Editor’s Letter – Issue 127

October 2017

HAMLIN LOVELL

The inaugural ESMA conference, held in Paris in October 2017, touched on a wide range of interconnected regulatory topics. There is much to play for if regulations are to attain their aims. The fact that 10 trillion Euros are sitting in deposit accounts paying sub-zero interest rates is viewed as a lost opportunity by ESMA’s Chairman, Steven Maijoor. This is partly because, after years of various initiatives (simplified prospectuses, KIIDs and now PRIIPS), fund literature is not intelligible to the vast majority of people. Clearly, the Capital Markets Union (CMU) project has yet to give European savers the confidence to embrace a US-style culture of investing into capital markets, which are still much smaller than in the US. Hence, Europe’s 23 million SMEs are still over-reliant on bank debt. Therefore, alternative lending, both directly and via capital markets, which many hedge fund and private equity managers pursue, has a long and strong runway of further growth ahead.

High hopes that MiFID II may enhance transparency and reduce costs are weighed against fears that MiFID II could have unintended consequences including further fragmenting equity markets and threatening liquidity, which could also be hampered by the levels of capital requirements for market makers (imposed by other regulations). These are perceived as excessive if market makers are not deemed to be systemic institutions. Additional MiFID II concerns are that it raises barriers to entry as larger asset managers can more easily absorb research costs, and that it may reduce (already patchy) sell side research coverage of smaller and medium sized companies. That could also impair liquidity.

If equity market liquidity is measured by daily turnover, Europe’s $40 billion is well below US levels of $200 billion. Net new issues are in fact rather low in the US and Europe, where regulations are thought to have made it onerous and costly for firms to go public. The number of public companies in the US and EU has been fairly static for years, whereas Asia has spawned 7,000 new ones taking its total to 27,000. Asia is also seeing an impressive number of hedge fund launches, many of which are smaller than those in the US or Europe.

These and other concerns are contributing to some degree of regulatory fatigue. From some quarters, including regulators themselves, there are refreshing noises suggesting that some regulations may have gone too far. European Commission Director General, Olivier Guersant, acknowledged that over-complex and over-specific rules could discourage long term investment. Hong Kong SFC chief, Ashley Alder, said that IOSCO was examining whether OTC derivatives rules were prohibitively expensive for hedging users. LSE chief, Xavier Rolet, expressed concern that European Commission proposals on CCPs go well beyond the US regime in terms of extra-territoriality.

Still, it would be premature to speculate that the regulatory pendulum is swinging back, not least because regulators expect to spend many years implementing, iteratively interpreting, and evaluating, existing rules.