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

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Calum Kerr on Governing the Digital Economy

With the publication of the UK Digital Strategy we’ve seen another instalment in the UK Government’s ongoing effort to emphasise its digital credentials.

As the SNP’s Digital Spokesperson, there are moves here that are clearly welcome, especially in the area of skills and a recognition of the need for large scale investment in fibre infrastructure.

But for a government that wants Britain to become the “leading country for people to use digital” it should be doing far more to lead on the field that underpins so much of a prosperous digital economy: personal data.

If you want a picture of how government should not approach personal data, just look at the Concentrix scandal.

Last year my constituency office, like countless others across the country, was inundated by cases from distressed Tax Credit claimants, who found their payments had been stopped for spurious reasons.

This scandal had its roots in the UK’s current patchwork approach to personal data. As a private contractor, Concentrix had bought data on a commercial basis and then used it to try and find undeclared partners living with claimants.

In one particularly absurd case, a woman who lived in housing provided by the Joseph Rowntree Foundation had to resort to using a foodbank during the appeals process in order to prove that she did not live with Joseph Rowntree: the Quaker philanthropist who died in 1925.

In total some 45,000 claimants were affected and 86 per cent of the resulting appeals saw the initial decision overturned.

This shows just how badly things can go wrong if the right regulatory regimes are not in place.

In part this problem is a structural one. Just as the corporate world has elevated IT to board level and is beginning to re-configure the interface between digital skills and the wider workforce, government needs to emulate practices that put technology and innovation right at the heart of the operation.

To fully leverage the benefits of tech in government and to get a world-class data regime in place, we need to establish a set of foundational values about data rights and citizenship.

Sitting on the committee of the Digital Economy Bill, I couldn’t help but notice how the elements relating to data sharing, including with private companies, were rushed through.

The lack of informed consent within the Bill will almost certainly have to be looked at again as the Government moves towards implementing the EU’s General Data Protection Regulation.

This is an example of why we need democratic oversight and an open conversation, starting from first principles, about how a citizen’s data can be accessed.

Personally, I’d like Scotland and the UK to follow the example of the Republic of Estonia, by placing transparency and the rights of the citizen at the heart of the matter, so that anyone can access the data the government holds on them with ease.

This contrasts with the mentality exposed by the Concentrix scandal: all too often people who come into contact with the state are treated as service users or customers, rather than as citizens.

This paternalistic approach needs to change.  As we begin to move towards the transformative implementation of the internet of things and 5G, trust will be paramount.

Once we have that foundation, we can start to grapple with some of the most pressing and fascinating questions that the information age presents.

We’ll need that trust if we want smart cities that make urban living sustainable using big data, if the potential of AI is to be truly tapped into and if the benefits of digital healthcare are really going to be maximised.

Clearly getting accepted ethical codes of practice in place is of immense significance, but there’s a whole lot more that government could be doing to be proactive in this space.

Last month Denmark appointed the world’s first Digital Ambassador and I think there is a compelling case for an independent Department of Technology working across all government departments.

This kind of levelling-up really needs to be seen as a necessity, because one thing that we can all agree on is that that we’ve only just scratched the surface when it comes to developing the link between government and the data driven digital economy. 

In January, Hewlett Packard Enterprise and the New Statesman convened a discussion on this topic with parliamentarians from each of the three main political parties and other experts.  This article is one of a series from three of the MPs who took part, with an  introduction from James Johns of HPE, Labour MP, Angela Eagle’s view and Conservative MP, Matt Warman’s view

Calum Kerr is SNP Westminster Spokesperson for Digital