing service providers 24 24 Re-locating or changing the legal/ 28 regulatory structure of my organisation 24 None of the above 21 26 Source: Economist Intelligence Unit survey, July 2012.20 © The Economist Intelligence Unit Limited 2012
  • 22. Benefits and unintended consequences of financial markets reform 6 The bottom line The survey makes clear that different companies (approx. USD$16m) to cover the cost of increased expect to be spending very different amounts on financial regulation. It also becomes more difficult the costs of implementation, although as might be to quantify the total anticipated spend for the expected there is some correlation between biggest companies: a further 31% said that they expenditure and company size. Thus, 20% of could not put a figure on the likely cost of moving respondents overall anticipate bills of less than into line with the new regime. £500,000 (approx. USD$810,000) over the next 12 “I have already seen eye-watering sums, months as a result of the regulatory changes, but running to many millions, spent by the big banks— in the smallest category (US$500m-1bn in annual and over the medium term those figures are likely revenue) that proportion rises to 37%. to become really massive,” says Ms Ground of At the other end of the spectrum, another 20% Schroders. of respondents, and one-third (31%) of firms worth How will these costs be dealt with? It is hard to over US$10bn, expect to spend more than £10m escape the conclusion that, in most cases, clients Chart 21 Q Approximately how much will you be spending in the next 12 months to cover the cost of increasing financial regulation (e.g IT, people, loss of sales, management time)? (% of respondents, by company size in USD revenue) Between $500m and $1bn Between $1bn and $10bn More than $10bn £0 to 0.5m 7 16 37 £0.5 to 1m 8 15 17 £1m to 5m 11 16 15 £5m to 10m 7 9 6 £10m+ 31 6 5 Cannot quantify 30 29 19 Don’t know 7 9 2 Source: Economist Intelligence Unit survey, July 2012.21 © The Economist Intelligence Unit Limited 2012
  • 23. Benefits and unintended consequences of financial markets reform will ultimately pick up the tab for increased asserts Ms Ground. regulation. Mr Stancombe at Insight Investment Looking at the derivatives landscape, Mr says that his company “would not expect to pass on Maloney at Ignis Asset Management suggests that the implementation costs to establish the the costs will be so great that a significant shift is infrastructure to support the new regulatory likely to occur within the FS industry, as asset requirements,” although he points out that clients managers have to re-evaluate how far the will see costs such as transaction charges rise as a increased costs of hedging using derivatives offset consequence of the changes, and these are passed the benefits of the hedge. “One would expect end directly on to investment clients. users to take comfort in having their assets in a But for other commentators, all costs are bound well-regulated product—but at what cost? I expect to be shouldered by end users. “Either consumers there to be further public discomfort once the true will pay in the end, or firms will stop offering costs of these reforms trickle down into end-user products that involve increased compliance,” returns,” he adds.22 © The Economist Intelligence Unit Limited 2012
  • 24. Benefits and unintended consequences of financial markets reform 7 Potential consequences The 2008-09 global financial crisis and subsequent involved.” Moreover, there is a further risk that the serious failures of the banking system to regulate derivatives market will become concentrated within itself have resulted in general consensus that far- a handful of the biggest clearing houses. “If a reaching reforms are both necessary and inevitable. major crisis occurs and banks begin to fail again, As Ms Ground from Schroders observes: “There has how will this huge concentration of risk be been a culture of excessive risk-taking and poor managed without systemic impact?” financial products, and substantial reform had to take Two-thirds (68%) of those surveyed anticipate a place. And a lot of this regulation is good: it means significant or fundamental impact on the more capital is backing the system, leverage ratios are profitability of their financing and risk- controlled and there is greater transparency and management models, while more than one-half regulation of counterparty contracts.” (51%) of respondents are concerned that planned Mr Stancombe at Insight Investment agrees that financial regulation will impact on growth in their the fundamental principles underpinning industry and 44% expect it to affect innovation. derivatives market reform are laudable. “Increased That effect could be made worse for some market transparency to regulators and systemic countries if there is not sufficient regulatory risk reduction have the potential to deliver greater collaboration and consensus between jurisdictions— security for market participants and wider in the face of regulatory threats, capital may well stakeholders,” he notes. migrate to other relatively “light-touch” But there is widespread concern over authorities’ jurisdictions. As the survey shows, that is clearly an swift moves to regulate in many areas at once. Says option being considered by both financial and Ms Ground: “They have tightened all the regulations non-financial companies of all sizes. It is particularly at once, without a clear understanding of the attractive to the biggest corporates, one-third of unintended consequences and costs.” which would seriously consider relocating. One of those unintended consequences may be In short, it is very difficult to say whether the that asset managers decide that it is no longer benefits of the forthcoming regulatory overhauls financially viable to use derivatives to hedge risk. will outweigh the negatives, as we have not been “The underlying risk will clearly continue to exist, here before. The regulators are keen to close the but will be borne by a group of people less many loopholes and skewed systems that led to equipped to manage it,” Mr Stancombe warns. previous systemic failures—but neither they nor Even if that does not happen, adds Ignis Asset anyone else can anticipate what the full Management’s Mr Maloney, “the market consensus consequences of the new regulatory regime will be is that performance returns will be compromised as in terms of its impact on companies and a result of the tremendous additional costs economies.23 © The Economist Intelligence Unit Limited 2012
  • 25. Benefits and unintended consequences of financial markets reform Appendix: survey results Percentages may not add to 100% owing to rounding or the ability of respondents to choose multiple responses. What do you see as the most important issues facing your company today? Select up to three (% respondents) Global economic uncertainty 58 Eurozone crisis 54 Regulatory changes 50 Lack of confidence 25 Lack of industrial/economic growth/investment 24 Lack of (consumer) demand 23 Availability of finance 20 Other 3 Do you agree or disagree with the following statements? Rate on a scale of 1 to 5 where 1 is strongly agree and 5 is strongly disagree (% respondents) 1 Strongly 2 3 4 5 Strongly agree disagree Our board is aware of how planned financial regulations will impact our company. 33 43 18 5 0 My company is prepared for the impact of planned financial regulations. 18 43 31 71 I worry that planned financial regulations will inhibit growth in my industry. 21 30 30 14 4 I worry that planned financial regulations will inhibit innovation in my industry. 17 27 31 19 524 © The Economist Intelligence Unit Limited 2012
  • 26. Benefits and unintended consequences of financial markets reform What are the biggest potential benefits to your company from planned financial regulations? Select up to two (% respondents) Better transparency of risk 42 More stable financial markets 41 Increased market (pricing) transparency 30 Reduced counter-party/credit risk 29 I don’t see any benefits 13 Don’t know 2 What are the biggest potential threats to your company from planned financial regulations? Select up to two (% respondents) Increased cost of compliance 59 Increased cost of funding 38 Increased IT costs 25 Restrictions on where we can operate 19 Increased cost of hedging risk 16 Difficulty in securing banking products or services we need 13 I don’t see any potential threats 5 Don’t know 1 Please assess the impact of the below regulations on your company. (% respondents) Low impact (impacts Medium impact High impact Don’t know Not applicable profit of our financing (Significantly impacts (Fundamentally and risk management profit of our financing challenges viability of model) and risk management our financing and risk model) management model) Basel III 26 35 24 6 10 Dodd-Frank (OTC) 26 30 14 11 18 EMIR (OTC) 30 27 11 16 16 MIFID II 24 34 13 15 14 Solvency II 24 32 18 13 14 Vickers Report (ICB) 27 25 10 20 18 Compound Impact of all Regulatory Change 19 41 27 8 525 © The Economist Intelligence Unit Limited 2012
  • 27. Benefits and unintended consequences of financial markets reform Do you agree or disagree with the following statements on the regulatory impact on the use of derivatives? Rate on a scale of 1 to 5 where 1 is strongly agree and 5 is strongly disagree (% respondents) 1Strongly 2 3 4 5 Strongly agree disagree We understand what will be required of our company under Dodd-Frank/EMIR. 12 35 30 16 7 We are speaking with appropriate institutions (e.g service providers, banks and clearing houses) to assess the impact of Dodd-Frank/EMIR on our company. 13 31 33 15 8 We have assessed the regulatory impact and this will makes it more expensive and/or difficult to hedge risk. 12 35 35 11 7 We are consulting politicians/regulators/trade bodies (either nationally and/or EU) for changes to Dodd-Frank/EMIR. 12 18 34 20 16 Are you actively considering or progressing with any of the following to mitigate the impact of upcoming financial services regulation? Select all that apply (% respondents) Changing my financing and/or risk management model 42 Seeking funding from different providers 27 Re-locating or changing the legal/ regulatory structure of my organisation 26 Changing/ reducing use of derivatives 25 Changing service providers 24 Centrally clearing derivatives 20 Becoming part of a co-operative bank with other corporates 9 None of the above 24 How has the the availability of the following services changed since the introduction of new financial regulations post-financial crisis? (% respondents) Less available No change More available Don’t know Risk Management 15 38 42 5 Funding Solutions 42 39 12 7 Cash Management 22 51 18 9 Trade Finance 27 46 12 15 How has the shift in pricing (and therefore attractiveness) of the following services changed since the introduction of new financial regulations post-financial crisis? (% respondents) More expensive No change Less expensive Don’t know Risk Management 56 30 4 10 Funding Solutions 58 29 4 9 Cash Management 38 45 5 12 Trade Finance 36 39 6 1826 © The Economist Intelligence Unit Limited 2012
  • 28. Benefits and unintended consequences of financial markets reform Approximately how much will you be spending in the next 12 months to cover the cost of increasing financial regulation (e.g IT, people, loss of sales, management time)? (% respondents) £0 to .5m 20 £0.5m to 1m 13 £1m to 5m 14 £5m to 10m 7 £10m+ 13 Cannot quantify 26 Don’t know 6 What are your company’s annual global revenues in What is your job title? US dollars? (% respondents) (% respondents) Board member Less than $500m 0 3 Between $500m 32 CEO/President/Managing director 9 and $1bn CFO/Treasurer/Comptroller Between $1bn 27 18 and $5bn CIO/Technology director Between $5bn 10 2 and $10bn Other C-level executive 13 Between $10bn 5 and $15bn SVP/VP/Director 24 More than $15bn 25 Head of Business Unit 6 Head of Department 9 Manager 14 In which region are you personally located? Other (% respondents) 2 Western Europe 54 Asia-Pacific 20 North America 20 Eastern Europe 6 Latin America 0 Middle East and Africa 027 © The Economist Intelligence Unit Limited 2012
  • 29. Benefits and unintended consequences of financial markets reform In which country are you personally located? What is your primary job function? (% respondents) (% respondents) United Kingdom Finance 34 31 United States of America Strategy and business development 16 14 India General management 6 12 Canada Risk 4 12 Australia Marketing and sales 3 7 Netherlands IT 3 6 Switzerland Operations and production 3 4 France Customer service 2 2 Singapore Information and research 2 2 Germany Supply-chain management 2 2 Italy Legal 2 2 Austria R&D 2 2 Belgium Human resources 2 1 China Procurement 2 1 Spain Other 2 3 Poland 1 Denmark 1 Finland 1 Hong Kong 1 Ireland 1 Sweden 1 Turkey 1 Indonesia 1 Luxembourg 1 New Zealand 1 Russia 1 Ukraine 128 © The Economist Intelligence Unit Limited 2012
  • 30. Benefits and unintended consequences of financial markets reform What is your primary industry? (% respondents) Agriculture and agribusiness 2 Automotive 1 Chemicals 2 Construction and real estate 2 Consumer goods (excluding retail) 4 Education 1 Energy and natural resources 5 Financial services: Bank 22 Financial services: Insurance company 8 Financial services: Asset manager 6 Financial services: Other financial services 8 Healthcare services 2 IT and technology 12 Logistics and distribution 2 Manufacturing 7 Media and entertainment 2 Pharmaceuticals and biotechnology 2 Professional services 9 Retail 329 © The Economist Intelligence Unit Limited 2012
  • 31. Benefits and unintended consequences of financial markets reform Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this white paper or any of the information, opinions or conclusions set out in the white paper.Cover: Shutterstock 30 © The Economist Intelligence Unit Limited 2012
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