Regulation runs the risk of hitting all the wrong targets

Date: Tuesday, May 3, 2011
Author: Nick Evans, Hedge Fund Intelligence

Bankers lecturing the world about systemic risk and the perils of ‘shadow’ banking may strike most people as taking the mickey. But to hear Alan Greenspan pontificating about there being no need for any new financial regulation truly takes the biscuit.

This is the man who created the conditions for the greatest financial bubble and collapse the world has seen. Who stoked the fire at every possible opportunity with his calamitously misguided policy of endless rate-slashing and liquidity-pumping.

Who turned a blind eye to every sign of the catastrophe that was brewing. And who repeatedly championed, with such blithe naivety, the ‘credit risk transfer’ that banks were engaging in to get around the Basle capital rules in the almost endearing belief that the banks were practising sophisticated risk management – when what they were actually doing was trying to make their supervisors (and ultimately making themselves) look like monkeys.

Sometimes certain people forfeit any right to have a view on certain things. Greenspan on finance and regulation is a case in point. It is simply time for him to shut up and go away.

Of course there needs to be new regulation for the banks. Any fool can see that. The only relevant issues are what kind of regulation; who it is supposed to penalise, to protect and to benefit; and whether it is designed in such a way as to prevent banks getting around it all over again and becoming the main beneficiaries of supposed attempts to restrain them.

It must be regulation that takes aim at – and hits – the right targets. It must be simple, clear, effective and practicable. It must be globally enforced and enforceable. It must carry strict penalties – for individuals, as well as institutions. And it must root out the culture of money-lust and self-interest that has become so engrained in the DNA of investment banking.

So far the omens are not good. Some rules, like the ban on bank prop trading, are clearly sensible. But the Dodd-Frank Act, in classic US style, looks like simply providing a bonanza for the legal community without achieving any clarity of purpose or content.

In the UK, the Vickers commission seems already to have fallen victim to vested interests – and looks to be in danger of ducking the key issue of how to rescue investment banking from itself by putting an end to the absurd fees that bankers charge their clients and the even more preposterous amounts they pay themselves.

It is hard to believe that most bankers are as stupid, or as lacking in self-awareness, as they sometimes appear. But to hear them going on about how regulation will make many of their activities unprofitable, without apparently stopping to think how their P&Ls might benefit if they paid themselves slightly more modest sums, is almost enough to make you weep.

The reality, of course, is that it is the customers who will pay for all this anyway – and that includes hedge funds. And for the hedge fund industry, these added costs will come at a time when a whole mass of new and generally needless new regulation is already coming its way – as if it were hedge funds, and not the banks, that caused all of this trouble in the first place.

The AIFM directive, Dodd-Frank, the capital requirement directive, the central counterparty clearing/OTC derivatives changes, new short-selling rules, the market abuse directive, MiFiD, the anti-bribery act – you name it, it’s either here already or on the way soon.

For the bigger hedge fund groups, all this additional red tape is a hassle they could well do without – but one that they can live with and afford, even if it will do little to benefit their clients. But many smaller boutiques, which are the heart of this most entrepreneurial of businesses, could be swamped by the legal and compliance burden and costs that will result.

Nobody would argue against well-thought-out regulation that makes investors more comfortable, makes markets less open to abuse and creates stronger public confidence in hedge funds.

But this degree of regulatory carpet-bombing is excessive, disproportionate and entirely counter-productive. And for what purpose? So that politicians can claim they have taken decisive action to sort out the financial system, when they have done nothing of the kind?

Is this really what the end result will be – that the banks can carry on largely as before (still too big to fail and still too powerful to control), while a whole load of harmless and blameless small businesses could end up being regulated out of existence? It would be a disgrace, but it’s starting to look ominously that way.