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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Keir Starmer: “I don’t think anybody should underestimate the risks of getting Brexit wrong”

The former director of public prosecutions is now heading up Labour’s response to Brexit. But can he succeed in holding the Tories’ feet to the fire?

Early in his new role as shadow Brexit secretary, Keir Starmer was accused of being a “second-rate lawyer”. The gibe, in a Commons debate, came from none other than Iain Duncan Smith. Starmer was director of public prosecutions for five years and later stood for parliament in 2015. No novice, then. Within a few days, Duncan Smith stood again in the House, this time to offer his apologies.

A fortnight later, I met Starmer at his quiet office in Westminster. He was sitting at a table piled with papers, in an office that, a discreet family photo aside, was unadorned. He had just got back from a whirlwind trip to Brussels, with many more such visits planned in the weeks ahead.

Starmer returned to the shadow cabinet after Jeremy Corbyn’s second leadership election victory last month. “The series of agreements we will have to reach in the next few years is probably the most important and complex we’ve had to reach since the Second World War,” he told me.

Starmer, who is 54, took his time entering politics. Born in 1962, he grew up in a Labour-supporting household in Surrey – his father was a toolmaker and his mother a nurse – and was named after Keir Hardie. After studying law at Leeds University, he practised as a human rights barrister and became a QC in 2002. In 2008, after varied legal work that included defending environmental campaigners in the McLibel case, he became the head of the Crown Prosecution Service for England and Wales as well as director of public prosecutions, positions he held until 2013.

When in 2015 Starmer ran for a seat in parliament to represent Holborn and St Pancras in London, it was assumed he would soon be putting his expertise to use in government. Instead, after Labour’s election defeat under Ed Miliband, he served as one of Corbyn’s junior shadow ministers, but resigned after the EU referendum in June.

Now, he is back on the opposition front bench and his forensic scrutiny of government policy is already unsettling the Conservatives. Philippe Sands, the law professor who worked with him on Croatia’s genocide lawsuit against Serbia, says he couldn’t think of anyone better to take on the Brexiteers in parliament. “It’s apparent that the government is rather scared of him,” Sands said. This is because Starmer is much more capable of teasing out the legal consequences of Brexit than the average Brexit-supporting Tory MP. Sands added: “It would be fun to watch if the stakes weren’t so very high.”

Starmer is a serious man and refused to be drawn on the character of his opponents. Instead, speaking slowly, as if weighing every word, he spelled out to me the damage they could cause. “The worst scenario is the government being unable to reach any meaningful agreement with the EU and [the UK] crashing out in March 2019 on no terms, with no transitional arrangement.” The result could be an economic downturn and job losses: “I don’t think anybody should underestimate the risks of getting this wrong.”

If Starmer seems pessimistic, it is because he believes time is short and progress has been slow. Since the referendum, disgruntled MPs have focused their attention on the final Brexit settlement. Yet if, as he argues, the starting position for our negotiations with the EU is wrong, the damage will have been done. MPs faced with a bad deal must either approve it or “risk the UK exiting the EU without a deal at all”.

It is this conviction that is driving his frantic schedule now. Starmer’s first month in the job is packed with meetings - with the representatives of the devolved nations, business leaders and his European counterparts.

He has also become a familiar face at the dispatch box. Having secured a commitment from David Davis, the minister for Brexit, that there will be transparent debate – “the words matter” – he is now demanding that plans to be published in January 2017 at the earliest, and that MPs will have a vote at this stage.

In his eyes, it will be hard for the Prime Minister, Theresa May, to resist, because devolved parliaments and the European parliament will almost certainly be having a say: “The idea there will be a vote in the devolved administrations but not in Westminster only needs to be stated to see it’s unacceptable.”

In Europe, Starmer said, the view is already that Britain is heading for the cliff edge. It was May’s pledge, that after Brexit the UK would not “return to the jurisdiction of the European Court of Justice”, which raised alarm. And among voters, there is “increasing anxiety” about the direction in which the UK is moving, he said. Even Tory voters are writing to him.

In the Labour Party, which is putting itself back together again after the summer’s failed coup, immigration remains the most vexed issue. Starmer told me that Labour had “earned a reputation for not listening” on the issue. Speaking on The Andrew Marr Show shortly after becoming shadow Brexit secretary, he said immigration was too high and ought to be reduced. But later that same day, Diane Abbott, a shadow cabinet colleague, contradicted him, publicly criticising immigration targets.

Starmer believes there is a bigger picture to consider when it comes to Britain’s Brexit negotiations. Take national security, where he warns that there are “significant risks” if communications break down between the UK and the EU. “Part of the negotiations must be ensuring we have the same level of co-operation on criminal justice, counterterrorism, data-sharing,” he said.

Crucially, in a Labour Party where many experienced politicians are backbench dissenters, he wants to reach out to MPs outside the shadow cabinet. “We have to work as Team Labour,” he stressed.

It’s a convincing rallying cry. But for some MPs, he represents more than that: a lone moderate in what can be seen as a far-left leadership cabal. Does he have any ambitions to lead Labour? “Having had two leadership elections in the space of 12 months, the last thing we need at the moment is discussion of the leadership of the Labour Party.” He has agreed to serve in the shadow cabinet, and is determined to stay there.

Starmer has found his purpose in opposition. “If we think things aren’t going right, we’ve got to call it out early and loudly. The worst situation is that we arrive at March 2019 with the wrong outcome. By then, it will be too late.”

Julia Rampen is the editor of The Staggers, The New Statesman's online rolling politics blog. She was previously deputy editor at Mirror Money Online and has worked as a financial journalist for several trade magazines. 

This article first appeared in the 27 October 2016 issue of the New Statesman, American Rage