Regulation: the West's new competitive disadvantage

Is it really the solution?

Regulation and more regulation have become the siren calls of governments and the general public across the Western world. The curtailment of banking freedoms and greater government oversight of the sector has been deemed by experts and laymen as the most effective way to prevent another financial crisis.

Whilst the banks were undoubtedly reckless in their pre-crisis activities, their behaviour did not occur in a vacuum and reflected the prevailing government and public sentiment of the time. Easy credit was a vote winner for both President Clinton in the US, where more African Americans were able to buy their own homes, and the Labour Party in Britain  who were buoyed by a property and credit boom in the traditionally poorer areas of the country. Governments were more than willing to tax banking profits and collect stamp duty revenue from house purchases and consumers were happy to spend money they didn’t have.

Despite efforts to hold the banks solely culpable for the financial crisis, governments across Europe have still fallen, swept away by disillusioned electorates. Against this backdrop, insufficient questions are being asked about the efficacy of the new regulation, its impact on trade and investment and the rebounding of the US and European economies. Far from being the salvation of Western capitalism, regulation may further accelerate the movement of the world’s economic centre of gravity eastward, a trend that increased in vigour during the economic crisis.

Whilst the US and the EU floundered under the burden of sovereign debt and banking failures, Asia rebounded from recession much more quickly thanks to its more robust banking system and debt dynamics. Cash-rich Asian banks seized the opportunity to ramp up their businesses and expand market share while Western banks retrenched.

In the wake of the financial crisis, growth has become the mantra of Asian markets whilst Western governments have adopted an ambitious programme of regulatory reform to address the fundamental weaknesses in the structure of financial regulation. The objective is to provide cohesion, consistency and coordination between countries and to ensure greater oversight of the financial sector and activities of private corporations. In the quest to achieve this noble objective little has been said about the impact tighter regulation will have on Western competitiveness.

The implications of this omission were quickly revealed when the panic associated with the global crisis dissipated and the emphasis on coordination and cohesion receded. While most regulatory changes are taking place under the auspices of the G20, significant differences are present between the EU, the US and Asia. The EU and to a lesser extent the US, are acting against a backdrop of fragility in the banking system and the sovereign debt markets, and are confronted with the unenviable task of solving the current problems whilst designing a regulatory system that will prevent future crises. All the while, the governments are facing increasing pressure from the public and large sections of the media to take action against the banking sector.

Europe’s reality stands in stark contrast to that of Asia. The region is booming and the focus is on the unimpeded development of the financial infrastructure rather than on crisis response. The debate centres on the benefits of a global approach to regulatory reform as opposed to the ability to retain local flexibility. Indeed there is a prime opportunity for the regional financial centres of Hong Kong and Shanghai to develop their own banking, brokerage and asset management sectors independently of the restrictive regulation of the West and to secure a competitive advantage in doing so. .

Capital adequacy and liquidity standards for banks are a key area to be targeted as a result of the crisis. Basel III, adopted in 2010, effectively triples the capital reserves for many banks to 7 per cent as compared with the 2 per cent required under Basel II. The Liquidity Coverage Ratio (LCR) will also be tightened to ensure banks apply adequate capital to all their exposures, including those off balance sheet, to offset forecast cash outflows during a 30-day crisis. Such a system should prevent a future financial crisis from spreading beyond the financial sector into the real economy, thereby limiting the impact and making a crisis more containable.

The threat to Western competitiveness posed by Basel III derives from the fact that the accords will fail to create a truly global level playing field among international banks. They lack the binding force of a treaty and their adoption is likely to be limited to European banks. Basel III regulates the amount of lending that a bank can do - in conjunction with the central bank reserve requirements - and as a consequence also ends up partially regulating the money supply expansion for the entire economy. The impact on trading activity will be particularly severe because the application of the new leverage ratio to the trading book, with a 100% credit conversion factor for trade related business, will make trade and asset secured lending much more capital intensive. There is a real possibility of a significant drop in trade and a further reduction in the developed nations’ GDP, particularly in the Eurozone.

Laws and norms governing financial regulation generally reflect the ideological leanings of those at the highest levels of government. What is palpable at present is that the historically capitalist and entrepreneurial spirit of the UK and the US is being dampened by regulation and in reversal of its strong commitment to economic and financial liberalisation, the US has led efforts to nationalise its financial and some aspects of its manufacturing sectors, to an unprecedented degree. As many EU governments become increasingly left leaning, the efforts to restrict the operations of the financial sector intensify.

After the dominance of the West, we are moving towards a new economic paradigm characterised by competing ideologies and regulatory systems of governance. It is highly possible that different regions of the world will adopt contrasting regulatory systems, creating opportunities for regulatory arbitrage. While this may create a competitive disadvantage for sovereign states, investors who are not restricted by borders will be well placed to benefit from the investment opportunities increasingly divergent economies have to offer, with a greater scope for diversification and risk control. Over time, such diversification may reduce the high degree of correlation between stock markets in times of crisis and a more diverse regulatory world may be more resilient to shocks.

The creation of economic inefficiencies and limiting the optimal allocation of capital will impact Western markets more keenly than their rising Asian peers and it appears that the growth of Western economies will be stymied by regulatory restrictions.

Photograph: Getty Images

JLT Head of Credit & Political Risk Advisory

Photo: Getty
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The rise of the green mayor – Sadiq Khan and the politics of clean energy

At an event at Tate Modern, Sadiq Khan pledged to clean up London's act.

On Thursday night, deep in the bowls of Tate Modern’s turbine hall, London Mayor Sadiq Khan renewed his promise to make the capital a world leader in clean energy and air. Yet his focus was as much on people as power plants – in particular, the need for local authorities to lead where central governments will not.

Khan was there to introduce the screening of a new documentary, From the Ashes, about the demise of the American coal industry. As he noted, Britain continues to battle against the legacy of fossil fuels: “In London today we burn very little coal but we are facing new air pollution challenges brought about for different reasons." 

At a time when the world's leaders are struggling to keep international agreements on climate change afloat, what can mayors do? Khan has pledged to buy only hybrid and zero-emissions buses from next year, and is working towards London becoming a zero carbon city.

Khan has, of course, also gained heroic status for being a bête noire of climate-change-denier-in-chief Donald Trump. On the US president's withdrawal from the Paris Agreement, Khan quipped: “If only he had withdrawn from Twitter.” He had more favourable things to say about the former mayor of New York and climate change activist Michael Bloomberg, who Khan said hailed from “the second greatest city in the world.”

Yet behind his humour was a serious point. Local authorities are having to pick up where both countries' central governments are leaving a void – in improving our air and supporting renewable technology and jobs. Most concerning of all, perhaps, is the way that interest groups representing business are slashing away at the regulations which protect public health, and claiming it as a virtue.

In the UK, documents leaked to Greenpeace’s energy desk show that a government-backed initiative considered proposals for reducing EU rules on fire-safety on the very day of the Grenfell Tower fire. The director of this Red Tape Initiative, Nick Tyrone, told the Guardian that these proposals were rejected. Yet government attempts to water down other EU regulations, such as the energy efficiency directive, still stand.

In America, this blame-game is even more highly charged. Republicans have sworn to replace what they describe as Obama’s “war on coal” with a war on regulation. “I am taking historic steps to lift the restrictions on American energy, to reverse government intrusion, and to cancel job-killing regulations,” Trump announced in March. While he has vowed “to promote clean air and clear water,” he has almost simultaneously signed an order to unravel the Clean Water Rule.

This rhetoric is hurting the very people it claims to protect: miners. From the Ashes shows the many ways that the industry harms wider public health, from water contamination, to air pollution. It also makes a strong case that the American coal industry is in terminal decline, regardless of possibile interventions from government or carbon capture.

Charities like Bloomberg can only do so much to pick up the pieces. The foundation, which helped fund the film, now not only helps support job training programs in coal communities after the Trump administration pulled their funding, but in recent weeks it also promised $15m to UN efforts to tackle climate change – again to help cover Trump's withdrawal from Paris Agreement. “I'm a bit worried about how many cards we're going to have to keep adding to the end of the film”, joked Antha Williams, a Bloomberg representative at the screening, with gallows humour.

Hope also lies with local governments and mayors. The publication of the mayor’s own environment strategy is coming “soon”. Speaking in panel discussion after the film, his deputy mayor for environment and energy, Shirley Rodrigues, described the move to a cleaner future as "an inevitable transition".

Confronting the troubled legacies of our fossil fuel past will not be easy. "We have our own experiences here of our coal mining communities being devastated by the closure of their mines," said Khan. But clean air begins with clean politics; maintaining old ways at the price of health is not one any government must pay. 

'From The Ashes' will premiere on National Geograhpic in the United Kingdom at 9pm on Tuesday, June 27th.

India Bourke is an environment writer and editorial assistant at the New Statesman.

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