The following interview is a transcript of an interview with Jiri Krol, deputy CEO and head of government and regulatory affairs, AIMA. For the complete video of the discussion, please click here. To read AIMA's Regulating Capital Markets, click here.
Hamlin Lovell: Thanks very much for joining us today. What are the consequences of a one-size-fits-all approach to investor protection regulation?
Jiri Krol: Well, the consequences are very simple and predictable: you will find yourself with only very narrow market segments developing – not just in the funds sector but most likely in the overall capital markets sector. So for example: you would probably not have the hedge fund industry in existence if the ‘40 Act funds were the only possibility to conduct collective asset management in the United States. Similiarly in Europe, if we only had UCITS in its original form – not the more expanded or liberal UCITS III – you would equally not have the hedge fund sector developing if there were no possibility to conduct asset management business under other regulatory requirements. So it is very important to ensure that there is a differentiation between the retail sector of the market and the wholesale sector of the market, where greater emphasis on investor protection needs to be introduced in the retail sector.
HL: Thinking geographically, what are the dangers of uncoordinated global regulations?
JK: The dangers are again quite clear and the policymakers are aware of them. I think the first and foremost danger is that we have fragmentation and Balkanisation (if I can put it that way) of the global markets. Capital markets have operated globally over the past decades, and that has lead to a dramatic decrease in the cost of capital, so I think the very end result and the final consequence of fragmenting those markets would be an inevitable increase in the cost of capital, at the time where the real economy has a need to find a substitute or a greater or more robust role for the sector whilst the banking sector deleverages and finds higher levels of capital for its operation.
HL: In the search for solutions to create more consistent global regulations, could the European Union equivalence rules be extended?
JK: Yes, that is one way in which you could deal with international and cross-border issues, and the provision of services of various providers across those borders. Of course, it is not the only solution – using equivalence – and equivalence assessment doesn’t necessarily have to be a solution. It can also be a barrier if conducted in a way which doesn’t take account of outcomes and focuses only on assessing the detailed rules and whether the rules of a third-country jurisdiction that is a candidate for being deemed equivalent are, and therefore allowing the service providers in that jurisdiction to cross borders into the EU. If the regulation is assessed in a very, shall we say, rule-by-rule, “tick box” manner then we are likely not to obtain equivalence and therefore the equivalence assessment is going to be an empty gesture. This was something with which we have had to contend with the AIFMD regulation, where it was clear that using equivalence as a passport mechanism was never going to work because the whole world had a very different standard of regulating hedge fund managers. We fought very hard for the preservation of the private placement regimes – at least in certain member states, because we felt the passporting mechanism wouldn’t work.
So equivalence is only an answer ifthe process has clearly defined goals which focus on outcomes as opposed to individual regulatory provisions, and as long as it is conducted with an open frame of mind, and as long, of course, as there is somebody on the other side who has a similar understanding of how cross-border provision of services should work. So in the United States, for example, we have an approach, called substituted compliance, which is slightly different, but in the end attempts to achieve the same result, making sure that cross-border activities can continue, with potentially some overlap in regulation but hopefully without an overlap which is not possible to resolve – an overlap which doesn’t place financial actors in a position where they have to choose between one or the other jurisdiction.
HL: Another area where some people in the industry would like to see more global consistency is in reporting requirements – the growing amounts of data which need to be reported to regulators. Is there a common global standard for this reporting?
JK: There isn’t, and we believe that it was an historic opportunity missed. Hedge fund manager systemic risk reporting wasn’t in existence until the FSA (at the time) started collecting data on the largest managers operating in its jurisdiction. When the regulatory push came along following the financial crisis, everyone agreed that it would be good to have a globally consistent and harmonised set of data reported by hedge fund managers so that we can have a global picture of what the industry is doing and have a tool to be able to understand how and whether there is a development in systemic risk from the industry, and crucially, whether the industry poses systemic risk in comparison to other segments of the capital market. Because this was an area where reporting didn’t exist previously we didn’t have the path-dependency problem of existing systems being difficult to change. We felt it was possible to develop a globally harmonised standard. However, the timing inconsistencies and the difference in the institutional adoption of the various legislative and regulatory provisions have led to considerable divergence in some of these reporting standards, especially between the United States and the European Union.
HL: It sounds like regulations haven’t been finalised in all areas. In which areas in particular do you think that regulations need to be further developed and clarified?
JK: Well overall we hope that we will experience a period of regulatory stability following the adoption of Dodd-Frank and associated rule-makings, and in Europe, AIFMD and other measures relating to the banking and the capital markets industry. There are some areas that we feel could be developed further. Very narrow and specific areas related, for example, to the protection of client assets, when it comes to segregation. We don’t believe we are fully there yet when it comes to achieving full physical segregation as an option in the United States. I’m talking about full physical segregation of collateral which is posted as part of the central clearing transactions that our members engage in. Equally, in Europe there could be some further movement and clarification to the optionality given to clients to clear centrally under the full segregation regime. This is one area where we continue to push for some further clarification, but it is going to be difficult. It’s interesting, in a sense, that this is one area of investor protection where we have not really received the same concern from the policy and regulatory community as we have in others. If you think about how much the European policymakers have fought for investor protection in the area of depositary liability and how much of a fierce battle that was, and how much political capital was put into that, it is strange that, in an area which is equally important, if not more, because we are dealing with systemically important institutions, CCPs and clients that participate in them, we haven’t received or seen the same level of concern being expressed when it comes to asset protection. But overall we don’t feel that there are any major gaps in the regulatory framework that has been introduced or that is about to be finalised.