Sunday, January 17

Regulatory Activities in Investment Banking: An Overview

The Great Recession observed during the late 2000s and early 2010s was the most severe economic and financial meltdown after the Great Depression (1930s).
The crisis led to the fall of American Investment Group Inc. Lehman Brothers, the 4th largest investment bank laid-off employees and filed bankruptcy.
The banking industry allowed more consumers to buy homes. When the US consumers backed out on their mortgage loans, the US banks lost money. The banks in other countries also lost money. The banks stopped lending that the consumers and businesses found difficult to get credit. 

As the US started falling into a recession, the demand for imported goods dropped, while prompting a global recession.
Some of the factors that might have triggered the crisis include the fall of the mortgage market, complex financial instruments, poor underwriting practices, poor regulation, deregulation, and lack of regulation.
The resilience activities and developments post-recession with reference to investment banking are much more influential. Because the post-crisis period witnessed an outbreak of regulatory activities. The regulations became stringent and intrusive. A few of them include –
• The Dodd-Frank Act
• Basel III
• Markets in Financial Instruments Directive (MiFID)
• European Banking Authority (EBA) Governance Guidelines
• Financial Stability Board (FSB) Principles
• European Market Infrastructure Regulation (EMIR)
• Foreign Account Tax Compliance Act (FATCA)
• Financial Transaction Tax (FTT) Act
Let us understand the evolving regulations on the investment banking industry here.

The Dodd-Frank Act

The Dodd–Frank Wall Street Reform and Consumer Protection Act (referred to as Dodd–Frank), the supportive legislation emerged from the crisis. It –

  •          Improved the regulatory blind spots
  •          Increased capital requirements
  •         Brought the hedge funds, private equity, and other investment firms as a part of minimally regulated ‘shadow banking system’.


Basel III:

It is an international regulatory accord which got designed to improve the regulation, supervision, and risk management. As a part of the continuous effort to improve the banking regulatory framework, it responds to the credit crisis.

Markets in Financial Instruments Directive (MiFID)

MiFID II – the European Union packet of financial industry reform legislation envelopes every asset and profession within the EU financial services industry. It regulates –
  •          Off-exchange and OTC trading
  •          Increases transparency of costs, and
  •         Improves record-keeping of transactions

European Banking Authority (EBA) Governance Guidelines

Internal governance is basic for systematic operation. EBA aims to improve and consolidate supervisory expectations. Further, new chapters are added to the
  •          corporate structure, tasks, and responsibilities of the supervisory function
  •         IT-systems
  •         Business continuity management

Financial Stability Board (FSB) Principles

FSB principles focus on areas like –
  •         Compensation policies and practices
  •        Maintain a capital base
  •         Link total variable compensation pool to the overall performance
  •         Limitations on guaranteed bonuses
  •        Compensation structure and risk alignment
  •       Transparency in compensation
  •        Corrective measures (if any)

European Market Infrastructure Regulation (EMIR)

EMIR is the European body of legislation set up to regulate over-the-counter derivatives. It got introduced to –
  •         Reduce operational risks
  •          Increase transparency in the OTC derivatives market
  •         Reduce systemic and counterparty risks
  •        Avoid fallout in the financial crisis in the future (if it happens)

Foreign Account Tax Compliance Act (FATCA)

This tax law which compels the US citizens to file reports on any foreign account holdings (at home and abroad). The Act motivates businesses to –
·        hire unemployed workers to reduce unemployment rates
·        increase the business tax credit for each new employee
·        include payroll tax holiday benefits
·        increase in the firm’s expense deduction limit for new equipment

Financial Transaction Tax (FTT) Act

The Act was introduced to discourage excessive risk. It is a small fee collected while trading financial instruments like stocks, bonds, options, credit default swaps, futures, and, etc. The key benefits of FTT are –
·        Raise tens of billions of dollars per year
·        Discourage short-term speculation
·        Encourage long-term productive investment


The regulations developed post-recession are here to stay. Investment banks must adapt themselves to the changing needs by involving professionals with investment banking certification, thinkers, and researchers to improve technological capabilities, prioritize portfolio optimization, adapt to the new business models, and focus to drive financial and operational efficiency.

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