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The financial services sector has seen more than its share of upheaval and regulatory shake up in the UK and overseas over the last few years. Michael Sholem, Special Advisor, European Financial Regulatory Affairs at Slaughter and May, looks at trends for the future in the sector.
What does the future of the financial services sector look like?
In the EU, the increasingly intrusive and complex nature of EU financial services legislation will have a material effect on the business models that will be used in the future.
At a global level, it seems likely that the large universal banks will continue to dominate, although they will have to adjust their structures and business models in order to adjust to regulatory requirements and initiatives designed to reduce systemic risk, and have detailed procedures in place for orderly recovery and resolution.
Smaller financial services firms will have significant challenges and opportunities in the future. In terms of opportunities, some of the activities which have drawn or will draw too much regulatory "heat" may be abandoned by global financial institutions, leaving the field to smaller, more focused firms. That being said, smaller firms are faced with a wall of extra regulation designed to improve transparency and risk management which may well make operating in the EU more expensive.
The perimeter of the regulated sector will also continue to expand as energy, commodity and other non-financial firms will be forced into a closer relationship with financial regulators than has historically been the case.
What business models are likely to be adopted/developed and why? What could the advantages/disadvantages of this be?
Although the UK government has moved to encourage branch activity in London by Chinese banks, the push for ‘subsidiarisation’ in the banking sector looks set to continue.
New regulatory standards mean that business models which can exhibit prudent business practices and transparent behaviour in markets will be rewarded with lighter capital burdens and less risk of enforcement action. In practice this means:
• a larger percentage of operating costs will be in compliance and risk management activities
• a withdrawal from non-core business areas which materially affect an institution's risk profile
• a reduction in cross-border financial services activities being instigated from some jurisdictions, with more of a national and/or EU-only focus for all but the largest institutions, and
• more group restructurings and the need to reduce operating costs in trading units
What trends will we start to see in 2014?
Unfortunately, we may continue to see the continuing breakdown in the G20 consensus on the direction of financial regulation, meaning global financial institutions are faced with a raft of conflicting regulatory initiatives and legislation.
In the UK, we expect to see a continuing rise in enforcement actions against institutions both large and small.
In the banking sector, we should see the introduction of the Single Supervisory Mechanism in the EU as a first step towards a eurozone banking union. These developments, combined with the eventual prospect of a Single Resolution Authority and the EU wide Recovery and Resolution Directive, mean that banks will be asked by regulators to come to a decision on the availability of cross-border banking services in a crisis and how to structure their operations in the future. In the UK, some of this thinking is relatively advanced, but the ECB, the EBA and national regulators will start to dig down into these issues in their discussions with all of the major European banks. We also expect to see a number of capital raisings by banks as new EU capital requirements are introduced.
In the asset management sector, we may see some consolidation as firms attempt to deal with the impact of AIFMD. Having said that, it appears that AIFMD will not have achieved one of its primary objectives by 2014 which was to have in place a harmonised regime for EU asset managers. It appears that there will continue to be a number of differences in national regimes, not least in terms of approaches to passporting of asset management activities.
The continuing introduction of EMIR reporting, clearing and risk management requirements in 2014 will also create a huge burden on EU national regulators. It is not altogether clear at this time that any national regulator has the resources or expertise to be able to support and monitor the new regulatory architecture built around derivatives trading.
What are the implications for lawyers? What action should they take in order to make the most of the challenges/opportunities presented by these developments?
All of these developments clearly point to a need for complex analysis to be provided by lawyers in a number of areas. Advice will be needed in relation to:
• the interpretation of new legislation and regulatory rules
• the drafting and design of new systems and controls at financial institutions
• dealing with a more intrusive supervisory and enforcement approach from the regulators, and
• assisting in the restructuring of financial institutions and the sector as a whole
Lawyers can be of most use to their clients, in this context, where they get involved at an early stage of any restructuring of an institution’s group or a redesign of systems and controls.
Financing, restructuring and transactional lawyers involved in this type of work will benefit from having some familiarity with the key legislative and regulatory initiatives which affect their clients and drive the types of work mentioned above.
Clients are often hard-pressed to keep track of the wide range of regulatory bodies and initiatives. There are therefore opportunities for lawyers to get involved in helping clients to understand the direction and shape of future regulatory developments and assist them in framing their lobbying or engagement strategy with legislators and regulators.
Interviewed by Nicola Laver.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
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