Benefits and unintended consequences of financial markets reform

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Benefits and unintended consequences of financial markets reform

Contents

1

Executive summary

2

Introduction

4

1

Regulation on the radar

6

21

Regulatory pros and cons

9

2
3

Overall expectations of regulatory impact vary

11

4

OTC derivatives overhauled

17

3
5

Corporate responses

19

4
6

The bottom line

21

5
7

Potential consequences

23

Appendix: survey results

24

© The Economist Intelligence Unit Limited 2012


Benefits and unintended consequences of financial markets reform

Executive
summary

In response to the 2008 financial crisis and the
world recession that followed, central bankers,
regulators and governments have drafted
numerous regulatory reforms and measures
designed to minimise risk and maximise consumer
protection in the global financial system.
In order to investigate the potential impact of
these new regulations on businesses, the
Economist Intelligence Unit, on behalf of Lloyds
Bank Wholesale Banking & Markets, surveyed over

450 senior executives from different companies
and also conducted interviews with experts.

Key findings include:
Companies are aware of and worried about
regulatory changes—but are not prepared
One-half of respondents cite regulation as one of
their main concerns, alongside the global
economic crisis (58%) and the euro zone crisis
(54%)—far ahead of other issues such as
availability of finance. More than three-quarters
(77%) of respondents believe that their boards are
aware of the impact of changes in regulation on
their company, but only 61% feel prepared.

About this report
In June and July 2012 the Economist Intelligence
Unit, on behalf of Lloyds Bank Wholesale Banking
& Markets, surveyed 454 senior executives in
order to explore what companies think about the
current regulatory landscape as well as how these
firms are planning ahead to handle the impact of
future regulation.
Respondents were drawn from Europe (60%),
Asia-Pacific (20%) and North America (20%),
and were divided into financial services (44%)
and non-financial services companies (56%).
In addition, in-depth interviews were

2

conducted with three experts from leading
financial companies. Our thanks are due to the
following for their time and insight (listed
alphabetically):
Jessica Ground, UK bank analyst at Schroders
Ricky Maloney, head of treasury processing
at Ignis Asset Management
Mark Stancombe, head of client management
at Insight Investment
The report was written by Faith Glasgow and
edited by Monica Woodley of the Economist
Intelligence Unit.

© The Economist Intelligence Unit Limited 2012


Benefits and unintended consequences of financial markets reform

There is concern that new regulation will hinder
growth and innovation
More than one-half (51%) are concerned that
planned financial regulation will impact on growth
in their industry, while 44% expect it to affect
innovation. UK and US companies are somewhat
more anxious (54 and 53% respectively) about the
negative impact of the new regulations than either
European or Asia-Pacific companies (46 and 48%
respectively).
Companies expect a significant impact on

profitability
Overall, two-thirds (68%) of respondents
anticipate a significant or fundamental impact on
the profitability of their financing and riskmanagement models, although some regulations
cause notably more concern than others. Almost
three-fifths (58%) expect at least significant
effects as a result of Basel III, compared with only
35% as a consequence of the Vickers Report.

3

The cost of compliance is the greatest worry
Almost three-fifths (59%) of respondents see the
increased costs of complying with the new
regulations as the biggest threat, but the rising
costs of obtaining funding (39%) and
implementing information technology systems
(25%) are also concerns.
Companies are contemplating a range of
responses
The most popular plan, selected by 42% of
respondents, is to change their company’s
corporate finance or risk-management model. But
significant numbers are also thinking of relocating
or changing their legal structure (26%), looking
for alternative funding (27%), reducing their use
of derivatives (25%) or seeking alternative service
providers (24%).

© The Economist Intelligence Unit Limited 2012

Benefits and unintended consequences of financial markets reform

Introduction

As a result of the 2008 financial crisis and
consequent world recession, central bankers,
regulators and governments have drafted a raft of
new regulations to better protect and stabilise the
global financial system.
The reforms have several broad aims, but
include (among others) measures to boost
surveillance, raise bank capital adequacy
standards, reduce risk in over-the-counter (OTC)
derivative activity and remove opportunities for
regulatory arbitrage among non-bank lenders
(known as “shadow banking”).
Some of the reforms, such as Basel III and the

International Financial Reporting Standards
(IFRS), will be implemented globally. Others are
regional directives; thus, the Markets in Financial
Instruments Directive II (MiFID II), the European
Market Infrastructure Regulation (EMIR) and
Solvency II affect the EU, while the US financial
landscape will be reshaped by the Dodd-Frank
reforms and the Foreign Account Tax Compliance
Act (FATCA). Then there are national reforms; for
example, the UK is introducing its own regulatory

banking requirements as a result of the Vickers
Report. (See box below for a brief explanation of
each regulation.)

Financial regulation definitions:
Basel III: global agreement on bank capital adequacy and
market liquidity risk
IFRS: creating a single set of enforceable and globally accepted
international financial reporting standards
MiFID II: far-reaching legislation designed to modernise, make
more transparent and harmonise the EU securities markets; it is
likely to affect everyone involved in the EU industry
EMIR: an EU directive providing for a harmonised regulatory
framework for OTC derivatives
Solvency II: EU directive requiring greater capitalisation for
insurance companies, which is expected to push them towards
more risk-averse investment strategies

4

Dodd-Frank: wide-ranging US reforms, including bank and
insurance company capital requirements but also regulation of
hedge funds
FATCA: US legislation requiring US taxpayers to report to the
Internal Revenue System (IRS) specific foreign financial assets
over a certain threshold. It also requires foreign financial
institutions to report similar information to the IRS on
companies operating in the US.
Independent Commission on Banking (ICB, known as the
Vickers Report): UK banking reform proposals including ringfencing of personal and SME deposits from wholesale and

institutional operations

© The Economist Intelligence Unit Limited 2012


Benefits and unintended consequences of financial markets reform

Although companies have always had to take
into account the changing requirements of the
regulators, both the pace and the scale of these
overhauls is unprecedented. Moreover, they have
major implications for non-financial as well as
financial corporations. For example, the cost of
borrowing will rise as banks’ lending spreads to
customers are pushed up by the banks’ obligation
to provide greater capital adequacy. In addition,
the introduction of reporting obligations and
central clearing for OTC derivatives will increase

5

transactional costs for both financial and nonfinancial firms that use derivatives to hedge their
costs or for other purposes.
This report examines the views on new
regulations of financial and non-financial
companies around the world, including how
important these firms think regulatory reform is in
the current global economic climate, in addition to
how prepared they are for those changes that will
affect them directly and others that may have an

indirect impact on their bottom line.

© The Economist Intelligence Unit Limited 2012


Benefits and unintended consequences of financial markets reform

1

Regulation on the radar

It is clear that the regulatory overhaul is a major
source of uncertainty for companies worldwide.
When asked to identify up to three macro issues
currently giving their business most cause for
concern, one-half of them cite regulatory changes,
with only the global economy (58%) and the euro
zone crisis (54%) scoring higher.
Responses vary regionally, however. European
companies are primarily focused on regional
problems and are less troubled by the impact of
regulation (only 41% cite it)—perhaps also
because they are already well used to a steady
stream of EU directives. By contrast, regulatory
change is the single biggest headache for North

American corporates, with 61% identifying it as a
concern.
As might be expected, there are also clear
differences in perspective between financial

services (FS) companies and non-financials. Only
36% of non-FS respondents see regulation as a
major issue. For them, sales-driven considerations
such as lack of consumer demand (30%) is well
over twice as significant as it is for financials
(12%).
By contrast, regulatory change tops the list of
worries for FS respondents, cited by over twothirds (68%).

Chart 1

Q

What do you see as the biggest issues facing your company today?
(% of respondents, by sector)

FS

Lack of industrial/economic
growth/investment

Non FS

23
26

Eurozone crisis

62
47

Lack of confidence

24
27

Availability of finance

15
25

Regulatory changes

68
36

Lack of (consumer) demand

12
31

Global economic uncertainty

58
58
Source: Economist Intelligence Unit survey, July 2012.

6

© The Economist Intelligence Unit Limited 2012

Benefits and unintended consequences of financial markets reform

Chart 2

Q

What do you see as the most important issues facing your company today?
% of respondents, by region
North America

Mainland Europe

UK

Global economic uncertainty

Asia-Pacific
55
55
56

Lack of (consumer) demand
19

21

24

Regulatory changes

61

41
48

Availability of finance

21
17

53

26

19

Lack of confidence

23

27
27
26

Eurozone crisis

44

57
48

Lack of industrial/economic
growth/investment

21

Other
1

66

27

60

27
25

27

3
3
3

Source: Economist Intelligence Unit survey, July 2012.

Ricky Maloney, head of treasury processing at
understand the implications of the regulations:

the UK-based Ignis Asset Management, foresees
more than three-quarters (77%) of respondents
Category 1
Category 2
Category 3
Category 4
Category 5
“severe difficulties” in regard to the OTC derivatives
say that
their board
of directors
is up toCategory
speed6 with
market changes, in the current economic climate.
the impact of the new regulations on their
“Governments and regulators have contradictory
company. But that does not necessarily translate
strategic goals, in that they are removing liquidity
into confidence that they are actually taking
from the markets by way of increased margin and
action, with only 61% believing that most or all of
capital requirements, while at the same time trying
the necessary preparations have been made, and
to stimulate economic growth,” he notes.
almost one in ten (8%) of respondents perceiving
At the corporate level, there seems to be
their company as unprepared.
reasonable confidence that senior directors at least
Chart 3

Q

Do you agree or disagree with the following statements?
(% respondents)
Strongly/somewhat agree

Neutral

Somewhat/strongly disagree

My company is prepared for the impact of planned financial regulations.
61

31

8

Our board is aware of how planned financial regulations will impact our company.
77

18

6

Source: Economist Intelligence Unit survey, July 2012.

Category 1

7

Category 2

© The Economist Intelligence Unit Limited 2012

Category 3

Category 4

Category 5

Category 6


Benefits and unintended consequences of financial markets reform

Although companies have little choice but to
take some kind of action in response to the
changes, most—and especially FS companies—have
serious misgivings about the wider impact on
economic growth and innovation. One in two
companies (51%) overall, and 64% of FS
respondents, expect growth in their industry to be
inhibited as a result of reduced market liquidity
and increased trading costs.
Again, there is some regional differentiation,
with European firms notably less fretful than those
based in other areas about the impact of
regulations on growth—again perhaps reflecting
the fact that regulatory issues are to some extent
eclipsed by the fragility of the euro zone economy

and the need for far-reaching political and
economic solutions.

It is also rather more worrisome for UK and US
companies than for those based in Europe or Asia:
54% of UK firms are downbeat about prospects for
growth, compared with 46% of European firms.
Jessica Ground, UK bank analyst at the Londonheadquartered Schroders, makes the point that
unilateral regulation is a real worry for the City.
“For global markets such as financial services,
human capital is very transferable. The system did
need substantial reform but with international
consensus; the danger is of jurisdictions acting
independently of each other and capital just
moving away.” She points to the UK’s unilateral
plans for bank ring-fencing and France’s proposed
transaction tax as examples of regulation that
could leave countries seriously vulnerable to lost
business.

Chart 4

Q

Do you agree or disagree with the following statement?
“I worry that planned financial regulations will inhibit growth in my industry”
(% respondents, by region)
Strongly/somewhat agree

Neutral

Somewhat/strongly disagree

Asia-Pacific
48

36

16

UK
54

33

13

Mainland Europe
46

26

28

North America
53

33

15

Source: Economist Intelligence Unit survey, July 2012.

Category 1

8

Category 2

© The Economist Intelligence Unit Limited 2012

Category 3

Category 4

Category 5

Category 6


Benefits and unintended consequences of financial markets reform

2

Regulatory pros and cons

Only 5% of respondents see no threat to their
company as a result of the new regulatory regime;
most are troubled by the various costs of
implementation. The biggest issue by far is the

impact of increased compliance costs, which
concerns 59% of respondents overall and more than
70% of large companies with annual revenue of
more than US$10bn (see chart 4). However, rising
funding costs (39%) and information technology

(IT) costs (25%) are also concerns. FS companies
are even more focused on compliance costs (see
chart 5).
“The FS industry is underestimating the longterm costs of compliance—there will be problems
down the line with the amount of work for
compliance departments and the extent of
reporting involved,” comments Schroders’s Ms
Ground. “The trouble is that additional regulation is

Chart 5

Q

What are the biggest potential threats to your company from planned financial regulations?
(% of respondents, by company size in USD revenue)
Between $500m and $1bn

Increased cost
of funding

37

Between $1bn and $10bn
39

39

Increased cost
of compliance

52

Increased cost
of hedging risk

70

57

17
16
16

Increased IT costs

23

29

23

Difficulty in securing banking
products or services we need

12

12
13

Restrictions on where
we can operate

10

I don’t see any
potential threats

4

Don’t know 1
1

9

More than $10bn

5

22

26

6

2
Source: Economist Intelligence Unit survey, July 2012.

Category 1

Category 2

© The Economist Intelligence Unit Limited 2012

Category 3

Category 4

Category 5

Category 6


Benefits and unintended consequences of financial markets reform

Chart 6

Q

What are the biggest potential threats to your company from planned financial regulations?
(% of respondents, by sector)

FS

Increased cost
of funding

Non FS

37
40

Increased cost
of compliance

74
48

Increased cost
of hedging risk

12
20

Increased IT costs

29
22

Difficulty in securing banking
products or services we need

9
16

Restrictions on where
we can operate

I don’t see any
potential threats

20
19
3
7

Don’t know 1
2

Source: Economist Intelligence Unit survey, July 2012.

absorbing firms’ profits, yet they don’t feel they’re
potential benefits are improved transparency with
getting better regulation because the regulators’
regards to risk (42%) and greater stability for
focus has been on volume rather than quality.”
financial markets (41%), with a further 30% also
Almost one-quarter of companies based in North
looking forward to greater pricing transparency and
America (24%) and Asia-Pacific (24%) are also
reduced counterparty risk (for differences between
Category 1
Category 2
3
Category 4
Category 5
anxious that the regulatory changes will restrict
FS andCategory

non-FS
respondents,
see
chart 6).Category 6
their freedom to operate in other jurisdictions.
But there is less consensus among respondents
When asked about the likely positive
over the potential downsides to the new regime;
consequences of the changes, most respondents
indeed, 13% take a somewhat sceptical view,
see some sign of a silver lining to the regulatory
claiming that they do not envisage any benefits for
cloud hanging over them. At the top of the list of
their company at all.
Chart 7

Q

What are the biggest potential benefits to your company from planned financial regulations?
(% of respondents, by sector)

FS

Reduced counter-party/
credit risk

Non FS

33
27

Better transparency
of risk

42
41

Increased market
(pricing) transparency

30
31

More stable financial
markets

38
43

I don’t see any benefits

14
11

Don’t know 1
3

10

© The Economist Intelligence Unit Limited 2012

Source: Economist Intelligence Unit survey, July 2012.


Benefits and unintended consequences of financial markets reform

3

Overall expectations of regulatory
impact vary

Most respondents (68%) are bracing themselves
for significant or even game-changing effects on
their financial and risk-management strategies as a
consequence of the new regulatory landscape, with
UK companies expecting to be hardest hit (76%).
Unsurprisingly, FS companies are also
predicting a higher impact than their non-FS
counterparts. FS respondents are particularly
worried about the regulations (such as Basel III,
MiFID II and Solvency II) that are likely to make
their investment business more complex or restrict
their ability to issue corporate debt, as well as

those affecting the derivatives market. For non-FS
firms, the survey suggests that the rising cost of
borrowing from banks is the biggest problem,
although they are less concerned than FS
companies about this issue.
However, the FS interviewees point out that what

affects their clients ultimately affects them as well.
“The big thing for us will be MiFID, though there
will also be some fallout from Dodd-Frank,”
according to Ms Ground at Schroders. She adds,
however: “Basel III and banks’ increased capital
adequacy requirements will also impact on our

Chart 8

Q

Please assess the compound impact of all regulatory change
(% of respondents, by region)
North America

Low impact (impacts profit of our
financing and risk management model)

Mainland Europe

UK

Asia-Pacific

18
19
24
11

Medium impact (Significantly impacts profit of

our financing and risk management model)

46
42
41
39

High impact (Fundamentally challenges viability
of our financing and risk management model)

22
34
21
30

Don’t know

7
3
9
15

Not applicable

8
2
5
6
Source: Economist Intelligence Unit survey, July 2012.

11

© The Economist Intelligence Unit Limited 2012
Category 1

Category 2

Category 3

Category 4

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Category 6


Benefits and unintended consequences of financial markets reform

Chart 9

Q

Please assess the compound impact of all regulatory change
(% of respondents, by sector)

FS

Low impact (impacts profit of our
financing and risk management model)

Non FS

7
29

Medium impact (Significantly impacts profit of
our financing and risk management model)

38
44

High impact (Fundamentally challenges viability
of our financing and risk management model)

46
12

Don’t know

5
10

Not applicable

4
6

clients, and therefore our business.”
EMIR is the biggest headache for Mark
Stancombe, head of client management at Insight

Investment of the UK. “It has the potential to have
a very large detrimental effect on our underlying
pension fund clients’ ability to mange the risks
associated with funding their pension obligations,

Source: Economist Intelligence Unit survey, July 2012.

and indeed on European pension and insurance
funds generally,” he explains.
It is unsurprising that concerns over specific
regulations vary with significant differences in the
primary areas of concern for FS and for non-FS
corporates. The differences for each regulation are
detailed in the boxes below.

Basel III
Categoryand
1
Categoryliquidity
2
Category
Global agreement on bank capital adequacy
market
risk3

Category 4

Category 5

Category 6

Overall, three-fifths (58%) expect a significant or fundamental impact on their finance and riskmanagement models from the Basel III banking reforms. Financials (69%) are expecting markedly
more fallout than non-financials (50%), despite the fact that widening bank lending spreads are
set to push up the latter’s borrowing costs. Indeed, Basel III is the single piece of regulation
expected by FS respondents to have the greatest impact on their business.

Q

Chart 10

Q

Please assess the impact of Basel III on your company
(% of respondents, by sector)
FS

Low impact (impacts profit of our
financing and risk management model)

Non FS

20
30

Medium impact (Significantly impacts profit of
our financing and risk management model)

29
39

High impact (Fundamentally challenges viability
of our financing and risk management model)

40
11

Don’t know 1
10
Not applicable

10
10
Source: Economist Intelligence Unit survey, July 2012.

12

© The Economist Intelligence Unit Limited 2012


Benefits and unintended consequences of financial markets reform

Dodd-Frank
Wide-ranging US reforms, including bank and insurance company capital requirements,
as well as regulation of hedge funds, among other issues
Unsurprisingly, North American respondents expect to be most significantly affected (36% of US
companies expect a fundamental impact, while a further 32% predict a significant impact,
compared with 14% and 30% overall). By contrast, around one-fifth of European (23%), Asian
(20%) and UK (18%) companies do not see Dodd-Frank as relevant to them.
Chart 11

Q

Please assess the impact of Dodd-Frank on your company
(% of respondents, by region)
North America

Mainland Europe

Low impact (impacts profit of our
financing and risk management model)

UK

Asia-Pacific

27
26
33
15

Medium impact (Significantly impacts profit of
our financing and risk management model)

30
36
23
36

High impact (Fundamentally challenges viability
of our financing and risk management model)

12
13
5
32

Don’t know

10
7
17
11

Not applicable

20
18
23
7
Source: Economist Intelligence Unit survey, July 2012.

Category 1

13

Category 2

© The Economist Intelligence Unit Limited 2012

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Category 4

Category 5

Category 6


Benefits and unintended consequences of financial markets reform

EMIR (European Market Infrastructure Regulation)
An EU directive providing for a harmonised regulatory framework for OTC derivatives trading
Just 38% of respondents overall expect to be significantly or fundamentally affected by the new
regulations. Surprisingly, that number falls to 35% for European firms—although it rises to 43% for
UK businesses. Non-financials (45%) anticipate more fallout than financials (32%).
Chart 12

Q

Please assess the impact of EMIR on your company
(% of respondents, by sector)
FS

Low impact (impacts profit of our
financing and risk management model)

26
33

Medium impact (Significantly impacts profit of

our financing and risk management model)
High impact (Fundamentally challenges viability
of our financing and risk management model)

Non FS

28
25
17
7

Don’t know

15
17

Not applicable

14
18
Source: Economist Intelligence Unit survey, July 2012.

Solvency II
EU directive requiring greater capitalisation for insurance companies, which is expected to push them
towards more risk-averse investment strategies
Again, despite the fact that this is EU legislation, it appears to be of much greater concern to UK
businesses across the board. Over three-fifths (63%) of UK respondents anticipate significant or
fundamental fallout from the reforms, compared with only 44% of European firms. This may reflect
the fact that the insurance industry in Europe is skewed towards small mutual specialists serving a
local community, which may not even be large enough to qualify for Solvency II, rather than the

Category 1 the
Category
2
Category 3
Category 4
Category 5
Category 6
major one-stop-shop insurers that dominate
UK market.
Chart 13

Q

Please assess the impact of Solvency II on your company
(% of respondents, by sector)

FS

Low impact (impacts profit of our
financing and risk management model)

18
29

Medium impact (Significantly impacts profit of
our financing and risk management model)
High impact (Fundamentally challenges viability
of our financing and risk management model)

Non FS

29
34
31
7

Don’t know

10
15

Not applicable

12
15
Source: Economist Intelligence Unit survey, July 2012.

14

© The Economist Intelligence Unit Limited 2012


Benefits and unintended consequences of financial markets reform

MiFID II
Far-reaching legislation designed to modernise, make more transparent and harmonise the EU securities
markets; it is likely to affect any firm involved in the EU industry
Just under one-half (47%) of respondents foresee a significant or greater impact; once again,
Europe is fairly in line with the rest of the world, while in contrast UK respondents (58%) are
expecting to feel much more heat from the reforms. Comparing FS and non-FS responses, more

than four times the proportion of FS firms see the regulation as likely to have a fundamental impact
on their business (23%, compared with just 5% for non-FS companies).
However, 15% of respondents overall (including a worrying 13% of FS firms) have no idea how
the impending MiFID II regulations will affect their business.
Chart 14

Q

Please assess the impact of MiFID II on your company
(% of respondents, by sector)

FS

Low impact (impacts profit of our
financing and risk management model)

18
28

Medium impact (Significantly impacts profit of
our financing and risk management model)
High impact (Fundamentally challenges viability
of our financing and risk management model)

Non FS

37
32
23
5

Don’t know

13
18

Not applicable

10
17
Source: Economist Intelligence Unit survey, July 2012.

Category 1

15

Category 2

© The Economist Intelligence Unit Limited 2012

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Category 4

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Benefits and unintended consequences of financial markets reform

ICB (Vickers Report)
UK banking-reform proposals including ring-fencing of personal and SME deposits from wholesale and
institutional operations
Across the board, 35% of companies (rising to 43% among UK respondents) anticipate significant
implications as a result of the ICB recommendations, which are due to become law in 2015. But
again there is widespread uncertainty among firms. One-third of respondents in both the US and
Europe do not know whether they will be affected.
Chart 15

Q

Please assess the impact of the Vickers Report on your company
(% of respondents, by region)
North America

Mainland Europe

UK

Asia-Pacific

Low impact (impacts profit of our
financing and risk management model)

28
34
25
16

Medium impact (Significantly impacts profit of
our financing and risk management model)

30
27
21
25

High impact (Fundamentally challenges viability
of our financing and risk management model)

7
17
4
13

Don’t know

14
7
32
32

Not applicable

22
16
18
15
Source: Economist Intelligence Unit survey, July 2012.

Category 1

16

Category 2

© The Economist Intelligence Unit Limited 2012

Category 3

Category 4

Category 5

Category 6


Benefits and unintended consequences of financial markets reform

4

OTC derivatives overhauled

Looking specifically at the potential impact of the
EMIR and Dodd-Frank regulations governing OTC
derivatives trading, one clear conclusion from the
survey is that companies do not fully understand
how the new regime will affect them. That problem
is echoed by Ms Ground at Schroders, who

observes: “Companies don’t have a good grip on
what’s involved, beyond the headlines.”
Thus, less than one-half (47%) of respondents
consider themselves reasonably au fait with the
impact of the new rules, although the biggest
corporates (with annual revenue of US$10bn or
more) are more up to speed, with 55% stating that
they understand the impact of the new rules.
Interestingly, the smallest category of firms
surveyed ($500m-1bn in annual revenue) is close
behind them at 53%—it is the medium-sized
businesses that seem to be lagging most.
However, many companies are clearly taking
measures to get a better grasp on the likely

implications. Around 44% of respondents are
taking advice from external institutions such as
banks or clearing houses as to how their business
will be affected, while some, including Ignis Asset
Management, are going further and recruiting
expert staff to deal with the changes.
Overall, there is little difference between
financials and non-financials in terms of
understanding. But those top-line figures mask
disparities between different subgroups. For
example, asset managers are likely to be well aware
of the implications for their institutional clients.
Insight Investment, for example, uses interest
rate and inflation derivatives markets to manage
the solvency risk of its pension fund clients,

enabling them to reduce the volatility and protect
the solvency of their pension schemes. “The
centralised clearing proposals, combined with the
current market-standard clearing mechanisms,
would significantly raise the long-term cost of

Chart 16

Q

Do you agree or disagree with the following statement?
“We understand what will be required of our company under Dodd-Frank/EMIR”
(% of respondents, by company size in USD revenue)
Between $500m and $1bn

Strongly/somewhat
agree

37

Neutral

30
21

Somewhat/strongly
disagree

17

Between $1bn and $10bn

15

© The Economist Intelligence Unit Limited 2012

27
26

More than $10bn
55
53

36

Source: Economist Intelligence Unit survey, July 2012.


Benefits and unintended consequences of financial markets reform

Chart 17

Q

Do you agree or disagree with the following statement?
“We have assessed the regulatory impact and this will makes it more expensive
and/or difficult to hedge risk.”
(% of respondents, by region)
North America

Strongly/somewhat
agree

Mainland Europe

UK

Asia-Pacific

37
45
41
63

Neutral

44
38
34
28

Somewhat/strongly
disagree

20
17
25
9

Source: Economist Intelligence Unit survey, July 2012.

providing pension benefits,” Insight’s Mr
the Dodd-Frank and EMIR proposals, just under
Stancombe warns.
one-third (30%) of respondents (or 42% of North
There is some disagreement as to how far the
American firms) are campaigning or consulting
OTC derivatives market reforms will make it more
with politicians, trade bodies or regulators to try
costly or difficult to hedge risk. Almost one-half
and get the regulations modified. Interestingly,
(48%) of respondents think that there will be some
36% are not interested in further change.
negative impact. North American respondents
are
OneCategory
particular
concern is the
difficulty
of
Category 1
Category 2
3
Category 4
Category 5
Category 6
most pessimistic: almost two-thirds (63%) believe
extending the reach of these derivatives reforms
that their ability to hedge will suffer as a
beyond their home jurisdiction, such as to overseas

consequence of the Dodd-Frank reforms.
offices of domestic companies. “Extra-territoriality
Against that, almost one-fifth (18%) of those
or crossborder application of Dodd-Frank and EMIR
surveyed think that there will be little impact on
is a real sticking point and regulators on both sides
costs or access to the market, with smaller companies
of the Atlantic have really struggled to come up
(23%) feeling markedly more positive than
with an appropriate framework thus far,”
businesses of US$15bn or more in revenue (12%).
comments Mr Maloney from Ignis Asset
Although there is significant unhappiness about
Management.
Chart 18

Q

Do you agree or disagree with the following statement?
“We are consulting politicians/regulators/trade bodies (either nationally and/or EU)
for changes to Dodd-Frank/EMIR”
(% of respondents)
Strongly/somewhat
agree

30

Neutral

34

Somewhat/strongly
disagree

36
Source: Economist Intelligence Unit survey, July 2012.

18

© The Economist Intelligence Unit Limited 2012


Benefits and unintended consequences of financial markets reform

5

Corporate responses

What kind of action are companies taking, or
considering, in response to the regulatory
changes? The most popular option by some way is
to adapt their existing finance or risk-management

strategy to the requirements of the new regime.
Over two-fifths (42%) of respondents intend to
make such changes. However, a number of
alternatives have significant support, including

Chart 19

Q

Are you actively considering or progressing with any of the following to mitigate the
impact of upcoming financial services regulation?
(% of respondents, by region)
North America

Mainland Europe

UK

Changing/ reducing use of derivatives

Asia-Pacific

34
29
17
24

Centrally clearing derivatives

13
21
23
20

Changing my financing and/or risk
management model

40
39
43
44

Becoming part of a co-operative bank
with other corporates

8
10
7
12

Seeking funding from different providers

22
29
24
30

Changing service providers

26
33
12
27

Re-locating or changing the legal/
regulatory structure of my organisation

17
33
20
33

None of the above

26
20
29
19

19

© The Economist Intelligence Unit Limited 2012

Source: Economist Intelligence Unit survey, July 2012.


Benefits and unintended consequences of financial markets reform

finding other sources of funding (27%), physically
relocating (26%), reducing the use of derivatives
(25%) and changing service providers (24%).
Interestingly, European companies seem
reluctant to consider any of these alternatives,
particularly a switch of service providers (12%) and
changes to the way they use derivatives (17%).
Almost three in ten (29%) of European
respondents claim that they would take “none of

the above” measures. By contrast, both UK and US
firms appear much more prepared to vote with their
feet: one-third of British companies are ready to
switch to new service providers, while physical
relocation and switching funding are also high on
the list for both countries.
Looking at the difference between FS and nonFS companies, it seems that financials are

considerably more willing than their non-FS
counterparts to reduce the use of derivatives (30%
versus 21%); indeed, this is the second most
popular option among FS respondents. Similarly,
FS firms are more prepared to make use of
centralised derivatives clearing: 26% of financials
said that they have taken or are considering this
option, compared with 15% of non-financials.
However, notes Mr Maloney at Ignis Asset
Management, regulation is likely to stimulate
innovation in financial products. “It is widely
expected that the market in general will move away
from such heavy OTC use…We expect to see new
products entering the market which, while having
the same risk-management characteristics as
clearable swaps, are neither clearing eligible nor
subject to higher capital charges.”

Chart 20

Q

Are you actively considering or progressing with any of the following to mitigate the
impact of upcoming financial services regulation?
(% of respondents, by sector)

FS

Changing/ reducing use of derivatives

Non FS

30
21

Centrally clearing derivatives

26
15

Changing my financing and/or risk
management model
Becoming part of a co-operative bank
with other corporates

48
36
8
9

Seeking funding from different providers

23
30

Changing service providers

24
24

Re-locating or changing the legal/
regulatory structure of my organisation
None of the above

28
24
21
26
Source: Economist Intelligence Unit survey, July 2012.

20

© The Economist Intelligence Unit Limited 2012


Benefits and unintended consequences of financial markets reform

6

The bottom line

The survey makes clear that different companies

expect to be spending very different amounts on
the costs of implementation, although as might be
expected there is some correlation between
expenditure and company size. Thus, 20% of
respondents overall anticipate bills of less than
£500,000 (approx. USD$810,000) over the next 12
months as a result of the regulatory changes, but
in the smallest category (US$500m-1bn in annual
revenue) that proportion rises to 37%.
At the other end of the spectrum, another 20%
of respondents, and one-third (31%) of firms worth
over US$10bn, expect to spend more than £10m

(approx. USD$16m) to cover the cost of increased
financial regulation. It also becomes more difficult
to quantify the total anticipated spend for the
biggest companies: a further 31% said that they
could not put a figure on the likely cost of moving
into line with the new regime.
“I have already seen eye-watering sums,
running to many millions, spent by the big banks—
and over the medium term those figures are likely
to become really massive,” says Ms Ground of
Schroders.
How will these costs be dealt with? It is hard to
escape the conclusion that, in most cases, clients

Chart 21

Q

Approximately how much will you be spending in the next 12 months to cover the cost of increasing
financial regulation (e.g IT, people, loss of sales, management time)?
(% of respondents, by company size in USD revenue)
Between $500m and $1bn

£0 to 0.5m

7

£0.5 to 1m

15

£1m to 5m

11
15
7
6

£10m+
5

37

17
16

9

31

6

Cannot quantify
19

Don’t know

7
2

21

More than $10bn

16
8

£5m to 10m

Between $1bn and $10bn

29

30

9

© The Economist Intelligence Unit Limited 2012

Source: Economist Intelligence Unit survey, July 2012.


Benefits and unintended consequences of financial markets reform

will ultimately pick up the tab for increased
regulation. Mr Stancombe at Insight Investment
says that his company “would not expect to pass on
the implementation costs to establish the
infrastructure to support the new regulatory
requirements,” although he points out that clients
will see costs such as transaction charges rise as a
consequence of the changes, and these are passed
directly on to investment clients.
But for other commentators, all costs are bound
to be shouldered by end users. “Either consumers
will pay in the end, or firms will stop offering
products that involve increased compliance,”

22

asserts Ms Ground.
Looking at the derivatives landscape, Mr
Maloney at Ignis Asset Management suggests that
the costs will be so great that a significant shift is
likely to occur within the FS industry, as asset
managers have to re-evaluate how far the
increased costs of hedging using derivatives offset
the benefits of the hedge. “One would expect end

users to take comfort in having their assets in a
well-regulated product—but at what cost? I expect
there to be further public discomfort once the true
costs of these reforms trickle down into end-user
returns,” he adds.

© The Economist Intelligence Unit Limited 2012


Benefits and unintended consequences of financial markets reform

7

Potential consequences

The 2008-09 global financial crisis and subsequent
serious failures of the banking system to regulate
itself have resulted in general consensus that farreaching reforms are both necessary and inevitable.
As Ms Ground from Schroders observes: “There has
been a culture of excessive risk-taking and poor
financial products, and substantial reform had to take
place. And a lot of this regulation is good: it means
more capital is backing the system, leverage ratios are
controlled and there is greater transparency and
regulation of counterparty contracts.”
Mr Stancombe at Insight Investment agrees that
the fundamental principles underpinning
derivatives market reform are laudable. “Increased
market transparency to regulators and systemic
risk reduction have the potential to deliver greater

security for market participants and wider
stakeholders,” he notes.
But there is widespread concern over authorities’
swift moves to regulate in many areas at once. Says
Ms Ground: “They have tightened all the regulations
at once, without a clear understanding of the
unintended consequences and costs.”
One of those unintended consequences may be
that asset managers decide that it is no longer
financially viable to use derivatives to hedge risk.
“The underlying risk will clearly continue to exist,
but will be borne by a group of people less
equipped to manage it,” Mr Stancombe warns.
Even if that does not happen, adds Ignis Asset
Management’s Mr Maloney, “the market consensus
is that performance returns will be compromised as
a result of the tremendous additional costs

23

involved.” Moreover, there is a further risk that the
derivatives market will become concentrated within
a handful of the biggest clearing houses. “If a
major crisis occurs and banks begin to fail again,
how will this huge concentration of risk be
managed without systemic impact?”
Two-thirds (68%) of those surveyed anticipate a
significant or fundamental impact on the
profitability of their financing and riskmanagement models, while more than one-half
(51%) of respondents are concerned that planned

financial regulation will impact on growth in their
industry and 44% expect it to affect innovation.
That effect could be made worse for some
countries if there is not sufficient regulatory
collaboration and consensus between jurisdictions—
in the face of regulatory threats, capital may well
migrate to other relatively “light-touch”
jurisdictions. As the survey shows, that is clearly an
option being considered by both financial and
non-financial companies of all sizes. It is particularly
attractive to the biggest corporates, one-third of
which would seriously consider relocating.
In short, it is very difficult to say whether the
benefits of the forthcoming regulatory overhauls
will outweigh the negatives, as we have not been
here before. The regulators are keen to close the
many loopholes and skewed systems that led to
previous systemic failures—but neither they nor
anyone else can anticipate what the full
consequences of the new regulatory regime will be
in terms of its impact on companies and
economies.

© The Economist Intelligence Unit Limited 2012


Benefits and unintended consequences of financial markets reform

Appendix:
survey

results

Percentages may not add to 100% owing to rounding or the ability of respondents to choose
multiple responses.

What do you see as the most important issues facing your company today?
Select up to three
(% respondents)
Global economic uncertainty
58

Eurozone crisis
54

Regulatory changes
50

Lack of confidence
25

Lack of industrial/economic growth/investment
24

Lack of (consumer) demand
23

Availability of finance
20

Other

3

Do you agree or disagree with the following statements?
Rate on a scale of 1 to 5 where 1 is strongly agree and 5 is strongly disagree
(% respondents)
1 Strongly
agree

2

3

4

5 Strongly
disagree

Our board is aware of how planned financial regulations will impact our company.
33

43

18

5

My company is prepared for the impact of planned financial regulations.
18

43

31

71

I worry that planned financial regulations will inhibit growth in my industry.
21

30

30

14

4

I worry that planned financial regulations will inhibit innovation in my industry.
17

24

27

© The Economist Intelligence Unit Limited 2012

31

19

5

0