The Global Exchange Industry Must Speak to Regulators with a Single Voice
This year’s Chief Regulatory Officers’ conference at the London Stock Exchange is being held at a time when our regulatory teams are responding to an unprecedented wave of proposed legislative responses to the financial crisis.
I believe that as an industry, we must act together to grasp this opportunity to reshape our economy towards a far more sustainable footing, based on the key characteristics of exchange trading: transparency, neutrality and liquidity.
From my conversations with political leaders in London, Brussels and Washington I believe that there is recognition at the highest levels that this was not a crisis of equity or exchange trading. But unless the exchange industry speaks with a strong, coherent voice, that recognition will not be reflected in the regulatory detail.
History shows us that future bubbles and other crises will follow this one, and unless the groundwork for a robust framework for capital markets regulation is laid now, we can expect the opacity and over leverage of the past ten years to return very soon indeed. This is especially true when you consider just how profitable the status quo is for some parts of the financial services industry.
Our first challenge is to make clear that organised markets are not in any sense culpable for the crisis, and should not be regulated as if they were. Our sector must not become conflated in regulators’ minds with unsustainable practices in the banking industry.
There is no doubt that exchanges played a crucial role in supporting the economy over the past three years. As the many of the OTC markets and bank finance channels all but dried up, public exchanges remained a stable, liquid source of business finance.
However desensitised we have become to the huge sums in which the crisis is described, the influence of capital markets is remarkable. Since the start of the crisis, £168 billion has been raised by companies seeking to stabilise their balance sheets in London alone, with similar records set across the major financial centres. This represents a rescue package larger than the UK Government’s quantitative easing programme.
Our second challenge is to make sure that the output of this whirl of regulatory activity supports, rather than diminishes, the value of this remarkable economic asset. We have a responsibility to offer leadership and expertise, making the case for transparent, liquid capital markets as clearly and effectively as possible. The best policy is made in collaboration between policy makers and industry.
To take two examples, policy responses to short selling and on exchange trading of OTC derivatives are at particular risk of having unintended consequences.
The London Stock Exchange’s own research and that of many other organisations has highlighted the importance of short selling to liquidity and market quality, and its measurable impact on volatility. To my knowledge there is no data or research to support the belief that short selling has a negative effect on the market. It is crucial that as market operators we make an evidence-based case to our regulators, especially in the EU and US, of the likely damage that a ban on the practice would have on the markets it is intended to protect.
As with so many issues, enhanced transparency will reap greater rewards than tight and ill targeted restrictions. I fully support the European Commission’s view that a two tiered short position disclosure regime could effectively balance transparency and privacy.
And regulators are correct to identify the excess leverage and securitisation on OTC markets as a significant contributor to the crisis. Exchanges and central clearing can bring disciplines of price discovery, transparency and risk management to standardised derivatives that are currently traded OTC. However we should resist attempts to force unsuitable, complex instruments through vital pieces of market infrastructure. In particular, the responsibility for defining which contracts can be safely cleared must remain with the central counterparties themselves.
These two issues have gained much coverage in the general press, but they are not the only issues concerning regulators. We will need to have an equal focus on a range of policy areas including the size of banks, resolution funds, clearing houses and corporate governance.
New regulation in many of these areas could have serious implications for our sector and for the effectiveness of capital markets as a fundraising mechanism. As an industry, we should be alive to the fact that policy is being agreed at the domestic, EU and G20 level. Our strategy for response will therefore need to be coordinated across these bodies in a coherent way.
The great truism about the exchange sector is that our businesses are defined by two things: scale and regulation. Competition with respect to scale drives us to offer better, lower cost and more innovative services to our customers.
But to give ourselves and our customers the best chance of achieving effective, stable solutions, regulation must be approached with a single, constructive industry voice supported with real, robust evidence.