Friday letter: Boon or bane?

Regulation loomed large again this week, as the Financial Stability Board announced new haircut requirements for repurchase operations between banks and non-banks. The moves shouldn’t have a big impact on most lenders in the private credit space, but it is another step by regulators towards more oversight of non-bank lenders.

In many ways, the Financial Stability Board (FSB) is to be congratulated. It is an organisation with broad membership from across the globe, and despite the demands of various markets it has hammered out a unified response to a clear issue for markets: the risks associate with repos, a specific short-term liquidity instrument.

But the FSB also invites criticism – why not apply the same rules to repos between two non-bank financial institutions? Others complain that the new haircut percentages, which are larger than the FSB originally planned, place too high a cost on institutions that are often a lot smaller than the average bank.

As to the first criticism, this has been addressed by the FSB which says it will introduce similar requirements for repo operations between non-banks.

That is important – it demonstrates that the FSB plans to address potential systemic risks as they are identified.

The pace of this work is slow. The consultative document on the new repo haircut rules was published over a year ago, at the end of August 2013.

Without clear guidance on the direction of regulation, it is very hard for non-bank financial institutions to make forward-looking business decisions.

Earlier this month, in the latest edition of its Global Financial Stability Report, the International Monetary Fund called for more regulation of shadow banking. That negative blanket description for non-bank credit intermediation isn’t particularly fair, but it has stuck. And the calls for regulation of non-traditional financial institutions continues to grow louder.

At PDI, we’ve heard over and over again from across a variety of areas within private debt that regulatory uncertainty is one of the biggest issues facing the asset class.

In the US, managers wonder aloud whether the European regulator’s ‘skin in the game’ retention requirements for CLO sponsors will be adopted in their market. Industry bodies argue that the requirements limit the scope for competition in the sector.

But of course, creeping regulation can also also benefit the industry. Earlier this year, the Irish authorities lifted restrictions on lending by investment funds and set out a new regulatory framework for funds originating loans.

PDI has also been told that the UK Treasury is looking at implementing a regime similar to the new Irish framework, which will come into effect at the end of the year.

This example, though, is a reminder that unlike the US, Europe is a collection of countries with a wide variety of regulatory regimes. Though the AIFMD (Alternative Investment Fund Managers Directive), which came into effect on 22 July, is designed to provide a European regulatory framework for funds, that doesn’t mean that the Central Bank of Ireland’s own framework will not apply. Funds hoping to do business in Ireland will be ruled by the local requirements as well as having to comply with AIFMD.

Were the FSB to address regulation of private debt, rather than hinder the asset class, as some may fear, it could be a boon.

The FSB represents 24 countries – many of them among the most significant for the global economy and alternative asset investment.

Regulation is coming. It would be better that it come from an agency with broad based support and applied rules that would be applicable in many jurisdictions, especially those where private credit is already large or growing quickly.