Regulatory change has transformed the financial landscape beyond recognition in just ten years

This article was first published on the Financial Times website on 10 September 2018.

To say the financial regulatory landscape has changed over the past ten years would be a considerable understatement. It’s entirely unrecognisable.

But some question whether the regulations imposed since the collapse of Lehman Brothers have been entirely for the good and how much of an impact they’ve really had.

For every investor reassured by the more abundant and stringent restrictions imposed on the financial sector, you will find others who counter that the markets are being stifled by overzealous regulation.

Few, however, have the hands-on experience gleaned by the lawyers at Linklaters who strode across the marble floors of Lehman Brothers in 2008, to begin a decade’s work of unpicking the most complex insolvency ever.

In the years since that day, policymakers have responded with a raft of new regulations. Thomson Reuters tracked around 9,000 regulatory alerts of interest to financial services companies in 2008. By 2017, this had risen to more than 56,000: a more than six-fold increase.

The positive impact of new rules

Uniquely well-positioned to comment on the new reality, Michael Kent, Global Head of Finance & Projects at Linklaters, believes the regulatory response to the collapse of Lehman Brothers has been “overwhelmingly positive”.

As an example, he cites the fact that, pre-Lehman, the clearing of over-the-counter (OTC) derivatives was optional. “The crash showed that clearing was an effective safety mechanism when properly undertaken. Accordingly, this was a focus of new regulation, with it becoming mandatory to clear many OTC derivative instruments. The structures and lessons learned have underpinned the increase in clearing ever since.”

The proportion of outstanding OTC interest rate derivatives that are centrally cleared is estimated to have increased from 24 per cent in 2008 to 61 per cent globally in 2016, according to data from the Bank for International Settlements.

While the broader landscape of financial regulation is hugely complex, some areas of change can be summarised more succinctly. One obvious improvement has been the obligation on banks to put greater safeguards in place. For instance, capital-to-assets ratios have increased significantly since the crisis. Banks in Europe and the UK now hold 5.5 per cent of their assets as a capital buffer, up from 3.4 per cent in 2008, according to data from The Banker Database.

A tsunami of technical detail

While regulation is necessary, however, the motivation behind it is also worthy of close consideration.

Benedict James, a Banking Partner at Linklaters, says: “The response of the world’s governments and regulators to the global financial crisis, perhaps predictably, was to say, ‘It wasn’t our fault but if we introduce lots more regulations, that should help fix the problems.’

“So, there was a tsunami of regulation across the world, and a lot of that was at least in part politically motivated by the need to be seen to be doing something. And in pretty technical areas like this, things that are done in a hurry for political reasons with time constraints, aren’t always done as well as they could be.

“That said, it is clear that much of the regulation has had the intended and desired effect of causing banks and investment banks to hold more capital – banks are undoubtedly safer than they were.” One area of concern is the Senior Managers and Certification Regime, a political response to perceived negative public opinion around senior managers in banks. While the legislation, introduced by the Financial Conduct Authority in 2016, creates additional clarity around specific areas of responsibility held by senior managers and is held up by some as one of the most progressive policies, there are fears about the potential for an ‘enforcement culture’.

Kent says: “There are huge merits in introducing accountability, you can see how it has changed the system. It takes out some of the risk-taking elements and brings a sense of clear responsibility. However, you don’t want that to create a blame culture or impact on people’s ability to experiment or create innovative products and solutions.”

A middle way model of regulation

Some argue there is a risk, not only in regulatory terms but also politically, that things have gone too far and the changes will do long-term harm to the sector. Sabine Lautenschläger, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, says tight regulatory standards are still needed.

“After all, bankers are people,” she says. “Like the rest of us, they sometimes tend to overestimate potential profits and underestimate risks …the crisis taught us that the failure of a single bank can damage the entire financial system and the economy. In a nutshell, that’s why banks need rules.”

With the pace of regulation gradually slowing, there is now cautious optimism that a ‘middle way’ can be found.

As Kent puts it: “We ought to be able to find a model where you can encourage innovation and entrepreneurial creativity within a retail banking and investment banking environment without creating horrible risks.”