Regulatory Wrangling

Rock, Meet Hard Place

With the US government declining to take the (politicized) step of naming China a currency manipulator just weeks ago, it seemed as though we’d perhaps moved beyond the trade tiffs and economic squabbling between the world’s two biggest economies. On Tuesday, though, relations took an interesting turn as US and Canadian securities regulators announced plans to file suit against five global accounting firms’ Chinese arms.

The investigation and subsequent lawsuit are based on the allegation the Chinese operations of the Big Four plus one are in violation of 2002’s Sarbanes-Oxley Act. But the firms suggest the real trouble is complying with SarbOx’s tight guidelines would put them in violation of Chinese law—and perhaps get them barred from operating in the country. So it truly seems the gripe or disagreement may be between US GAAP accounting standards and Chinese.

That there’s a gulf between Chinese and US standards isn’t exactly new news. China argues its standards are sufficient and aren’t under the purview of the US government. The US argues the SEC is charged with protecting investors trading on American markets and China’s standards aren’t up to snuff. For some time now, Chinese firms trading on US markets have been subject to rather intense scrutiny.

All in all though, it seems a little bit strange for the US government to punish US firms for not violating another sovereign’s rules. To be sure, the matter as it stands now is limited in scope and broad market impact. But the story may not end there in the sense it could amount to another trade tiff—and in that sense, it’s worth watching.

EU Bank Regulation, Take 1

Negotiations over Europe’s proposed banking union hit a stalemate at Tuesday’s gathering of EU finance ministers with several key issues unresolved. Among them: How would centralized regulation impact the UK, home to three fourths of Europe’s financial services industry and over 40% of euro-denominated forex transactions?

France’s central bank chief, Christian Noyer, suggests the new scheme should strip London of its status as Europe’s financial hub: “It is clear there is no rationale for the biggest financial center active in our currency or providing services in our economic union being an offshore center.”

He tried to tie this to the ECB’s ability to provide liquidity and, under the new system (assuming it gets off the ground) regulate the eurozone, but protectionism is also likely at work. France and other nations don’t like that more euro-denominated capital markets activity happens in London than the eurozone. They covet the economic benefits London enjoys and, most likely, the revenue they assume their financial transaction tax would bring if banking moved from London to Paris, Frankfurt or wherever else. Repatriation is their likely goal.

Trouble is, short of capital controls, the eurozone can’t make this happen. Even if London were somehow forced to submit to an EU banking watchdog and surrender its regulatory and tax advantage, capital markets activity wouldn’t automatically flow to the continent. Instead, firms would likely seek other areas with friendly regulatory regimes—areas completely out of the EU’s remit, perhaps—transact there, and then repatriate the funds. Euro capital markets activity would not only happen outside the eurozone, but outside the EU. That’s likely the opposite of what Mr. Noyer intends.

EU Bank Regulation, Take 2

Another rift widened at Tuesday’s EU talks, this time between Germany and France. Both nations agree on the broader concept of centralized banking regulation, but they differ on the details. In question is the ECB’s remit: How broad should its oversight be as the eurozone’s single bank supervisor? France, Spain and (of course) the ECB believe it should oversee ALL eurozone banks (with France suggesting it should regulate the entire EU)—since most banks hold cross-border assets, they argue, all oversight should transcend local and cross-border politics. Germany, however, believes the ECB should only oversee the dozen or so largest eurozone banks. Regional banks, German officials argue, “operate differently from large multinationals,” and the ECB may not properly account for these issues. Germany also registered concern over potential conflicts of interest, fearing the ECB may have difficulty separating banking regulation from monetary policy duties.

These differences, along with the wrangling over London, are just some of the issues stalling the EU’s banking union. Other non-euro countries (Sweden, Hungary, Poland, the Czech Republic, etc.) are concerned how centralized oversight would affect their financial interests in eurozone neighbors’ banks. Would non-euro countries have representation on the ECB’s governing board? Would their investments be hindered by too-harsh regulation, or would they be able to opt out of provisions that should apply only to eurozone banks? What role would their national regulators play?

The longer these issues linger, the less likely the EU meets its (arbitrary) year-end deadline. But while some eurozone officials bemoan this, in our view, kicking this can likely helps eurozone leaders lower the risk of rushing into a suboptimal scheme.

The Volcker Rule Strikes Again

The Volcker Rule, one of the many work-in-progress provisions of the Dodd-Frank/Wall Street Reform legislation, reared its ugly head again Tuesday, when it came to light that several foreign officials have expressed concern over its unintended consequences. It seems Japan, Mexico, Canada and the UK fear the rule, which aims to limit banks’ proprietary trading, could limit liquidity in sovereign debt markets.

They may have a point. Though the rule aims to mitigate the risk of bank bailouts by barring banks from making allegedly risky investments with their own money, it may also interfere with banks’ ability to purchase and sell securities on behalf of clients. These trades are typically a large source of market liquidity, and limiting them could, in theory, impact capital markets. The US Treasury market wouldn’t feel the pinch as Treasurys are exempt from the rule, but foreign sovereigns are another matter.

This is yet another example of how vaguely written regulation like the Volcker Rule can yield unintended consequences. Sure, the global banking industry would likely find a way around the regulation, perhaps by shifting more trading activity outside the US, which might help mitigate the liquidity issue. But then New York would lose some of its appeal as a global financial hub, and the US economy would miss that capital markets activity. As well-intended as this rule might seem, to us, the likely side effects render it more of a solution in search of a problem.