The finance industry seems to accept -- publicly at least -- that more regulation is inevitable, and indeed necessary. Where they differ, of course, is over the areas where they want to see tighter rules and the extent of the restrictions imposed.
Schroder Investment Management's London-based global head of fixed income, for one, would be happy to see a more level playing field for different types of fund managers and increased capital requirements. Karl Dasher is also comfortable with standardising credit default swaps, but less so with the idea of limiting the use of these instruments between counterparties.
AsianInvestor asked Dasher, who was on a recent trip to Hong Kong, about the major regulatory changes that he feels should or shouldn't happen in the fixed-income markets in the coming years.
"First of all, one area that's been sensitive for people is derivatives," he says. "We use credit default swaps [CDSs] to create more efficient risk-adjusted portfolios. Where people got burned is where they -- incorrectly -- used them for leverage. I hope that doesn't lead to an over-reaction that detracts from our ability to use them for efficient portfolio management."
Dasher doesn't have an issue with the current shift to more standardised CDSs, but says it would be an overreaction to put extreme limits on the ability to use CDSs between counterparties. "What killed the system was the leverage," he says, "and firms like AIG providing way too much exposure to the market and earnings to their shareholders that were artificial."
He suggests regulators need to make sure there's a level playing field in this respect for all parties involved.
As for plans to increase regulation on hedge funds for transparency purposes, Dasher is entirely comfortable with that idea. "We run in a very regulated, transparent way as a long manager and we would like to see the entire industry that has responsibility for third-party capital fall under very similar types of rules," he says. "We don't have an issue with forcing transparency so that pools of leverage are disclosed and limits on leverage and systemic risk are set.
Meanwhile, the biggest regulatory changes will be around statutory levels of capital, especially in the US banking system, Dasher says. "As a senior creditor, that's not a bad thing, because that's insulating you from risk," he says. "There are times when the senior creditors and equity holders are at odds, because the latter want to enhance ROE, which typically leads to lower equity balances. But what they've seen [in the recent crisis] is that [the tangilble equity level] can be too thin and lead to forced recapitalisation and at very low prices." This has diluted shareholders.
Dasher says it seems obvious that the regulator will force capital to be rebuilt beyond the prior levels, which will lead to lower ROE. "As debt owners, we're comfortable with that," he says. "In fact, we encourage it."
With regard to the shadow banking system, Dasher believes the US authorities should look at the money market fund industry. "Running a fixed NAV using book value accounting with daily liquidity can lead to costly valuation distortions and highly assymmetric risks. It is not the natural order of the world without having reserves built in to absorb that," he says.
Schroder in Europe does not run any money market funds with the fixed NAV dual-accounting approach -- everything is mark-to-market [MtM]. "It would not surprise me to see the regulators move to do away with [the fixed NAV system for money market funds in the US]," says Dasher. "That would result in a higher frequency of small losses along the way and true MtM accounting. To some extent, that would probably be a good thing for all concerned, especially when you look at the amount that has been lost by sponsors of money market funds over the past two years."