Why the world wants more regulation. And what it means

Globalisation is receding. Across a range of measures such as cross-border trade flows, corporate expansion, tariffs or foreign direct investment, the momentum is away from a trend responsible for much of the economic growth of recent decades.

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The reasons are many, ranging from resurgent nationalism and populism in politics to aftershocks from 2008’s financial crisis to market power in technology. 

"Regulation is more like a current underneath rather than an obvious wave.”

In financial services, for example, prior to 2008, deregulation was in ascendance together with far greater homogenisation of regulation across borders, enhancing globalisation. Since the crisis, governments have become far more sensitive to local control over their financial systems and the data fuelling them – understandably.

What are the mechanics of this return inwards? There are two major forces: investment sentiment and regulation. The latter tends to drive the former but sentiment obviously can drive regulation.

In Australia, the Royal Commission into financial services and superannuation will engender more regulation. The impact will be quite explicit.

Often however, regulation is more like a current underneath rather than an obvious wave.

Incoming trade war

Consider the internet: increasingly there are concerns we are heading towards a new Cold War, this one between the US and China, where alignment is not a military construct but a digital one.

Are you with the US and hence part of an ecosystem not treated equally under Chinese regulation? Or with China whose technology giants are increasingly banned from certain businesses in the US and allied nations?

Facebook, Google, Amazon and others are already facing – and facing increasing calls for more – regulation, notably in Europe and most significantly over questions of privacy and market power.

Already, various models from a more interventionist regulatory history are being drawn upon: should these digital giants be broken up like Standard Oil and The Bell System before them?

Should there be a version of the Glass-Steagall Act for tech? Glass-Steagall was a US law establishing barriers between the retail banking and investment banking and broking operations of banks. Its repeal in 1999 is considered by many to have contributed to the excesses leading to the 2008 financial crisis.

Asset or currency

The idea of a Glass-Steagall for big tech came a week after the US Federal Trade Commission created a task force “dedicated to monitoring competition in U.S. technology markets”. 

Each of these and many other regulatory interventions, as well as responding to often justified civil dissatisfaction, will reshape industries.

While technology will undoubtedly continue to be a seismic force, how those forces play out will be at least steered by regulation. Take cryptocurrencies, spruiked by their promoters as a way to avoid the established financial system.

According to the global banking regulator, the Bank for International Settlements, “the continued growth of crypto-asset trading platforms and new financial products related to crypto-assets has the potential to raise financial stability concerns and increase risks faced by banks”.

“While crypto-assets are at times referred to as ‘crypto-currencies’, the Committee is of the view that such assets do not reliably provide the standard functions of money and are unsafe to rely on as a medium of exchange or store of value. Crypto-assets are not legal tender, and are not backed by any government or public authority.”

While the BIS via its Basel reforms has been intent on more global regulation, anti-global regulation and supervision in financial services has been a major factor in banks simplifying their businesses and even withdrawing from some markets and jurisdictions.

Whatever the impetus, new regulation adds layers of complexity and risk – even if that may well be a price worth paying.

Simple solutions, complex problems

As Sabine Lautenschläger, a member of the Executive Board of the European Central Bank, said recently “we must remember that Basel III is targeted at a financial sector that is very complex. It is a grave mistake to believe that there are simple solutions to complex problems”.

A good proxy for the new rules proliferating is the amount of money being devoted to so-called regtech – regulatory technology – on the premise companies will have to become vastly more efficient and responsive in this domain.

The latest data from RegTech Analyst shows in 2014, 54 per cent of a total of 125 deals were focused on cyber security, identification and compliance regulation. By 2018 that had reached 58 per cent of 164 deals.

Climate risk

Although as a genre “self-regulation” may have lost considerable allure, notable either for being gamed or ineffectual, in some circumstances it has real power – and that is when stakeholders directly influence an organisation.

For example, Google staff have taken a public stance against the company’s strategy of compromising its principles to provide a modified search app in order to do business in China.

More particularly, major investors are moving on climate change responses well in advance of most national governments. Regulators too. The BIS has long been forthright as have other agencies including the Australian Prudential Regulation Authority.

That tier of regulation is now being reinforced by global accounting bodies which have begun to alert companies, executives and directors to the probability of climate risk being a “material” factor in company accounts.

Meanwhile, Australia’s central bank has joined global peers in considering the import of climate change.

In a recent address, the bank’s deputy governor Guy Debelle noted “both the physical impact of climate change and the transition are likely to have first-order economic effects”.

The RBA accepts climate change will happen whether we like it or not given prevailing circumstances and it will represent a trend change not a cyclical one.

Debelle also acknowledged there will be structural changes due to policy, politics and public sentiment.

“The policy environment has a key effect as well as the climatic environment,” he said. “It is worth noting that the effect on the Australian economy is not just a function of the domestic political environment, but also that of other countries, most notably our trading partners.”

Among the responses to climate change will inevitably be regulation. That will manifest too in adjacent realms like financial reporting.

The business models financial institutions adopt will in part be driven by regulation because regulation can impact the return on capital. That regulation can be explicit – what a corporation can or can’t do – or implicit – affecting which businesses are the most profitable.

But whether it is financial system regulation, tech or privacy regulation, climate regulation or nationalist regulation, we are entering a more regulated world. Of course, that’s not necessarily a bad thing but the pendulum is swinging back.

Andrew Cornell is managing editor of bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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