Complex Rules Beget Costly Unintended Consequences

A new report from Acuiti Management Intelligence has found that almost half of EU and UK-based proprietary trading firms are considering moving to a different jurisdiction to avoid increasingly burdensome regulation.

The report also found that a quarter of the firms surveyed are looking at potentially giving up their Mifid II licenses and exiting European markets altogether.

The findings come as significant pieces of financial regulation affecting the trading sector are being reviewed across the globe, with the European regulator ESMA currently evaluating whether MiFID II has met its objectives, HM Treasury assessing the UK’s future regulatory framework and the SEC proposing new market structure reforms in the US.

Across these markets we’re seeing some recurring messages from the market: the need to move away from complicated and costly rules towards a more nimble framework based around a set of common principles and increased communication between regulators and market participants.

The Acuiti report demonstrates why. The firms surveyed are primarily concerned with the impact of the Investment Firms Prudential Regime (IFRD), which came into force on 1st January 2022.

The regulation was originally designed “to introduce a lighter touch capital and governance regime for Mifid II investment firms who would otherwise have been subject to the regime designed for banks”.

However, as unintended consequences would have it, proprietary trading firms are already reporting exceptionally high capital requirements and substantial governance burdens.

The survey found that 92% of respondents had seen an increase in their reporting requirements, while almost 75% said their capital requirements had also increased. Additionally, only 12% believed that the new regime correctly reflected the prudential risk their firm posed to the market.

According to the report, these burdens are putting “significant” pressure on the firms’ ability to compete in the market.

This has been a recurring theme with financial regulation instituted since the financial crash of 2008. The increased compliance costs associated with sprawling, rules-based regulation have led to an industry consolidation which has been forcing smaller firms out of the market.

Simply put, the problem of ‘too big to fail’ has been replaced by the phenomenon of firms unable to compete or even enter the market because they are ‘too small to comply’.

To avoid losing firms to jurisdictions with genuinely lighter touch frameworks, regulators in the EU and UK will need to ascertain why regulation intended to make life easier for targeted sections of the market seems to be having the opposite effect.

Thankfully, the recently created UK-EU Memorandum of Understanding on Financial Services Cooperation, which came into force on 19th May, established a Joint EU-UK Financial Regulatory Forum in which such issues can be discussed. Let’s hope that some of their costly unintended consequences make it onto the agenda.