The following is a speech given at the recent AICGS Symposium “Fueling the Recovery: The Role of Capital Markets and Banks” in Frankfurt, Germany by Jeffrey Tessler, Member of the Executive Board at Deutsche Börse. The Symposium featured two panel discussions focused on analyzing the impacts of economic and financial policies in Germany and the United States in order to increase cooperation and understanding in the transatlantic relationship. Mr. Tessler gave this opening speech, which emphasizes the need to carefully examine levels of regulation and cooperation on both sides of the Atlantic.
Good afternoon Ladies and Gentlemen,
First of all, let me congratulate the American Institute of Contemporary German Studies for the impressive line-up of speakers today. This clearly shows how relevant the theme of this symposium is “Fueling the Recovery – The Role of Capital Markets and Banks”. This topic is obviously of great importance, not only for Frankfurt as a financial centre, but also for the European and US economy – in fact, for the global economy as a whole. Deutsche Börse Group is therefore more than happy to host today’s event.
My name is Jeffrey Tessler and I am a member of the Executive Board of Deutsche Börse, responsible for its banking business and the post-trade activities.
I am doubly pleased about this opportunity to talk to you today, not just from a professional but also from a personal point of view. As an American who has been living and working in Europe for more than two decades and for whom London, Frankfurt and Luxembourg have become second homes, the relationship between the EU and the US is a topic that is close to my heart. Events like this are also very important to ensure that the relationship between these leading economies is constructive and driven by a spirit of mutual respect for each other’s interests. This includes an awareness of what we have in common, but also of where we differ – and especially, where we can learn from each other. The AICGS and its President, Dr Jackson Janes, are doing a great job here – so thank you once more for making this get-together possible at Deutsche Börse’s traditional trading floor.
Today’s theme is about recovery and how the banking business and markets can become more transparent, safer and more resilient. We believe that exchange organisations have a major responsibility and a fundamental role to play in achieving these goals. At Deutsche Börse Group, we process any transaction end-to-end from the initial trade until the securities are deposited on our books. We are involved in all steps of the trading, clearing, settlement and custody cycle and as a result we are affected by the majority of regulatory developments that have been or will be implemented during the recovery from the crisis. Managing this necessary but very heavy regulatory agenda – also in support of our customers – is one of the ways in which we as Deutsche Börse Group are contributing to market recovery. We are an intermediary between the market on the one side and the political and regulatory stakeholders on the other side and our intention is to facilitate and take a very active role in this market dialogue.
I think we would all agree that financial markets should be based on principles such as stability, transparency and fairness. Regulation is helping us to amend current shortcomings where the market alone failed to meet security and risk mitigation standards, in other words, the shortcomings of pure market-led behaviour. What we need, however, are cautious regulatory measures and increased collaboration between the market and regulators. We also need a regulatory level playing field, a concept which is particularly relevant to today’s transatlantic theme.
I would like to start my speech today by taking a closer look at the financial crisis of 2007 / 2008 and the following re- regulation. In order to better understand how it came about, it helps to have a look at what came before the crisis, which was a lengthy period of deregulation. This deregulation actually started back in the 1970s and peaked in the 1990s. At the time, regulation was seen as an administrative burden which stifles innovation and creates inefficiencies in the market. There was a drive to give the markets greater freedom and to let them find their own balance and create their own rules.
This deregulation unleashed the leverage potential of financial markets as a reaction to a period of stagflation and supported the reconstruction of whole economies in Eastern Europe after the fall of the Iron Curtain.
While it may have served its purpose well during its time the rule of deregulation suffered a severe blow with the onset of the financial crisis in 2007. The crisis exposed ineffective risk management practices, a lack of transparency and questionable incentives for individual behaviour. The increasingly deregulated and highly leveraged markets created in the years before the crisis did not perform as efficiently as some economic theorists believed they would. So it should have come as no surprise that the key response by policymakers to the crisis was to launch a period of re-regulation. But does this mean that we should give up the idea of markets as instruments of rational decision- making altogether? Definitely not.
Let me make this very clear right away: At Deutsche Börse Group, we have always supported regulation and it is my deep belief that there is no free market without rules and regulations. What we need is a form of regulation that gives reason a chance – market freedom and regulation do not need to be at odds with each other. Regulation that is both efficient and effective provides the framework for competition that is free in the sense that no participant enjoys an unfair advantage over another. This means that we must stop to see regulation and free markets as a contradiction. To put it strongly: Only regulated markets are free markets – with the important condition, however, that regulation needs to refrain from intervention. Any hidden national, political or economic agenda behind regulation will inevitably make a level playing field impossible and will result in regulatory arbitrage.
I feel that the crisis has exposed certain core values which policymakers are now trying to protect and which, in fact, all market participants should strive to adhere to with our without regulation:
- The first value to be rediscovered after the crisis was a greater emphasis on safety and an individual responsibility for risk taking.
- The second value to be rediscovered after the crisis is a sense of integrity and the avoidance of excessive exposures. In response, we have seen a greater emphasis on risk management and collateral solutions which we will talk about more later.
- The third value to be rediscovered after the crisis is efficiency and transparency which is being brought about by a simplified market structure. For example, regulators are striving to dry up dark pools and are pushing for the clearing of more OTC trades.
Being a Member of the Executive Board of a regulated exchange organisation, I welcome this rediscovery – while I am also concerned about its possible costs. However, some imbalances are perhaps inevitable in the implementation of rules in support of these new values, especially when carried out on a global scale at G20 Summits.
One of the big disadvantages is that we are currently witnessing uncertainty about the regulatory changes in Europe. Some of these changes are so complex that even experts find it difficult to gain an overview of their impact. Until they have become established in the market, they will in any event cause uncertainty – and thus restraint.
We have also noticed concern in the market about the increasing cost of regulatory compliance – which is a side effect of the fact that the regulatory agenda is heavily charged. What I get to hear from our customers is that they struggle with costly adaptations in times where revenue generation is more difficult than ever.
We are also witnessing an increasing politicisation of financial markets. This is not surprising since the current regulatory push means that financial regulation is moving closer to the top of political agendas and hence also to party politics. The financial transaction tax is a good example of how a rather technical – and ultimately counterproductive – financial regulation can end up topping political agendas and expose rifts between countries and political parties both at EU and national level.
The danger of this politicisation is that it could undermine certain established economic values such as entrepreneurial spirit and free trade. The more politicised financial markets become, the more rigid the rules. However, free trade necessitates a certain amount of tolerance, for example it implies the acceptance of different industrial norms and trading practices but also understanding for trading partners with different values and cultures to our own. I am of course thinking about the ongoing negotiations for the free trade agreement between the EU and the US, where we are witnessing different opinions despite our common aims.
However, while the financial crisis and the following re- regulation have brought many changes, I have noticed that two overriding principles have remained untouched: investor protection and system protection. In other words: fair and equal treatment of each market participant, as well as rules, regulations and technologies that guarantee systemic stability. And it is no coincidence that these core principles of investor and system protection are also the objectives of exchange organisations.
In my opinion, while regulated markets are definitely part of the solution to stabilise the global financial services industry, they must be duly embedded in a diversified exchange system. In fact, I believe that diversified and regulated exchange organisations that are oriented towards the real economy will contribute to improving stability and fairness in the financial industry in the new re-regulated market environment. Exchanges not only support regulators through risk management but also offer solutions for banks and even the economy at large through collateral management services. Market infrastructures such as Deutsche Börse not only played a stabilising role during the crisis, we are also helping to pave the way out of it.
Our strategy is to ensure greater safety and integrity, but also greater efficiency, for uncollateralised and unregulated markets. We are expanding our risk and liquidity management capabilities to those areas of the capital market that hitherto have been uncollateralised and unregulated. To this end, we are currently focusing on two major global projects: firstly, clearing for OTC derivatives, and secondly, collateral and liquidity management. I do not wish to become too technical here, so suffice it to say that they are essential and innovative offerings to improve risk management in line with new regulatory requirements, while keeping costs for market participants at bay.
So now that we have established the pros and cons of the current re-regulation, let’s take a closer look at the regulatory approaches in the EU and US.
As I said before, in implementing the re-regulation on a global scale such as at G20 Summits, some imbalances are perhaps inevitable.
According to the Bank for International Settlements, the volume of OTC derivative markets, measured in notional amounts outstanding, amounted to more than 600 trillion US Dollars last year. So far, the percentage traded on derivative exchanges and cleared via CCPs is very small in overall trading. This means that up to the present day, a huge amount of extremely complex financial instruments allowing highly-leveraged trading strategies is left completely unregulated and unsupervised which creates a huge risk. To tackle this enormous problem, the US have implemented the Dodd Frank Act and Europe is catching up with the US in this respect with EMIR. However, it should be noted that EMIR is stricter on OTC derivative clearing than the Dodd Frank Act, especially when it is taken together with the EU’s Capital Requirement Regulation. So while the EU might be slower than the US, we feel that the EU standards are stricter and we would welcome their implementation as a global benchmark.
Similarly, the EU is looking into ways of capping trading in off- exchange trading platforms tellingly referred to as “dark pools”. The reason for this is, to quote the “Financial Times”, a “lack of transparency”, which has “damage[d] the role of a stock exchange as a venue for investors to establish asset prices”. I could not have said it more clearly and concisely. Let me underline again that increasing transparency is of chief importance for regaining confidence in markets, which logically implies limiting dark trading. The proliferation of off-exchange trading platforms has made the US securities markets increasingly unstable in recent years. This is an area where Europe enjoys a definite advantage, and we need to do all we can to keep it this way.
It is often claimed that the American way of regulating capital markets is superior to what we have in Europe and that this applies in particular to the German regulatory regime because far too much attention is paid to security here. The regulation of high-frequency trading, which has recently hit the headlines again in the US, seems to me to be a good example that the opposite holds true. Here in Germany, the law regulating high- frequency trading unites sensitivity to the market with investor protection. Deutsche Börse combined computerised trading with a range of security functions a long time ago. We have equipped our trading systems with mechanisms that restore trading to calmer waters if it is hit by irrational fluctuations. In addition, the European market structure is different from the US market, it is considerably less fragmented and is organised differently. I can only hope that European policymakers will ensure that these differences are adequately reflected in future regulation. And my preference would be for this German law to be a model across Europe and the US.
Capital requirements are another area in which the EU and the US have different regulatory approaches. In Europe we have Basel III and CRD IV, in the US – to our knowledge – the implementation is partly ongoing and several planned regulatory initiatives are not yet published. Likewise, here in Europe, we are discussing a financial transaction tax whereas the US are currently not considering such a move.
In general, I think it is safe to say that the US remain a pioneer in many respects, even though certain occurrences there triggered the financial crisis. They are ahead of the EU in the re- regulation of capital markets and they made use of the crisis to quickly create new, effective banks and stock exchange organisations which are strengthened through mergers and disciplined through sanctions. We in Europe do our best but all too often quarrel over dubious bureaucratic and wrong regulatory hurdles.
In general, we have observed that the US have moved on quickly after the crisis despite party politics and that the EU is slower than the US in adopting regulations. While I believe there are merits to both regulatory approaches, it is of utmost importance to aim for a harmonised regulation of financial markets as these markets are global markets. A level regulatory playing field is of essential. Even when regulators strive for common solutions at a global level such as at G20 summits, differences in the implementation speed and scope endanger this level playing field and open the door to regulatory arbitrage and should therefore be avoided.
So let me now come to the end of my speech by giving you a little summary:
Financial markets should be organised based on integrity, stability and fairness and the current period of re-regulation can achieve just that as long as the regulatory measures are proportionate and do not get over-politicised. While regulated markets are definitely part of the solution to stabilise the global financial services industry in a sustainable manner, they must be duly embedded in a diversified exchange system. Exchange organisations such as Deutsche Börse Group play a key role in ensuring transparency and fairness in line with upcoming regulations as they provide efficient price discovery, risk management and collateralisation services.
While we support the current push for re-regulation, there are some considerable differences in the scale and scope of implementation of global regulatory initiatives between the EU and the US. I believe there are merits to both regulatory approaches, but it is of utmost importance to aim for a harmonised regulation of financial markets as these markets are global markets. A level regulatory playing field is absolutely essential to meet the goals of transparency and fairness.
I will now hand over to the first panel that will delve deeper into the subjects I have just touched upon by examining the role of capital markets.
I wish you a successful conference, with insightful discussions.
Thank you very much for your attention.