One theme of the Finadium conference this year was that securities finance is now meeting the world. This idea extends to how regulators view securities lending and repo. A regulatory understanding of these markets is critical not only for regulators to achieve their goals, but also to connect regulatory objectives with impacts for the real world. We think that the dangers of disconnect in some parts of the world is at a real high; the sooner that regulators understand the role that securities finance plays in financial markets and real economies, the better the results of their policy making for banks and real economies.
We think that banks do need to be regulated within reason. The world’s largest banks do carry systematic risk and should be adequately monitored to ensure that individual desires for a bigger bonus do not get in the way of the success of an institution for both shareholders and the real economy. Banks perform genuine services for domestic and international economies in moving capital from point A to point B and providing credit intermediation. This theory applies whether thinking about providing a mortgage in a local market to providing financing for a global infrastructure project to financing hedge fund positions. The more regulation applied, the less that banks will be able to perform their credit intermediation job. On the other hand, too little regulation means that banks may have a freer hand than they should in taking on riskier tasks that, as we saw in 2008, can lead to a global blowup.
Our thinking about bank regulation applies to Shadow Banking as well. Shadow banking truly has a terrible title for the beneficial activities it offers to financial and economic markets. Securities lending provides tremendous and substantial liquidity to financial markets, which in turn are a core mechanism for capital raising in modern economies. The more liquidity in financial markets, the lower the cost of capital for companies that issue shares on those markets. While politics unfortunately plays into short selling bans, every sane regulator we have ever spoken with has agreed that both short selling and securities lending are beneficial for the markets.
Likewise, repo transactions facilitate funding for assets that otherwise investors would not purchase. These assets do not materialize out of thin air; they are the product of individual or corporate consumers with needs at some point in the economic cycle. Without these funding markets, these consumers would not receive the credit upon which most of economic activity worldwide is based. We wish we knew the correlation between funding markets and consumers getting credit; that would be a fascinating figure to put up on a big screen.
In Europe, our colleagues have expressed tremendous dismay with the Financial Transactions Tax, which in some cases may create taxation costs well and above the revenues of financing desks and effectively stop these operations. Speaking to The Telegraph two weeks ago, Gabriele Frediani, head of the electronic fixed income market MTS, said “the tax would cause repurchase or Repo trades to plunge by 99pc. ‘The Repo market would disappear overnight,” he said.'” We agree with his conclusion.
To hear regulators talk about financial transactions taxes, these appear to be a penalty on banks; regulators want banks to give back for the losses they caused in 2008. It is now well understood that the real tax will be passed through to investors, and this will serve to reduce overall transactional volumes. Already in Italy stock exchange volumes are down 39% from Jan/Feb 2013 to March 2013. While the FT speculates that some of this may be due to Italy’s recent election, another portion is certainly tax driven. New taxes will also raise the cost of capital for national governments and possibility create more costs than the revenues they create.
The disconnect we see is that many bank functions including securities finance appear to be viewed by regulators as little more than money centers for banks. The understanding of what banks do, how they make money and how they serve the real economy appears to be broken. The more that regulators can strive to understand how banks work and how they serves the real economy, the more that senseless and self-defeating regulation can be avoided. Likewise, the more the banks can present themselves as providing services to the real economy, the more they will be in line with regulatory desires for financial stability.