For anyone paying attention to the way in which governments and regulators are coming to grips with the financial crisis and its causes, these times continue to be ever so interesting. For those of us who have been in this business for a long time, particularly we who fancy ourselves familiar with prudential and public policy foundations underlying the financial system since the early 1930s, these times are “interesting” in the sense of the old Chinese curse: there is every reason to be frightened by much of what is in the legislative pipeline – especially in the EU.
Let there be no doubt: the assaults unleashed over the past year on the perceived failings of “Anglo-Saxon capitalism” by certain (code for French) continental European governments represent a potential prudential paradigm shift in such elemental questions as who should be incentivised to do what – and bear the associated risk - not just in terms of his or her own private interest, but in terms of the interest of the public and the public purse. Some of this intentional: contrary to subsequent damage control – mainly by Michel Barnier – President Sarkozy meant exactly what he said when he referred to “the triumph of French ideals” which is under way in Brussels, particularly with the new proposed "Alternative Investments Fund Managers Directive" (AIFMD). People – especially Brits – should not delude themselves into thinking the French will be reasonable. They will not: they are bent on nothing less than imposing a French civil law regime affecting property rights across Europe.
If this were just about a French plot, things might be manageable. Unfortunately, the legislative sausage-making process in Brussels is even more chaotic and farcical than it is in Washington – especially when the stakes are high and the facts are as technical and/or highly legalistic as they are here.
The reality is this: beginning with AIFMD, member state civil liability regimes around the nature of your right to the return of your property (i.e., your cash or investments) are going to be irrevocably replaced by how the French feel about this (goodbye, English common law) – albeit at first only in piecemeal fashion affecting investments in funds. The good news is the French think you should never be at risk of losing your investments and a bank responsible for them will be forced to return them immediately. The bad news is – considering the trillions of euros banks will then need to reflect as guarantor risk on their balance sheets – the banks will be forced to either raise fees massively (while massively increasing risk-based capital required to support the risk) or get out of the business altogether. This will massively increase concentration in the financial sector – probably not a great idea in the wake of the crisis – which in turn will ultimately expose taxpayers to new kinds of massive bailouts - possibly more frequently.
Oh, and as a side-note, the legislation as drafted literally prohibits any investment outside of Europe: think of the impact of this on potential return on investment. The European Parliament’s own commissioned report, such as it is, makes for interesting reading: it predicts disaster but, in my view, doesn’t go nearly far enough and misses some crucial elements.
The impact will be on all – ALL – funds other than retail UCITS: e.g., private equity funds, hedge funds, real estate funds, funds-of-funds, you name it. Despite the supposedly limited scope of the directive, UCITS funds will not, of course, escape: it was announced early on that UCITS will be “revised” in some way along the same lines.
So, put that pension fund liability hole and smoke it.
But don’t worry, if you have concerns, you have until 21st January to get your amendments in.
I would like to believe that even the French don’t intend to completely destroy Europe’s financial and investment sectors, so I have got to assume that much of what will happen as a result of this crazy legislation is also unintentional. Sadly, unless the possible consequences of these proposed public policy changes are fully addressed in an inclusive and rational debate, the EU and its citizens are likely to rue having allowed their leaders to succumb to political pressures and philosophical inclinations without these being tested under the disinfecting glare of a truly public, inclusive consultation.
Jean-Paul Gauzes, the European Parliament’s Rapporteur who is shepherding through the new legislation, is fond of noting publicly the unprecedented lobbying efforts in Brussels by industry groups and other stakeholders who object to some aspect or other of the directive. This seems to be stated with a relish which only seems to confirm in legislators’ minds that they must be getting something right if so many in the detested financial services industry doth protest so much. At the same time, officials in Brussels bristle at the notion that public consultation on the directive was lacking, citing prior consultations on such topics as short-selling, private placement passports for non-UCITS funds and regulation of hedge fund managers. Selective memory may serve as a political expedient, but in this case it will prove a dangerous misdirection as it is irrefutably true there has never been any public consultation on the most crucial aspects of the legislation.
This state of affairs brings to mind the infamous case in the United States of the woman who sued McDonalds restaurants for serving coffee in a drive-thru that was hot enough to severely burn her lap[1]. The end result has been that it is now impossible to get a decent cup of coffee anywhere in the United States and, to add insult to injury, consumers are subjected to infantile warnings printed on the outside of take-away cups that the contents therein may be hot (when, in fact, they are not).
There is an old lawyers’ saying that bad facts make bad law, and the facts, according to Andrew G Haldane, Executive Director, Financial Stability, Bank of England[2], are that
. . . the scale of intervention to support the banks in the UK, US and the euro-area during the current crisis . . . totals over $14 trillion or almost a quarter of global GDP . . . [i]t dwarfs any previous state support of the banking system.
Alors: we have very bad facts indeed, and they are well on their way to making very bad laws. For this, instead of a lady with the burned lap, we can thank Bernie Madoff and perhaps some risk managers who evidently were unable to assess the meaning of ever-widening spreads in credit default swaps among the major banks throughout 2008.
The governments and regulatory agencies now sifting through the ensuing wreckage can hardly be blamed for reacting politically: indeed, it is the obligation of those of us in the affected industries that ran the ship aground to redouble our efforts to offer sensible prescriptions for patching the hull and getting under way again – and we need to do this thoughtfully and humbly, for we must realise we lack credibility and so will be looked on (not unreasonably) with scepticism if not suspicion.
All investment funds in Europe, UCITS and non-UCITS alike, are facing a fundamental shift in allocation of responsibilities and risks. The possible consequences and risks which may flow from this reallocation cannot be overstated. What regulators and governments urgently need to understand is this is not an issue for the financial services industry alone: it is an issue for the future of Europe as a financial centre and for ordinary citizens as well as pension fund trustees who are struggling to determine how they will plug the holes in their pensions.
[1] The jury awarded the 81-year old plaintiff $2.7 million, largely because of McDonald’s allegedly callous behaviour. The award was reduced on appeal to $480,000.
[2] *Andrew Haldane, ‘Banking on the State’, BIS Review 139/2009
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