Europe's global regulatory influence
Despite political turmoil, EU sets standard for market supervision
by Jim McCaughan in New York
Fri 22 Jun 2018
By the end of May, markets began to recognise the ramifications of political instability in Italy. Still, Europe's influence on global investing isn't limited to semi-regular turmoil in the European Union. The bloc has a chance to benefit investors around the globe by improving investor protections and market transparency.
Italy presents a conundrum for the EU – and more than just the fact that commentators can't get 'Quitaly' to roll off the tongue as nicely as Brexit or Grexit. Italy is a major EU economy, much larger than Greece, and its exit from the union and single currency would create critical economic turbulence.
One reason why markets took so long to react to the election of populist and eurosceptic politicians in Italy was French President Emmanuel Macron; markets were still enamoured with his centrist triumph last year over the National Front, France's right-wing nationalist party. But investors also like stability, and Italy's problems in forming a government injected a measure of uncertainty that markets disliked.
The long-term fear is that the new Italian government will be hostile to the EU and look to leave the union. This, however, is a remote risk. Leaving the euro would be a messy process that could force Italy to adjust its constitution and potentially suspend economic and banking operations for months to deter speculation. The near-term worry is that a financial crisis will arise while Italy's government is still in transition. If an Italian banking crisis were to emerge, it is difficult to imagine who in the government would have the experience or clout to handle the fallout.
But Europe's ability to influence investors doesn't end with political turmoil and anti-euro machinations in parts of the continent. It has the chance not only to influence global investing, but to be a leader in this field, to the benefit of all investors.
That opportunity comes from regulation, specifically the second phase of the Markets in Financial Instruments Directive (Mifid II), which aims to improve market transparency and trading behaviour. Rather than being an apologist for regulation, I would argue that thoughtful rules that encourage client confidence profit the industry. One example of confidence-boosting regulation is the Undertakings for Collective Investments and Transferable Securities, which provides a single regulatory framework for investment vehicles. Although Ucits was designed as a pan-EU solution, other non-European countries came to respect the regime because of the transparency and efficiency that it brought to fund buying.
Mifid II has the same opportunity. There is an appetite for greater clarity in paying for investment research. Investors' clients want to know where their money is going and what is being done with it. With that sort of demand for transparency, Europe seems to be setting a new standard for the rest of the world to adopt. Global asset managers and investment banks won't be able to be more transparent with European clients and less transparent with those elsewhere. Mifid II appears to be a decisive step towards a single global transparency standard.
This transition will compel investment firms to be more self-sufficient in their research efforts by developing robust quantitative and fundamental research capabilities. This will also place more attention on the use of artificial intelligence, machine learning and data analytics in investing.
Mifid II and other industry-benefiting regulation can help firms become more efficient and promote scalable operations. Ultimately, the market will grow more robust, and investors' clients will enjoy reduced costs.
Jim McCaughan is Chief Executive Officer of Principal Global Investors.
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