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Regulatory Harmonization: Time To Network

The U.S. financial regulatory landscape is highly decentralized, with different agencies and bodies having separate objectives, yet overlapping remits. At a recent conference co-hosted by S&P Global Market Intelligence and the NYU Stern School of Business, industry experts spoke about the need for greater harmonization between regulators on a global scale.

From the FRB to the SEC, many industry commentators feel as though there are ‘too many cooks’ involved in the creation and oversight of US banking regulation. Recently, banks’ frustration at the fragmented regulatory landscape has been reignited by the news that the FASB (Financial Accounting Standards Board) will now play a critical role in the framework for expected credit loss.

Although the FASB has always been involved in loan losses to some extent, what the market is objecting to is the final current expected credit loss (CECL) standard, which was released on 16th June 2016, and its wide-reaching impact on financial institutions. The current impairment model is based on incurred losses: in contrast, the new CECL model, which is being described as the most significant change to accounting in the last decade, is a forward-looking estimate of what the total losses will be in the portfolio.

The reason for this sea change, said Mark Carey, Associate Director in the Division of International Finance at the Federal Reserve, is that over the last 20 years fair value accounting models have “crept in.” While the accounting bodies tend to look favorably on these, due to illiquid instruments and the desire to be more forward-looking on loan losses new models are required.

Tug of war

The concern among market participants is the potential impact of CECL on capital ratios. While there is currently no clear response from the FASB on that point, Mark Flannery, Chief Economist and Director of Economic and Risk Analysis at the Securities and Exchange Commission, said that if a pinch on capital ratios does result, the prudential banking agencies may be able to step in and change the treatment for loan losses. While this may be good news for banks, it only highlights the ‘tug of war’ that exists between the US financial regulatory and oversight institutions.

Aside from the FASB’s specific involvement in loan losses, Knut Kjaer, Founding partner of Trient Asset Management and Chairman at FSN Capital, commented that the industry has much more to do in order to model risk in an appropriate way. This is not just a job for the regulators and oversight bodies, however: he believes that financial institutions themselves must take greater responsibility for building a risk management culture and developing appropriate models.

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Nevertheless, he conceded that financial institutions do not currently have the right culture built-in, and an inevitable result is highly prescriptive regulation – and a complex web of regulatory protagonists.

A regulatory network

On that note, Audrey Costabile Blater, Director of Research at International Swaps and Derivatives Association, raised the need not only for greater cooperation between U.S. regulators, but between regulators across the globe. The tidal wave of post-crisis regulation, she said, has highlighted holes in the global regulatory response, with many overlapping regimes on both sides of the Atlantic – Dodd-Frank and MiFID II being a case in point.

This lack of coordination among global regulators is placing a perceived burden on financial institutions, leading to regulatory fatigue and, ultimately, impacting profitability (financial institutions’ annual spend on regulatory compliance is now estimated to be in excess of $70 billion1).

Going forward, it will be critical for global bodies to look at regulations as a network and study the way they interact, noted Costabile Blater, in order to minimize duplication and reduce the burden of unintended consequences. 

Financial institutions’ annual spend on regulatory compliance is now estimated to be in excess of $70 billion.
This kind of coordination could also help to lessen market dislocation resulting from regulatory initiatives – which is not uncommon. Since the October 2013 Swap Execution Facility (SEF) rules came into force, for instance, there has been a fracturing of global swap markets and some liquidity pools have become split along US and non-US lines, she explained.

Without doubt, a coordinated regulatory regime which acts as a network rather than a patchwork must be the way forward – both in the U.S. and on the global stage.

Read a full discussion of the topics covered by the panel at our recent event on the regulatory landscape for banking.

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Sep 14, 2016