Still only end of the beginning for new bank rules

January 12, 2011

By Peter Thal Larsen and Richard Beales
The following article is part of Reuters Breakingviews’ e-book, Predictions for 2011. The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

LONDON/NEW YORK — Policymakers and regulators around the world put in a lot of work in 2010 designing post-crisis regulations. But there are still plenty of question marks over implementation — and some knotty issues have barely been tackled. Meanwhile, a level global playing field looks an ever more distant dream. If financial institutions hoped that 2010 was the high watermark for regulation, they will be disappointed. Here’s a look at potential developments in 2011.

Systemic risks: One of the biggest post-crisis developments has been the creation of bodies that are supposed to identify and help prick financial bubbles. These so-called macro-prudential regulators are in various stages of being set up in the United States, the UK and Europe.

But the devil will be in the detail of how they work; for instance their interaction with monetary policy authorities such as the Federal Reserve, the Bank of England and the European Central Bank. That’s still largely a work in progress.

Bank structure: Regulators will spend much of 2011 trying to ensure a future financial collapse doesn’t do too much damage. The Dodd-Frank Act passed by the U.S. Congress gave regulators specific powers to wind down a failing financial institution. The UK passed similar rules. However, this approach is inadequate when it comes to winding down large cross-border banks. There’s still plenty of room for debate and disagreement on how best to tackle this problem.

U.S. bankers and regulators, meanwhile, need to figure out what proprietary trading really is. Dodd-Frank included a near-ban on banks trading for their own accounts rather than for clients. But working out where to draw the line is a continuing headache.

And in September, the UK’s Independent Commission on Banking is due to deliver its final report. It is likely to stop short of breaking up banks. But it may push for them to separate their investment and retail banking businesses more effectively.

Bank capital: The Basel III rules, agreed by global authorities in September, spelled out how to increase banks’ capital strength. The challenge now is making sure they are consistently implemented.

This is far from assured: U.S. regulators never formally introduced the previous set of rules, while countries like Japan have been pushing for a slower timetable. To keep bankers on their toes, an additional capital buffer for too-big-to-fail banks is due to be agreed by mid-2011.

Derivatives: Dodd-Frank requires standardised derivatives to be cleared through central clearing houses, thereby reducing the risk that one bank’s failure will drag down the system. Now the Commodity Futures Trading Commission, along with the Securities and Exchange Commission, must decide — in pretty short order — how the law will be implemented. For example, it must draw up governance requirements for clearing houses, avoiding, for instance, the danger that clearing houses themselves become systemically risky.

The European Union will in 2011 play catch up with the United States on derivatives. Its proposed rules, published in September, concentrate mainly on central clearing. One big challenge will be trying to minimise the differences between the EU and U.S. approaches.

Bonuses: The Fed has set out high-level principles, but has no plans to set specific rules. This is in stark contrast with the EU, which has introduced specific limits on how much of a bankers’ bonus can be paid in cash. Such differences put the likes of Barclays and Deutsche Bank at a distinct disadvantage when competing in New York or Singapore — making further contentious debate likely.

Hedge funds: Hedge funds are feeling their way into a more regulated world. Dodd-Frank requires them to be registered, while regulators will keep a closer eye on whether they are taking risks big enough to threaten the system. In Europe, hedge funds will also have to be more transparent, and subject to more scrutiny, to gain access to onshore investors.

The rest of the world: Europe and the United States have done the most to overhaul financial regulation — hardly surprising considering they suffered the worst effects of the recent crisis. But for new rules to be effective, there can’t be big differences between jurisdictions. Most emerging economies have long demanded high capital ratios for their banks, so adopting Basel rules should not be too hard. But securing a level playing field for winding down big banks or regulating derivatives could prove more difficult.

This means Western governments will face a new dilemma in 2011. Will they follow through on tougher rules even if this prompts banks to shift businesses to more friendly parts of the world? Or will they relent, at the risk of making future crises more likely? The mechanical and political machinations of financial reform have a long way to go.

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