16 April 2012

Speech by Financial Secretary to the Treasury, Mark Hoban, at the IOMA annual conference

Regulatory reform

The financial crisis vividly exposed the shortcomings in transparency and management of counter-party credit risk in the OTC market, a market which had exploded in size in the years preceding the crisis. But even as we fix those past failures, we also have to ensure that we keep pace with evolving markets. As we drive forward regulatory reform, we need to learn the lessons of yesterday, but also recognise that today’s markets could trigger tomorrow’s financial crisis.

Of course, there are those who argue that regulatory reform is the enemy of growth…that we should postpone, or water down reform. But we reject that argument outright – ineffective regulation and supervision of banking led to a massive contraction in the UK, European and global economy. A stable, resilient, innovative, efficient, and competitive financial system is the vital precondition for sustainable economic growth.

But even as we pursue reform, not just in the derivatives market, but across the financial sector, we have a delicate balance to strike… How to preserve the innovation that fuels the sector’s success, whilst securing long term stability? It’s a difficult line to tread, but it means that as we reform, we have to ensure that regulation is consistent, evidenced based,  proportionate, and promotes competition. Inconsistent and discriminatory regulation merely divides markets into narrow silos, stifling open and competitive markets that are critical to financial sector growth. Disproportionate regulation, based on political whim rather than economic evidence, merely restricts investment, leading to less choice and higher costs for investors and lower returns for business.

But proportionate regulation does not mean weak regulation. We will continue to guard against those who will use reform to unpick tough minimum regulatory standards – reform has to be consistent and non-discriminatory. Full, consistent and non-discriminatory implementation of regulatory reform is essential to ensure the stability of the international financial system, but also to protect free and open competition that allows all our sectors to thrive.

EMIR/MiFID

In the global derivatives market... we have a general consensus at the G20 that we need to move towards the central clearing of derivatives. We need to think carefully about how best to implement central clearing – about how we are going to put principles into practice. First and foremost it is essential that we are consistent across borders. That’s why through EMIR we have worked hard to ensure a clear recognition of the principle of non-discrimination – derivatives should be cleared in any Member State regardless of which currency they are denominated in. It is because of our commitment to this principle that we are challenging the ECB’s location policy in the ECJ which will limit user choice and increase investors costs.

Furthermore, we have to ensure that we safeguard fair, open non-discriminatory access and competition between trading, clearing and settlement systems. That is not to say we must mandate a particular model be it horizontal or vertical. Users must be able to choose where they trade, clear and settle; and not be constrained to using one provider for all these services. Fair and open competition is critical to delivering efficient systems that are responsive to users’ needs, reducing costs for market participants, and boosting growth across the financial system and the real economy.

At the same time, we must also be aware of the potential dangers involved in concentrating risk in clearing houses. That’s why we have pushed for robust risk management requirements to help mitigate against this in EMIR.

But EMIR also only applies to over-the-counter derivatives. We believe that the obligations and safeguards we are applying to OTC derivatives must also apply to exchange traded derivatives. It makes no sense for the same basic product to have different obligations. We must close this loophole if the regulation is to have credibility, avoid arbitrage, reducing systemic risk and establish a competitive market in post trade financial services.

So we welcome the Commission’s proposals in the MiFID review to complete the work started in EMIR by extending the application of two-way open access requirements between CCPs and trading venues to all financial instruments. Indeed, through MifID we have a huge opportunity to promote competition across the Single Market in financial services.

We have already seen the beneficial impact MiFID has had in lowering costs and spurring growth in equity markets through competition, and it is right that we update the directive for the significant changes we’ve seen across the market in recent years. The introduction of the Organised Trading Facility – or OTF – is a bold step and should enable Europe to bring a significant proportion of the OTC derivatives market onto regulated, organised venues, in line with G20 objectives.

But reform has to be considered and evidence based. For instance, whilst it is clear that greater transparency has had a positive effect in equity markets, extreme care is needed to ensure that transparency requirements are carefully designed to work for other, less liquid, asset classes. The success of the OTF category depends on this.

Similar care is needed in updating MiFID to reflect substantial changes in the market place in recent years such as high frequency trading. For that reason, the UK is again leading the way through its Foresight project which is undertaking a detailed assessment of how computer trading may evolve and how this will affect market quality and stability.

The financial crisis was a rude awakening for all of us about the risks posed by inadequately regulated financial markets. But we also all know that a strong, resilient, and competitive financial services sector is an asset to our families, businesses and economies.

Full speech

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