Tuesday, 23 October 2018

The Ever-growing Importance of ESG: BlackRock and Audi

In today’s post, we shall examine a concept that we have examined a number of times before here in Financial Regulation Matters, and that is the concept of ESG, or more accurately the integration of ‘E’nvironmental, ‘S’ocial, and ‘G’overnace concerns in relation to business. Today’s post focuses on two stories in particular, and uses them as a vehicle for examining some merging debates around this ever-growing sector.

We looked over the summer at the story that Nissan had admitted to falsifying some of its emissions-related data, which naturally should lead us to think of the sector-defining Volkswagen scandal, a scandal which will leave a massive mark on one of the industry’s powerhouses. In line with those developments, Audi was fined €800 million last Tuesday for similar transgressions, ranging from 2004 to 2018. There are, of course, a number of issues and variables that are affecting the auto industry at the moment, but for our discussion surrounding the concept of ESG, it is clear to see that for an investor, ESG is important. We are seeing that, due to environmentally concerned regulations, large corporate entities are at risk and, as such, so are the investments of the institutional investors who facilitate the movement of capital. Audi’s punishment, when combined with the massive penalties felt by VW and the potential penalties that will be given to Nissan, serves as a reminder to investors that they really ought to consider ESG within their investing decisions. If we look to the business media, there is a story today that suggests that this message has been received loud and clear.

BlackRock, one of the world’s leading investment vehicles, has decided that it needs to be at the forefront to the ‘sustainable finance’ revolution. Speaking yesterday, Larry Fink – Chairman and CEO of BlackRock – stated that his intent is for BlackRock to become a ‘global leader’ in sustainable investing, and that ‘sustainable investing will be a core component for how everyone invests in the future’. He continued by discussing his view that, for exchange-traded funds (ETFs), those that incorporate ESG factors will grow from $25 billion to $400 billion within a decade, which provides us with an insight as to the rate of development that BlackRock foresee in this area. Interestingly, he also discussed the changing mentality when it comes to sustainable investing practices, noting that ‘we are going to see evidence over the long term that sustainable investing is going to be at least equivalent to core investments. I believe personally it will be higher’. This is interesting as, based upon the discussions we have had regarding the PRI initiatives, it very much appears that sustainable finance is irreversibly heading towards the ‘mainstream’. There have been questions that have been raised as to whether sustainable finance can maintain its ethos, and ultimately its impact, if it becomes mainstream, but it is safe to say that it will be considered mainstream very shortly; news recently that Barclays are extending studies into the effect of ESG upon credit portfolio performance, only enhances this suggestion. Furthermore, leading figures within JP Morgan suggest that whilst there are some parameters left to develop, namely that definitions need to be agreed upon, the development of ESG incorporation into mainstream investment practices is seemingly irreversible.

Ultimately, the penalties received by Audi and VW serve as clear indictors as to why the incorporation of ESG will become a mainstream investing practice. For large investors, it is just too evident that ESG concerns, particularly in relation to both environmentally-concerned regulations and also the importance of ‘G’overnance within the modern corporation, will affect their investment in some form, and at some point. Some investors, of course, will be lucky and avoid having their investment affected by these issues, but for many investors that risk will be far too high. The expected outlay in research and the necessary quantification of ESG-related issues will move the incorporation of ESG irreversibly into the mainstream and, if all parties submit to that approach and the ideal of internalising a long-term vision, then the financial sector will surely be better for it. It is, unfortunately, when entities do not internalise that ideal that the sector, and society as a result of the interconnectedness of the two spheres, that we are all put at risk.


Keywords – ESG, Investing, Business, Auto, Audi, BlackRock, @finregmatters

Friday, 12 October 2018

Post-Brexit Credit Rating Agency Regulation Decided: The Correct Call?

In 2017, this author produced an article that examined the potential regulatory framework that exists in the UK where Credit Rating Agencies are concerned (later published in 2018). We spoke about this issue here in Financial Regulation Matters, where we discussed how there may be a need to incorporate sole regulatory responsibility within one of the regulatory bodies should the UK be unable to come to a ‘deal’ with their EU partners. As part of the EU (Withdrawal) Act, the Government has recently come to a decision regarding which body would be responsible for regulating the CRAs in the wake of a no-deal Brexit, and it confirms the findings of the article. However, it is worth revisiting this developing story to examine what the consequences of such a decision may be.

It has been decided, as the original article produced by this author predicted, that the Financial Conduct Authority would be the regulatory body charged with supervising the credit rating industry, should the UK be unable to negotiate a post-Brexit deal with the EU. In a very short document, the FCA state that a draft Statutory Instrument will transfer the regulatory responsibility to the FCA from the ESMA, and change the FCA’s role from ‘competent authority’ to that of principal regulator. Also, there is no details made available regarding the fees the CRAs would be charged, and the proposed timeline advanced by the FCA describes how a consultation of applicable technical standards for CRAs will be made available from the 9th of October , and that the application window for CRAs wishing to transfer their registration status to the FCA will open from ‘early 2019’. In the FCA’s ‘Business Plan’, they do discuss how the resources required for ‘onshoring’ the CRAs will be derived from the CRAs themselves via levies and fees, with the suggestion being that the required level of resources may be around £6m.

As we discussed in the associated post from 2017, the FCA was always going to be the likely regulator selected for this task. The fear from the business media was that there would be the need for a ‘cobbled-together’ regulatory framework to govern the rating agencies, but in reality the CRAs are accommodated much easier within the FCA than any other regulator, and offer a much cheaper alternative than creating a new regulator. The FCA was the regulator of choice for the CRAs themselves, who were rightly worried that to go unregulated would cause massive problems for their business, and their users. The FT also suggested that there may be an issue of regulatory imbalance between the FCA and the ESMA from the perspective of the EU, but with the FCA acting as a competent authority since its inception in this realm, this is unlikely to be the case in reality. However, the real issue is not whether the process is smooth or not, but whether the FCA is the right regulator for the job.

In truth, the FCA is the best placed regulator amongst the British regulatory framework for the job. Yet, this does not mean that it will be successful in doing so. Rather, it is feared that the FCA will struggle with what is a massive task in regulating such an industry. We have covered the FCA so many times here in Financial Regulation Matters it is difficult to select an appropriate link to a post, but this post that examines whether the FCA is ‘soft’, or has its hands tied, is a snapshot of the problems surrounding the FCA. Its performance this year has not been good at all, and its performance regarding RBS and the GRG Unit specifically leaves a particularly sour taste in the mouth. In terms of Gatekeepers, the FRC is tasked with regulating the audit industry (and is not doing a great job, as evidenced by persistent transgressions by those firms), and now the FCA may have to regulate another Gatekeeper. The fear is that a lax regulatory approach is the last thing required when regulating the credit rating agencies, because they have the capacity to transgress and cause serious damage, as evidenced by the Big Two’s recent and record fines. Does the FCA have the authority to properly regulate an oligopolistic powerhouse like the credit rating industry? It seemingly does not have the authority to properly regulate the banking industry, so by deduction it is difficult to see how it may properly regulate the Credit Rating industry. One aspect that does not aid in this vision of the FCA having regulatory authority is its extraordinarily limited range of penalising options, which would need to be addressed if it were tasked with regulating the rating industry – fines of a few hundred thousand pounds will not suffice with this industry.

Yet, there is scope for development. The FCA could learn from the experiences within the US, where the SEC were tasked with developing an ‘Office for Credit Ratings’ but performed woefully in doing so (it was not even staffed for 12 months). In attempting to learn such lessons, the development of a dedicated office, or ‘spearhead’ for the FCA would be positive, and allow the FCA to accelerate its understanding of this tremendously complex relationship that exists elsewhere between CRAs and regulators – the FCA have no experience in this regard. Whilst the risk of ‘capture’ is increased with the creation of a dedicated ‘office’, in reality that risk is probably no greater than the general risk of ‘capture’ between a highly specialised and oligopolistic sector and its regulator.

Ultimately, the FCA is the right regulator to be selected from the framework, but this does not mean that it is the right regulator. In the event of a no-deal Brexit, there would need to be organisational changes within the FCA to cope with this new burden. Any political or regulatory belief that one can simply just transfer the registration from the EU and continue to regulate effectively is massively misplaced, and will be taken advantage of – such oligopolistic sectors thrive on such regulatory arbitrage, and the post-Brexit environment is both primed for such arbitrage, but also incredibly vulnerable to the effects of regulatory arbitrage. British society has been consistently placed under severe pressure since the Crisis, and a period of upheaval borne from financial actors taking advantage of gaps in the marketplace could be massively detrimental.


Keywords – FCA, Credit Rating Agencies, Business, Politics, UK, EU, Brexit, @finregmatters

Sunday, 7 October 2018

The FCA Attempt to correct the post-Brexit Narrative

We have spoken here in Financial Regulation Matters of the potential for a regulatory race-to-the-bottom in the post-Brexit era. With the U.K. choosing to go out into the economic landscape on its own, the potential for a weakening of regulatory protection to encourage foreign trade and investment is tremendous, and hardly a surprise. Yet, the FCA, as one of the fundamental elements in the regulatory framework that governs the U.K., has no option but to refute any suggestion that the framework will be weakened as a result of Brexit. In this post, we shall examine their latest insistence on the back of what were very telling declarations by leading British politicians.

Speaking on a recent visit to Tokyo, the Economic Secretary John Glen told his audience that ‘we will do whatever it takes to keep the UK as a global hub for financial services and to maintain the City of London as an asset for Europe’. This follows on from Theresa May telling the UN Summit in New York recently that the post-Brexit Britain would be ‘low tax’ and ‘unequivocally pro-business’. Glen continued this pro-business narrative by stating that the British Government is determined to provide ‘one of the lowest, if not the lowest corporation tax environment’. There is a clear narrative being advanced by the Government, and of course it is no surprise – it is clear that the Conservative-led government will take this approach as we had towards the uncertain time of the post-Brexit era.

This official rejection of a move towards a race-to-the-bottom scenario has been prevalent since the decision of the British electorate. However, with a arguable change in approach as we near the projected date of withdrawal, the Chairman of the FCA has this week made the point that ‘the FCA does not see the UK’s withdrawal from the European Union as an opportunity to join a race to the bottom in regulatory standards’. Charles Randall continued by stating that ‘strong global standards also reinforce the competitiveness of the UK financial services sector’. This sentiment has been repeated in the business media, with one author going as far to say that Brexit brings with it the potential to actually outdo the EU in terms of financial regulation, and that ‘the UK should compete post-Brexit… with tough, fair and proportionate rules based on evidence’. Interestingly, this week’s statements from Randall are not his first on the matter, and the fact that there is a fear that, globally, a race to the bottom is very much underway (think of the Trump Administration’s protectionist approach) is potentially underpinning Randall’s need to show a progressive aim for the regulator.

However, there is one massive piece of evidence that suggests the FCA will take another route, and that is its dealings with Saudi Aramco. The FCA’s changing of listing rules, designed to enhance the UK’s chances of hosting the Saudi Arabian colossus’ stock market floatation, is clear evidence of assisting with the push envisioned by the government – ‘unequivocally pro-business’. Despite concerted opposition to the FCA’s actions, the regulator admitting meeting Saudi Aramco months before the rule change, and now a reported crackdown on any domestic opposition to the plans to float the company, the FCA is maintaining its course to fulfil the Government’s agenda, and not the one it portrays for itself. Is this acceptable, that one of the most important financial regulators essentially does the Government’s bidding? Perhaps, but really if this the case, then surely advancing the same message is the correct course of action.

Regulators in this current climate has a difficult job in maintaining any sense of authority. With the post-Crisis era, in terms of financial penalties at least, coming to a close, financial regulators are entering a phase where, essentially, they cannot be seen to be ‘getting in the way’. Amnesia is alive and well in the current climate (one thinks of the dancing Theresa May declaring that ‘austerity is over’), and as such there will be many calls to allow business to flourish. The problem with that, and this is something we have discussed many times, is that we have not had the chance to have our version of the ‘quiet period’. The post-Depression era was followed by WWII, and whilst it is obvious that nobody would want a repeat of those horrors, it did essentially force the ‘quiet period’ upon the world; in this generation, there is an attempt to move straight past this necessary post-shock period and straight into the next Bull era. Regrettably, the actions of financial regulators inform us that they see the responsibility to consider future systemic movements as the responsibility of politicians. Perhaps many would argue that this is democracy at work (as the regulators are not elected), but the real question is should a financial regulator be merely an extension of the sitting government?


Keywords – Brexit, Financial Regulation, Business, FCA, race to the bottom, @finregmatters