At the recent City & Financial compliance conference in London, the great and the good debated the main issues of the day. These included MiFID II, the effect of stringent money-laundering regulations on private banking business and money services, the centralisation of EU regulation, the Equality Act, living wills for banks, 'job handover documents' and other things that are going to be part and parcel of various supplements to the UK's Approved Persons Regime.

Angela Hayes, a partner at the City law firm of King & Spalding, was in the chair. On the panel were Reinder van Dijk, a Dutch partner at a Europe-wide economic consultancy called Oxera, Andrew Clarke of PwC and Matt Baker, a senior associate at the City law firm of Berwin Leighton Paisner. Each panellist was asked to talk about upcoming regulatory developments that were of interest to them or of general importance. Baker set the ball rolling by talking about the world of MiFID II, the EU's Markets in Financial Instruments Directive which is a replacement for the 2004 directive, which was implemented in November 2007.

“Then, the markets were still going great guns. The users of the market didn't see a huge amount of difference. Then the global crisis happened and we had all those dark pools of liquidity and flash crashes that the press enjoy writing about. The EU decided that something must be done and came up with MiFID II, which replaces the old directive but also includes a set of regulations.

“It has been about 3 or 4 years in the making and, given the huge amount of other stuff going on, I think an awful lot of practitioners are tempted to think well, it's all to do with dark pools and algorythmic trading, I don't do that so I don't need to worry about it. But the [EU has] snuk in an awful lot of things [including] the new concept of organised trading facilities. 'Systematic internaliser' is another wonderful phrase found in MiFID I but they are expanding what it means spectacularly.”

The existing MiFID states that a firm should be treated as a systematic internaliser if it deals on own account by executing client orders in shares outside a regulated market on an “organised, frequent and systematic basis”.

Baker went on: “Anthony Hilton wrote an article in the Evening Standard a couple of weeks ago that argued that we are going back to 1985 again, before the Big Bang, and actually we're going to have to go back to days of jobbing brokers. I'm not entirely sure if that is exactly correct, I

think that analysis may be slightly too colourful, but it is one of the many problems with this particular piece of EU legislation.

Not just algorithmic trading and dark pools

He bemoaned the fact that much of the EU's legislation consists of a vague 'framework (skeleton) directive' and 'framework regulations' that leave it up to the European Commission, the nearest thing that the European Union has to an executive branch, to “pretty much make it up as they want.” The arbitrary decision-making of this body, and of its regulatory sub-body, was of concern to him: “In July the European Securities and Markets Authority dropped about 800 pages on us that consisted of consultations as to what they do with the more detailed rules and we don't have a sense yet of how broadly or how badly it's going to hit the market. In terms of conduct, they are introducing things like product intervention, we have changes to appropriateness rules, we have the fact that senior managers will have to take more responsibility for product designs, reversals of ability for soft commissions - it's a not-quite-endless list. It is certainly a lot more than algorithmic trading and dark pools.”

A series of tipping-points

Throughout the day of the conference Angela Hayes had been warning that financial business in most of the developed world was approaching “a series of tipping points, one of which is that because of the amount of regulatory change coming both from Europe and from America (Dodd Frank, Volcker...some of those have already bedded in) it is becoming impossible for compliance and operations functions to sensibly get their hands around what they have to do and it is very unlikely that firms are going to be able to prepare properly to meet the MiFID deadline.” She asked the panel for their views.

Baker thought that this gloomy prophecy was entirely right: “There is a huge risk of that, and not least because we don't have the detail, we're not expected to have the detail, until late next year or probably the year afterwards. Eventually, there's a hard deadline of January 2017.

“When you don't have your detailed rules and you don't know what you're doing with your procedures, that isn't very long at all. Then there's the crossover of regulation and how difficult it is to do it. You mentioned ring-fencing; it's a perfect example of the cross-over of regulation. Earlier this week the Treasury or the PRA came out with 4 massive papers on UK ring-fencing. At the same time Europe is looking at Liikanen, which is like ring-fencing but different, at ways of chopping up banks, and an awful lot of institutions are global so they're also trying to sort out Volcker. How do you physically chop up your bank into the different bits if you can't put them all in the same subsidiaries? It generates great work for lawyers, but is less good for the people who run banks.”

Money-laundering regulation and the law of unintended consequences

On the subject of financial crime, on which he is an expert, Andrew Clark noted: “Look at some of the unintended consequences that the existing set of regulations is creating. A lot of the big financial institutions are looking at the risk profile of their customer-base and doing a 'de-risking' exercise,

which is basically 'exiting' customers who, they feel, pose a greater risk of financial crime or money-laundering than they are willing to bear. There's a cascade of people who might pose a high

(or higher) risk of ML who are going to migrate to organisations that are perhaps less well able to deal with those ML risks or perhaps not be able to get banking services at all, and if you find

situations where people who travel to sanctioned countries to visit relatives, Iran being a good example, are suddenly told that UK banks cannot provide them with banking, before too long there are going to be sectors and types of people who can't get banking services at all. And banks are going to stop operating in particular countries, because of the risk profiles of those countries or of business segments.

“Why would anyone want to do business with Somalia given the risk profile? Why would they be willing to support the Money Transmission Association? It's all just too difficult. When you think about the common good, is it helpful to prevent countries that need support from the financial services of developed economies being chopped off by corporations that are worrying about regulatory pressure?

“I think the unintended consequences could be quite interesting, and some new business models - things like crowd-sourcing and virtual currencies - are perhaps less focused on customer risk and money-laundering. The latter pose all sorts of jurisdictional problems. Some of those virtual currencies came out of a stated ambition to try and avoid the authorities.

“Also, financial institutions are changing their business models to deal with the pressures of regulation, particularly with 'know your customer' or KYC. The expectations and the requirements to get that done better has led people to ask why every bank has to verify/identify the same set of people and whether it might not be better to have some central utility and some national single unique identifiers for natural persons and corporate entities that would do away with the need for you to do that at a corporate level. Some utilities are open for business; others are being set up. Certainly some of the bigger banks have service delivery centres where they themselves have a centre of excellence but could you spread that across countries and organisations? And how would you then regulate that? And wouldn't that be a better way of perhaps feeding a central utility with better intelligence about the people whom you truly want to keep out of the system? I don't necessarily have any answers to any of those things.

Angela Hayes, taking a leaf out of the Biblical book of Revelation, joked that everyone might end up with barcodes on their heads. Clark agreed that the issue threw up “all sorts of civil liberty questions” including the spectre of cyber-attacks and the fact that centrally-held information is always unsafe. HM Government, to name but one jurisdiction, has a fine reputation for losing millions of people's data in briefcases left on trains.

They do things differently in Europe

Reyner van Dijk, returning to the topic of MiFID II, thought that European centralisation and the European mindset might cause the City of London future problems: “It's interesting to see that more and more is being determined by Brussels and by some of the European regulators but the approach there is still very different. Among the national regulators in continental Europe there is much more of an appetite to intervene directly. Product regulation, price regulation. And it will be interesting to see how the UK's Financial Conduct Authority is going to deal with that. We would suspect that that's going to result in some tension. So when you look at the ESMA consultation on MiFID II, it's a very detailed document, hidden in the details there are elements of price regulation in the wholesale sector – a very different approach from what we see here in the UK.

“There are examples of national regulators banning products. We have a little bit of that in the UK, but in continental Europe it is much more of a trend. At some point that could have an impact on the UK as well.”

Liam Russell of the Chartered Insurance Institute took note of the amount of business – especially with money transmission organisations and customers from 'high risk' territories – that private banks are now turning down. He asked: “Is there a risk that those companies are going to have to tread on eggshells, because there could be discrimination arguments, for example if you stereotype people from Somalia or do anything along those lines and say, "You're from Somalia, I'm not going to give you banking." That's going to wind up in a lot of vilification because, under the Equality Act, you can't do that. Has that been a consequence of the things that you've seen?

Clarke replied: “I think we haven't yet got to that place but I think it's a very valid point. The bank's line would be "this customer presents a risk profile I am not willing...to manage." If you go back about 10 years ago, the Financial Services Authority, as it was then, stepped up the focus on customer identification and a lot of banks implemented fairly clumsy mechanisms that meant that little old ladies who didn't have passports couldn't open new savings accounts and there was a public backlash and politicians were written to and I wonder whether, before too long, we'll begin to see the same kind of thing if some of these de-risking processes lead to certain sections of the community feeling that they are being excluded.

Reinder van Dijk added: “It's not just affecting individuals, it's also affecting a lot companies offering money transmission services etc. where ML is a high risk and it's difficult for them to get services from the banks.”

Living wills for zombie banks

Peter Langham from the National Audit Office changed the subject to the policies that banks will soon have to have in place to allow them to 'collapse in an orderly way.' He said: “There was a lot of talk about living wills after the financial crisis and promises that the taxpayer was not going to be on the hook the next time. I saw a couple of months ago that the US had thrown out all the living will plans that the banks had submitted. I just wondered where things had reached. Are we ever going to see those living wills and recovery resolution plans? Will they ever be effective and ready to be implemented or do you think that's pie in the sky?”

Matt Baker's outlook was gloomy: “I think we'll probably never see the whole documents. These things go on forever and they have all the banks' state secrets in them. Unfortunately, it's another of those areas where too many regulators are trying to poke their fingers in. The UK has theBanking Reform Act 2009 which talks about it in broad terms, but now we also have the European Recovery and Resolution Directive.

He noted that, in tandem with the emergence of recovery plans, the UK's approved persons regime was due to change: “One of the key planks of that is that everybody's got to have a job handover document and presumably that will have to match up to the recovery and resolution plan because if it doesn't, what's the point of it? So when you've got every relevant person's handover list, you put them together in a great big pile with all the contracts and it's an absolutely monstrous undertaking.”

Van Dijk pointed out that such resolution schemes were initially developed for banks but are now being extended to other types of firm including central counterparty clearing-houses or CCPs “because we have realised that some of those companies have become very big - as a result of regulation, actually – and may therefore need those resolution schemes as well.” Angela Hayes added her fears that conflicts of law between countries would cause severe problems for international companies, private banks among them, and would ensure that no such organisation could reach 'a holistic solution.' She agreed with van Dijk when he said: “I think it's more a skeleton than a real plan.”

The direction of travel for enforcement

Angela Hayes asked the audience about the UK's forthcoming Senior Managers' Regime (designed to focus accountability on a narrower group of senior decision makers than the existing Approved Persons Regime does) and the future (or 'direction of travel') of enforcement action against individuals. Under what circumstances, she mused, would it be fair and proper to hold a board member responsible for his bank's or financial firm's actions?

“If he believes that he is doing the right things, that he has put competent people in place with a good control mechanism but [he is wrong and] things go still wrong, and the FCA thinks of him as an incompetently good guy who tried to do the right thing but failed, do you think...that his career should be at an end and he should have a massive fine?”

Andrew Clark said no: “One of the dangers of that is 20/20 hindsight and, post event, it's easy to say that that was the wrong decision but at the time it may have been a perfectly fair decision. I spent three years helping to run the administration of Lehman Brothers. There was a big question about the culpability of the executives in the UK and whether they had done anything wrong, so I did quite a lot of investigating. What that came down to was that there was no conscious act to do anything improper - most of the problems were in the US - but there was a desire on the part of the regulator to find someone and blame them regardless. I'm worried about that retrospective [view that says] 'we can see it was wrong because look at the outcome.'”

The Dutchman added: “If you think about the mis-selling cases, a slightly different area, it's very interesting to look at endowment mortgages. At the time those mortgages were being offered, there wasn't anyone who would say that those products would not result in good outcomes for consumers. [Editor's note for readers outside the UK: In the 1980s product providers sold endowment policies alongside mortgages with promises that they would pay those mortgages off and produce additional returns. The stock market later fell, rendering the policies toxic.] Even the consumer bodies thought that it was a very good product. Macro-economic circumstances changed and endowment mortgages did not [benefit] some consumers. At the time the harm materialised it became very obvious where decisions had been wrong, but looking at it ex ante is very difficult. Also, there is a big difference between prudential risk (which can be managed to a large extent) and conduct risk (where events are unpredictable). Lastly, [this new regime] is a development that we haven't observed in any other country.”