When is a regulation not a regulation?

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The European Parliament in session in Strasbourg, France.

The EU seems to be working on a regulation which will spread around the risk that exists in the hands of a few. The crisis that took place in the US, termed “too big to fail”, occurred due to the fact that too much risk was concentrated in few hands. This meant that many were left holding on to assets which could lose value and be detrimental to the balance sheets of the few corporations. In addition to that, the magnitude of the loss was going to be so huge that it could not be handled by the corporation and so the effects would bleed on to the other participants forcing some sort of bailout to protect the risk takers from going bust.

The EU is working to avoid that situation by passing laws that will prevent a few hedge funds and private equity groups from threatening the global financial system. In an expert’s point of view, the EU should first look inwards and correct its own affairs (read Greece) rather than looking to regulate other investors. Greece is looking like a failed cause day by day with the recent waiver of 2 years on its debt payments to get itself into shape. The last thing EU needs is to put in place a regulation that does not work. Or in this case, does the exact opposite by placing more risk rather than less risk in the hands of a few investors at the top.

The impressive sounding Alternative Investment Fund Managers Directive (AIFMD) is being hashed out currently and is expected to be passed in the next few weeks. The goal of the directive is to bring out the secretive trading carried out by asset managers and bring them into the open by expanding the regulatory net that already exists. This will allow the regulators to monitor the trades in a better manner and would be able to keep tabs on the fund management industry.

The opponents of the measure say that the additional cost of complying and monitoring would actually push some investors to trade secretively and to hide from the officials in order to avoid the costly and lengthy processing required. There seems to be a lack of amnesty and incentive system in place and that is why fund managers would rather stay in the background than have an additional supervision imposed on them.

These seems to be a hard decision for the EU to make in the midst of a fiscal and sovereign debt crisis, LIBOR and EURIBOR manipulation and turmoil in the equity and commodity markets. The last thing Brussels needs is more backdoor dealing going on that evades the scrutiny of the law.

On one hand, the EU can either leave the industry as it is and hope that the increase in activity and trading would somehow sustain the system while circumventing the financial crisis that the US faced. On the other hand, it can look to put the necessary measures in place and then hope that the additional certainty will drive investment and funds to the region leading to better investor confidence.

The measures that have been talked about till now involved independent depositories to hold the assets in order to keep them safe and avoid any unexpected withdrawal without approval or knowledge of the depository. This does mean that investors are safer and their assets cannot disappear all of a sudden, but the paperwork and the processing can weigh down fund managers from actually using depositories and avoid them to play by the rules by shifting their funds elsewhere.

This point gains more momentum when one looks at the fact that currently emerging markets of Far East and the BRIC nations are still yielding better returns than US or the eurozone dollar for dollar.

Regulation in financial markets has always been seen as a double edged sword where the fact that they are put in place not only drives the investors away but also the ineffectiveness of the laws in the first place means that the regulators lose in both terms. The impact of these regulations has to be seen in coming months and considering the slow recovery it might take more time to actually see the changes come into place. At this point in time, it should be hoped that this measure gets some much needed injection of hope and optimism into the markets which, to be honest, is losing it more day by day…

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