The raft of US and European financial regulatory reforms is creating regulatory arbitrage as many companies are moving to Asia because the region is perceived to have less costs and a more favourable compliance environment, says a leading lawyer in securities financing.
“Asia is booming. Corporate governance and ongoing reporting requirements in the US, UK and through the EU are seemingly pushing companies to Asia for equity and convertible debt listings, namely Singapore and Hong Kong, as they are perceived to have less compliance costs and constraints,” says Scott Cameron, partner at Reed Smith. “Another interesting point is seeing how various directives and regulatory changes will have a big impact on capital requirements and funding for banks. The UK, Europe and the US are going to be the most hit, in terms of capital required and liquidity maintained, so it’s no surprise that a number of banks or companies are paring back operations in the west and expanding in Asia, where it is perceived to be a more favourable tax, capital and liquidity environment.”
Regulators have taken with renewed vigour to oversight of the markets since the near systemic meltdown of 2007.
In the US, under Dodd-Frank Wall Street Reform and Consumer Protection Act, standardised derivatives must be traded on exchanges or swap execution facilities; over-the-counter derivatives also have to be cleared through a central counterparty. The European Union is introducing similar new rules. Dodd-Frank also has something to say on bonuses and salary caps, while the Volcker Rule restricts US banks’ ability to engage in speculative trading.
The Basel III accord seeks to create a globally regulated standard on bank capital adequacy and liquidity.
Cameron believes that it is important to see some historical context for regulatory arbitrage, starting with the collapse of Enron and WorldCom.
“Since then, people felt there had to be better corporate accountability, which many believed wasn’t there, and more financial transparency and personal responsibility was needed,” says Cameron. “In the US, the result was the enactment of Sarbanes-Oxley in 2002. However the overriding consequences for those outside the US was a shift to European capital markets and in particular London. Many non-US companies deregistered with the SEC. Subsequently, European markets grew to such an extent that by 2005 London was widely seen as taking over as the number one global financial centre from New York City.”
After 2005, there was a wave of directives targeted to overhaul EU financial services, which included the Prospectus, the Transparency and the Market Abuse directives, in a bid to harmonise European regulation and markets.
“At the same time, EU regulations were becoming co-extensive with US regulation, eroding the edge that the UK enjoyed post-Sarbanes-Oxley,” says Cameron. “The EU regulations most likely contributed to a number of companies moving their listings to other jurisdictions, due to high compliance costs. For instance, previously companies would look to London to launch an IPO, but now we are seeing many companies moving into rapidly expanding Asian markets.”
However, when asked if Asia would be likely to follow in the US and Europe’s regulatory reform footsteps and therefore close the opportunity for regulatory arbitrage, Cameron says it would be a substantially long time for any type of reform at this level is likely to be implemented in the region.
“If you look at the US, the Dodd-Frank Act is a significant piece of regulatory reform; you have to go back to the 1930s to see regulatory reform of this magnitude,” says Cameron. “If you look at how long the Dodd-Frank Act took to put together, to respond to changes and criticisms and to timeframe for it to be fully implemented, it is a substantial amount of time. So for Asia, being as varied, broad and deep as it is, doing something of similar magnitude would take a long time.”
The report, called The cumulative impact on the global economy of change in the financial regulatory framework and released on September 6, estimates that banks in the leading industrial economies will require additional capital of $1.3 trillion by 2015, which could push bank lending rates up by over 3.5 percentage points on average over the next five years. The study also revealed that banks’ long-term net debt funding requirement will be $816 billion by 2016, rising to $1.5 trillion by 2020, of which about $670 billion is for banks in the eurozone.