Saturday, 21 July 2018

Who guards the guardians?

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Anthony Peters bemoans what he sees as regulation for regulation’s sake.

Anthony Peters

Anthony PetersSwissInvest strategist

I WAS A little shaken when I opened the FT on Tuesday and read a report on the precipitous growth of shadow banking in the US and how it should be regulated more carefully.

Should it really? Banking regulation is surely supposed to be for the protection of depositors and not borrowers. So, as shadow banking entities broadly distinguish themselves from banks by the very fact that they don’t take deposits from the public, should they not be treated as commercial enterprises with commercial risk like any other business?

I happen to sit on a working committee which deals with communication between the market, regulators and legislators. The same issues come up again and again with respect to regulators, namely that they are trying to turn markets into risk-free environments.

It was at a meeting of this committee that one of the members alluded to a conversation he had had with a regulator, who admitted that he didn’t give a fig what happened to markets and that all he was concerned with was that no disasters should happen on his watch.

In other words, the regulator in question was not seeking to protect the end-user – in our case the investor or the depositor – but himself.

So who guards the guardians? Deeply chastened by the events leading up to the financial crisis, banks and bankers have often sounded like spoilt children when they have sought to resist the implementation of regulation for regulation’s sake, but this is not entirely fair.

IT WAS AFTER all the politicians who decided not to let banks fail and who drew on significant amounts of taxpayers’ money in order to save them – or, maybe more accurately, to save them in their entirety and intact.

The price for failure by regulators to suitably regulate before the crisis is being charged to the banks now and, by proxy, to those who were supposed to be protected by the process.

Although our primary market appears to be in reasonably decent working order, the secondary market is, for lack of a better description, broken. Capital costs have made trading and inventory positioning prohibitively expensive and we now find ourselves with institutions forced into becoming de facto buy-and-hold investors.

And if we remind ourselves where the institutions take their investment dollars from, we find that (with the notable exceptions of the property and casualty insurers and the reinsurers) most significant institutional investors directly represent the interests of the very Aunt Augustas who are supposed to be protected.

The growing difficulty – even inability – of pension funds, mutual funds and life companies to optimise their portfolios in line with their strategic or tactical intentions must surely not be what the authorities had in mind when they decided to clip the markets’ wings.

Regulation for regulation’s sake – and for the sake of the regulators – must be avoided in order to protect the free flow of capital

WOULD COLUMBUS HAVE found funding for his trip to America, or would the railways that bind continents together ever have been built if they had depended entirely on bank finance?

More to the point, who would be able to buy a car if they could not rely on the “shadow banks” which are the automaker’s finance companies? General Electric and Siemens are both now seen as core lenders with residual interests in electrical engineering. In fact, GE’s bonds are traded in the financial space.

The latest round of regulation was put in place in order to encourage changes to the world of banking, especially with respect to the amount of leverage that can be generated.

Whether it was the chicken or the egg in terms of the way that the industry has mutated over the past five years or so might be a moot point, but it has changed enough to make some of the rules already look out of date. Many of these are not in need of fine-tuning, but of a wholesale conflagration.

BUT BACK TO my original question. Who are the regulators supposed to be protecting and from whom and what exactly?

To what extent should finance companies which do not draw funds from the public be regulated? If they fund themselves in public markets, then perhaps they should be subject to judicious oversight, as one could argue that Aunt Augusta might be carrying exposure.

But have not the events of the past years taught lenders and investors to ask more and more searching questions of their own volition?

Unless the purpose of regulation is made very clear and unless a cost/benefit analysis can demonstrate that the benefits gained from regulation clearly outweigh the cost to the economy in terms of unavailable credit, then a rethink is required.

Regulation for regulation’s sake – and for the sake of the regulators – must be avoided in order to protect the free flow of capital, and losses taken along the way are nothing more than the price of capitalism. And that is a price that I believe is worth paying.

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