Regulation is key concern

Regulation in the financial industry has reached a saturation point and has become one of the biggest risks facing the financial markets today, say risk managers. "The pendulum has now swung too far one way," said Kenneth Winston, global chief risk officer at Morgan Stanley Investment Management, speaking at Risk magazine's Global Risk Management Summit, held in Monte Carlo at the end of April. "In five years' time, it should swing back towards allowing freer markets, but with the right level of regulation."

Risk managers have had to deal with an unprecedented volume of new legislation this year, with Sarbanes-Oxley, International Financial Reporting Standards and Basel II just a few of the major regulatory initiatives facing banks. "More stringent regulation will drive out less stringent regulation," said Winston during a chief risk officer panel discussion on the impact of regulation on the financial markets.

These thoughts were echoed by Jerry del Missier, London-based head of rates and private equity and regional head of Europe, at Barclays Capital. "We're at risk of rolling back 20 years of progress," he told delegates, using his keynote address at the summit to express his fear that the integration of Europe's financial markets faces an acute danger from nationalist self-interest among its regulators. "I'm a bit worried about what I see in Europe. We're moving away from a pan-European way of doing things to an environment where national interests are filtering through. We're no closer to having a single European financial system than we were five years ago."

This focus on regulation at the Summit follows the release of the 'Banana Skins' poll earlier this year, an annual survey of bank risk managers undertaken by consultants PricewaterhouseCoopers and the Centre for the Study of Financial Innovation, a London-based financial think-tank. This year, 'too much regulation' was voted the greatest risk facing banking for the first time in the poll's 10-year history, moving up from sixth place in 2004.

Meanwhile, the Corporate Risk Barometer, a new study undertaken by the Economist Intelligence Unit in April, points to regulatory and reputational risk as the most significant issues. These two categories each scored around twice as many votes as credit and market risk, and more than double the votes for foreign exchange or country risk.

Much of the new regulation is born from a perceived lack of transparency within the derivatives market and knee-jerk reactions to corporate failures such as Enron and WorldCom, say bankers. As such, Barclays' del Missier called for the derivatives industry to embrace greater transparency as a means of averting more regulation and putting an end to the general perception of derivatives as 'weapons of mass destruction'. "We need to focus on pushing back those misconceptions," he said, adding that the industry has "an obligation to educate analysts and the press at large". In last year's Banana Skins survey, derivatives were voted as the greatest risk facing the market. This year, they slipped to fourth.

But regulation itself is not the only problem. How regulators implement the rules is also important, with some risk managers concerned that supervisors will focus on ensuring banks comply with the letter of the law. This in turn could lead to banks taking a box-ticking approach to risk management, rather than genuinely improving risk controls and processes. "Where regulators are a hindrance is where there is too much emphasis on form and not a fair evaluation of quality," said Kanwardeep Ahluwallia, senior managing director of global risk management at Bear Stearns, speaking during the panel discussion. "Regulation that is too rigid can be counter-productive. We're looking for knowledge, flexibility and consistency in our regulators."

Some regulators acknowledge that banks have their work cut out to cope with the bevy of new rules. However, Ryozo Himino, secretary general of the Basel Committee on Banking Supervision, says that it's often difficult to balance requests for formal guidelines by some institutions with complaints by others that they are being inundated with new legislation. After five years of consultation on Basel II, banks are still requesting formal guidance on a range of issues, such as supervision on modelling techniques, he adds.

Patrick Fletcher