Thursday, November 01, 2007

The regulatory nightmare continues

"It has been nine years in gestation and today it takes effect. But implementation day for Mifid - the markets in financial instruments directive - will not be a Big Bang event in the creation of the European Union's single financial market so much as the start of a long roll-out."

So says The Financial Times, marking the kick-off of the EU’s Markets in Financial Instruments Directive – all in terms of glowing approval:

Mifid is a substantial and potentially sweeping piece of EU law-making. Its objectives of creating efficient conditions for trading securities and other financial instruments, promoting competition and providing EU-wide standards for investor protection serve the laudable goal of fostering economic growth in Europe through the creation of deep, liquid and well-regulated financial markets of a continental scale.
You would not expect the Europhiliac FT to write in any different way so it is to The Daily Telegraph that we must look for the downside. And downside there is:

John Tattersall, chairman of the financial services regulatory practices at PricewaterhouseCoopers, said sophisticated investment firms and brokerages in the City of London would be well placed to benefit from the rule changes, while smaller operations had most to lose.

"In the UK, where many firms have been gearing up for this for some time, it will be less of a step up than elsewhere," he said. However, he added, many firms would be hit with extra costs of compliance, which some have estimated at more than £1bn initially in the UK alone, plus an extra £100m a year.

"Brokerages will have to write to all their clients saying how they have classified them. They will have to disclose much more in terms of conflicts of interest and keep many more detailed records," said Mr Tattersall. "The costs are a concern to many people." But he said larger firms would likely attract more business as a result.
That is the story of EU regulation - and also the explanation of why big business is generally in favour of the EU. Broadly, whether it is hygiene standards for slaughterhouses, the manufacture of toys, electronics, drugs production or – as we see here – financial services, the regulatory system always favours the "big boys" at the expense of the small and medium enterprises.

Taken in the round, the biggest competitors of the giants are not their closest rivals but the hundreds and thousands of smaller business which are fleet of foot, more innovative and often able to operate with lower overheads – thus offering the consumer better value and more choice.

Competing for market share in such a diffuse market is expensive. Major advertising campaign may cost hundreds of thousands, rarely yielding more than a few percentage points. In fact, most advertising and promotion "spends" are directed simply at maintaining market share.

New regulation, however, is a much better prospect. Compliance costs, although onerous, are invariably less than the advertising budget and, in any case, can often be passed on to the consumer. But – as an almost universal rule – they have a disproportionate effect on the smaller business, many of which go out of business, giving gains in market share which may reach double figures.

In purely commercial terms, therefore, regulation is good for (big) business. The more cumbersome and expensive it is the better, as long as the market can be rigged. They are the most effective and economic mechanisms for increasing market share.

The flaws, though, are also manifest. Consumer choice goes out of the window – but since when did big business ever care about that? Furthermore, in a global market – and financial services is nothing if not global – business migrates to less regulated areas.

There then follows a beggar-thy-neighbour policy of trying to impose regulation on those areas but, with financial services, this will not always be possible and unexpected places like Dubai are already making considerable inroads into the London markets.

However, by the time the slide happens, everybody has forgotten what caused it – if they ever knew. The decline is put down to "market forces" or some such – never the real cause. And so the regulatory nightmare goes unchecked – and the FT will continue to write laudatory pieces as we nail the coffin lid down on our economy tighter and tighter.


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