The regulatory environment

&
organizational structure
The Set-up

 Financial markets have the particularity of being overseen by several

governmental entities. Moreover, the complexity of the regulating
structure has increased since the 2008 financial crisis
 In this environment, investment banks have to adapt to regulations
imposed directly upon them and to other ones that their clients, such as
institutional investors, are subject to. The objective is to customize their
products and services and review their business models as regulation
evolves

 This lecture will focus on the roles of central banks, financial markets
authorities and government entities regulating the insurance industry.
However, it is worth to bear in mind that:
 These entities work separately but increasing conjugate their efforts to
ensure financial stability
 Other state-backed institutions are involved in regulating the industry
Central banks and investment banks

 By influencing money markets and bond markets through its

instruments, central banks impact significantly the activities of several
divisions of investment banks:
 Asset Management Division: the level of interest rates will determine the
returns offered by bond mutual funds and, therefore, the size of assets under
management
 Corporate Finance Division: the level of interest rates determine the
attractiveness of the bond market to this division’s clients (firms seeking
alternative to banks’ loans), or even syndicated loans
 Trading Floor: the volume of the market making and intermediation
activities, and proprietary trading depend on the level of interest rates and the
financing available

 The FX Swaps operations can impact the capacity of an investment bank

to offer competitive prices and best execution on structured products
that are related to the FX market (FX swaps, FX options…)
Financial Markets Authorities (FMAs)

 Financial markets authorities have two main missions: to protect

investors and maintain a fair and orderly market. To this aim, these
institutions have the authority to bring civil enforcement actions against
those who violated the securities law
 Examples of these institutions include the Securities and Exchange
Commission (SEC) in the U.S., l’Autorité des Marchés Financiers (AMF) in
France and CDVM in Morocco

 FMAs oversee many of the investment banks activities, especially:

 Brokerage and trading activities
 Asset management activities
 Corporate finance (validation of a deal’s prospectus…)
 Structured Finance (validation of new products, risk, financial innovation…)

 In all these activities, FMAs constantly increase the level of transparency

through enhanced and regular reportings, which are crucial to investors…
 The institutional investors

 Institutional investors (especially insurance companies and pension

funds) are key clients to investment banks. As such, investment bankers
have to understand the regulatory environment of these investors to serve
them best
 In particular, investment banks have to possess a deep knowledge of the
constraints that institutional investors face in managing their portfolios
(types of assets allowed to invest in, required asset class allocation…)
 This set of regulations is to ensure the financial solvency of insurance
companies and pensions funds. Moreover, and because of its importance,
the whole sector is regulated by a dedicated governmental body that
 Licenses insurances companies and others entities involved in the industry
 Standardizes the products and monitors the market

 For example, in Morocco, the State has given this mission to ACAPS
(Autorité de Contrôle des Assurances et de la Prévoyance Sociale). In the
U.S., the sector is subject to both federal and state laws
 The future of regulation (1/2)

 In the aftermath of the 2008 financial crisis, the investment banking

industry has been subject to more intrusive and stringent regulations,
impacting all aspects of its business activities (capital, liquidity, systemic
risk, remuneration…)
 Some of these regulations that will change the investment banking
industry include Basel III, the Dodd-Frank Act and the Financial Stability Board
(FSB) principles. Although they differ in scope across countries, they aim to:
 Increase investors protection: by increasing transparency and making investors
more aware of potential risks
 End the Too Big to Fail bailouts: by increasing capital requirements and
liquidity cushions
 Improve Corporate Governance: by reviewing the compensation of investment
bankers
 Implement Early Warning system: by making credit rating agencies more
accountable
 The future of regulation (2/2)

 In light of this new regulatory constraints, investment banks revenues are

expected to come under pressure:
 Capital requirements: additional stress tests for all products, limits on the size
of total assets…
 Funding costs: more Asset-Liability Management is imposed, requiring more
long-term, and more costly, financing (as opposed to less expensive day-to-day
financing)
 Types of assets: the percentage of high quality assets (mainly government
securities) in banks portfolios have increased to enhance liquidity
 To adapt, investment banks will have to:
 Invest in technological capabilities to meet new reporting and trading
requirements
 Optimize the asset allocation of their portfolios (impact of credit valuation,
OTC transactions…)
 Enhance financial and operational efficiency: reducing costs structures of
business lines, upgrading collateral management systems…
 Risk Management

 Risk Management is critical to an investment bank. It can be grouped into

two main categories:
 Market risk: focuses on sales and trading activities. The Value at Risk (VaR)
model is one the main tools used to manage this risk
 Credit risk: focuses on activities such as loan syndication, bond issuance, debt
restructuring…

 Additional risk groups may include counterparty risk, operational risk,

country risk… In the aftermath of the 2008 financial crisis, regulation and
internal controls have become more stringent, looking more closely to the
quantitative aspects of risk models used and putting more capital
requirements in face of the risks taken
 Risk management solutions are not only important to manage the
exposure on a bank’s balance sheet but they can also be a source of
revenues by selling risk advisory products and services to clients
 People working in investment banks

 To cope with constraints imposed by regulation, modern investment

banks have constantly to come up with new and complex products,
trading strategies, upgrade trading platforms… As such, they increasingly
recruit people with degrees in mathematics, computer science, physics…
 Nevertheless, there always is a need for people with degrees in finance
and economics in activities such as research, brokerage, financial
advisory…
 Bonuses and other forms of variable remuneration have become an
important issue. Indeed, it is believed that they have encouraged
speculation and are considered as one of the main causes of the 2008
financial crisis
 In the aftermath of this crisis, regulation is trying to limit variable
compensation. Thus, the tradeoff for banks is to attract talent while
complying with the new regulatory environment