Regulation – A new form of competitive disadvantage

Corruption and lack of regulation are often considered to be impediments to doing business in much of Sub Saharan Africa. However when we consider the development of regulatory frameworks in the west and the UK Bribery Act it quickly becomes apparent that too much regulation undermines the effective operation of the business environment and the competitiveness of companies operating within it. One of the most notable outcomes of the financial crisis has been the idea that the movement of the world’s economic centre of gravity eastward has been given a concerted push. While the US and the European Union (EU) floundered under the burden of sovereign debt and banking failures, Asia rebounded from recession much more quickly as its banking system and debt dynamics were more robust. Cash-rich Asian banks seized the opportunity to ramp up their businesses and expand market share while western banks retrenched. In the wake of the financial crisis, growth has become the mantra of Asian markets while western governments have adopted an ambitious programme of regulatory reform to address the fundamental weaknesses in the structure of financial regulation.hideThe objective is to provide cohesion, consistency and coordination between countries and to ensure greater oversight of the financial sector and activities of private corporations. In the quest to achieve this noble objective little has been said about the impact tighter regulation will have on western competitiveness. The implications of this omission were quickly revealed when the panic associated with the global crisis dissipated and the emphasis on coordination and cohesion receded. While most regulatory changes are taking place under the auspices of the G20, significant differences are notable between the EU, the US and Asia. The EU, and to a lesser extent the US, are acting against a backdrop of banking system and sovereign fragility and are confronted with the unenviable task of solving the current crises and designing a regulatory system that will prevent future crises. This is set against the backdrop of public pressure, exacerbated by populist media coverage, that governments be seen to take action against the banking sector. Europe’s reality stands in stark contrast to that of Asia. The region is booming and the focus is on the unimpeded development of the financial infrastructure rather than on crisis response. The debate centres on the benefits of a global approach to regulatory reform as opposed to the ability to retain local flexibility. Indeed there is a prime opportunity for the regional financial centres of Hong Kong and Shanghai to develop their own banking, brokerage and asset management sectors independently of the restrictive regulation of the west and to secure a competitive advantage in so doing. Capital adequacy and liquidity standards for banks are a key area to be targeted as a result of the crisis. Basel III, adopted in 2010, effectively triples the capital reserves for many banks to seven per cent as compared with the two per cent required under Basel II. The Liquidity Coverage Ratio (LCR) will also be tightened to ensure banks apply adequate capital to all their exposures, including those off balance sheet, to offset forecast cash outflows during a 30-day crisis. Such a system should prevent a future financial crisis from spreading beyond the financial sector into the real economy, thereby limiting the impact and making a crisis more containable. The threat to western competitiveness posed by Basel III derives from the fact that the accords will fail to create a truly global level playing field among international banks. They lack the binding force of a treaty and their adoption is likely to be limited to European banks. Basel III regulates the amount of lending that a bank can do—in conjunction with the central bank reserve requirements—and as a consequence also ends up partially regulating the money supply expansion for the entire economy. The impact on trading activity will be particularly severe because the application of the new leverage ratio to the trading book, with a 100% credit conversion factor for trade-related business, will make trade and asset-secured lending much more capital intensive. There is a real possibility of a significant drop in trade and a further reduction in developed nations, particularly eurozone, GDP. Laws and norms governing financial regulation generally reflect the ideological leanings of those at the highest levels of government. What is palpable at present is that the historically capitalist and entrepreneurial spirit of the UK and the US is being dampened by regulation and in reversal of its strong commitment to economic and financial liberalisation the US has led efforts to nationalise its financial and some aspects of its manufacturing sectors to an unprecedented degree. As many EU governments become increasingly left leaning, the efforts to restrict the operations of the financial sector intensify. After the dominance of the west we are moving towards a new economic paradigm characterised by competing ideologies and regulatory systems of governance. It is highly possible that different regions of the world will adopt contrasting regulatory systems, creating opportunities for regulatory arbitrage. While this may create a competitive disadvantage for sovereign states, investors who are not restricted by borders will be well placed to benefit from the investment opportunities increasingly divergent economies have to offer with greater scope for diversification and risk control. In time, such diversification may reduce the high degree of correlation between stock markets in times of crisis and a more diverse regulatory world may be more resilient to shocks. The creation of economic inefficiencies and limiting the optimal allocation of capital will impact western markets more keenly than their rising Asian peers and it appears that the growth of western economies will be stymied by regulatory restrictions. The UK Bribery Act adds another dimension to the burden of government oversight that impacts on all investments and business activity. The Act is designed to make companies and other corporate bodies responsible for failing to prevent bribery committed on their behalf by employees, agents or subsidiaries, forcing all UK companies to evaluate their business practices. When the passage of the UK Bribery Act was delayed, in February 2011, Mark Pieth, the Chairman of the Organisation for Economic Co-operation and Development (OECD) argued in February 2011, that ‘it hurt the competitiveness of British industry…as they become dependent on illegal means’. This followed threats made by the OECD in October 2008 to ‘blacklist British companies if they remained under-regulated’. While this is noble rhetoric, the OECD failed to clarify how companies bound by the UK Bribery Act were to compete with their Indian, Chinese and Arab peers who are not bound by the act. The implication is that all states will adopt the same business principles, ie western norms, which is counterintuitive and an assertion that ‘the west knows best’ in an age when imperialism is derided. For a company operating in far flung territories with different customs and practises to the UK, the requirements of the Act are onerous. The Act makes a company criminally liable for acts undertaken by its employees, its agents and contractors, a challenging array of participants to micromanage for an international business operation. The Act does little to facilitate business activity, rather it does the converse, at a time when western economies are in the most perilous economic state for decades. Sub Saharan Africa provides an excellent example of where western companies have lost out to their Chinese counterparts in the allocation of natural resources contracts, not only because Chinese deals have been considered more financially beneficial but because leaders rejected western business emphasis on dialogue on good governance and human rights as part of the package. One can only assume that UK business will lose out again as the tentacles of the Bribery Act spread around the globe. Empire is long since dead. Efforts to prevent another financial crisis or to prevent corrupt business practices are to be applauded. Were all countries to adopt the same measures the world would be a safer, fairer and more transparent place. However the rhetoric and reality of noble causes often diverge. At a time when economic power is inexorably moving eastwards, international competitors in Beijing, Qatar, Delhi and Brasilia must be incredulous that the US, UK and EU are willingly taking steps to further undermine their competitiveness.

Regulation – A new form of competitive disadvantage

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