Last month a US government delegation once again made its way to Brussels for the semiannual shouting match with the European Commission over transatlantic financial sector regulation: the Financial Markets Regulatory Dialogue (FMRD).
British author Rebecca West once said that “true conversations do not exist, only intersecting monologues.” This is certainly a good description of the Financial Market Regulatory Dialogues (FMRDs) between the United States and the European Commission over the past few years.
One might expect these meetings, where the US and EU discuss financial regulation on both sides of the Atlantic, to be civilized and somewhat boring, technical occasions. In recent years, however, they have often descended into shouting matches.
The main reason for these disagreements were the headlong pursuits of new regulations in both the United States and Europe in the wake of the 2008 financial crisis. While the fundamentals of these new rules were often agreed upon at the G20-level, the specific laws finally enacted in the EU and US contain differences that often make them incompatible.
The FMRD that took place last month was supposed to represent a fresh start with a new (and British) European Commissioner in charge, a new CFTC Chairman, and personnel changes in both the European and American delegations. Nonetheless, while a cosmetic and atmospheric change for the better may have occurred, all the good intentions in the world cannot conceal the major regulatory headaches the authorities of the two biggest financial blocks in the world will face in the coming years.
Same old story
First, there are the old disagreements about the results of the biggest regulatory overhaul since the Great Depression, particularly in respect to the complex and often opaque financial instruments known as Over-The-Counter (OTC) derivatives. The lack of transparency in OTC markets was a major catalyst in the 2008-09 financial crisis.
Following G20 agreements, the US (Dodd-Frank) and the EU (EMIR) introduced new rules that are to bring OTC trades out of the dark and make them transparent and less risky.
However, incompatibilities between Dodd-Frank and EMIR have caused heated arguments that have dragged on for years. While it seemed a solution was forthcoming, and despite increasing political pressure, no compromise is yet in sight. Transatlantic trade is likely to suffer in the absence of an agreement – a disaster all parties would surely like to avoid.
It is because of these longstanding differences that the US has argued for the exclusion of financial services from the TTIP trade negotiations.
More trouble ahead
On top of these old arguments, new problems are emerging.
Last year, the EU introduced new legislation for financial exchanges and asset managers. There are now concerns about whether the regulatory rules in the US are similar enough to those in Europe. If not, US banks and asset managers operating in Europe will find it near-impossible to continue to offer services to European clients.
Following the manipulation of the LIBOR interest benchmark in 2012, the EU has also imposed new laws on benchmark and financial indices publishers. The US, like the rest of the world, has no plans of passing any new legislation on this topic, a situation which could well see European investors unable to invest in important US indices such as the Dow Jones or the S&P 500. The financial catastrophe and market unrest of such an outcome would make the 2008 crisis look like child’s play.
In the field of banking, the US and EU are also diverging in a way that is likely to cause regulatory clashes. Recent discussions surrounding the separation of commercial and investment banks in Europe may cause some US banks to become subject to three different types of organizational rules.
The same is true for new regulations on the size of total bank capital buffers, the so-called “total loss-absorbing capacity” (TLAC) rules. Europe has already introduced its own rules (MREL) and is struggling to ensure they can be made compatible with international TLAC rules.
Finally, there is the new Capital Markets Union (CMU) plan proposed by the European Commission. This includes lighter regulatory treatment of certain financial products called securitizations. However, the US, keeping in mind the subprime mortgage securitizations that blew up the American mortgage markets and were responsible for the start of the 2008 financial crisis, has voiced its opposition to the new proposal, already casting doubts on how efficiently the CMU can be carried out.
Add to these disagreements discrepant rules on money market funds and the upcoming headache issue of clearinghouse resolution and it becomes clear that while the financial crisis may be largely over, the regulatory crisis and rows will rage on for quite some time to come.
Fortress Europe
The ongoing inability of the two largest financial and economic blocks in the world to cooperate and coordinate on issues of financial services regulation throws sand in the engine of the globalized economy, creating unnecessary uncertainty, inefficiencies and costs for the financial industry which has arguably become the most globalized industry of them all.
Not all regulatory differences are necessarily bad; some stem from historical economic differences or genuine discrepancies in the way markets work. Many, however, are due to political inertia and indifference towards or disregard for regulatory developments on the other side of the Atlantic.
While different rules of the game have become a barrier to integration for both sides, Europe should be the most cautious about over burdensome regulation. With its banks still weak after the crisis, sluggish economic recoveries and undersized capital markets, the continent should be looking to attract investors and investment globally. Especially now, the EU cannot afford to let excessive and incompatible rules turn it into a financial ‘Fortress Europe’.
