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Regulatory Arbitrage

is the practice of taking advantage of a difference (usually price difference) between two or more markets.

In order to have arbitrage opportunities, we need to find a difference.

Regulatory Arbitrage
is the practice of taking advantage of a regulatory difference between two or more markets.

Two examples

A. Basel ii / Basel iii frameworks

B. The 8th Company Law Directive (the European Sarbanes-Oxley)

An Overview

Basel ii / Basel iii

Basel ii
(and its amendment, Basel iii) is a mandatory framework which is full of differences (different approaches, different deadlines, different options, different national discretions etc.)

When we have all these different approaches and options by design (Basel ii is proud of that), we also have "flexible" countries that create opportunities, and "non-flexible" countries (compliance is just an obligation).

Hedge Funds select the more favorable jurisdictions, playing one government off against another. 

Is it fair? Absolutely!

The "flexible" countries
know that. They have a plan, to retain or attract foreign direct investments.

They know that hedge fund managers like shopping, especially "regulator shopping".

They try to find the friendliest regime to do business.

The "non-flexible" countries
complain. They say that a general easing of regulations is a "race to the bottom". And, they continue to lose money, jobs, investments.

Basel ii is supposed
to be the framework that attempts to align economic and regulatory capital more closely to reduce the scope for regulatory arbitrage.

At least, this is what they say.

But, you can not have so many differences (approaches, deadlines, options and national discretions) and the same time to say that you try to reduce the scope of regulatory arbitrage!!!

This is an oxymoron.

Example: By providing at least three alternative capital calculation methods, Basel II creates differences that do not exist in Basel I.

The treatment of non-investment-grade credits under the standardized approach is so different from the treatment under the foundation or advanced internal ratings based (IRB) approach. 

The 8th Company Law Directive (the European Sarbanes-Oxley)

After the passage of the US Sarbanes-Oxley Act in 2002, US and non-US companies listed in a US stock exchange have the difficult task to comply with the Sarbanes-Oxley Act.
After the passage of the European Union's 8th Company Law Directive on Statutory Audit (Directive 2006/43/EC), European and non-European companies listed in any country of the EU have to comply with the 8th company law directive.
The 8th directive is considered the European post Sarbanes-Oxley regulatory retaliation.

And, like in the US SOX, there are extremely important extraterritorial consequences

The Offshore Financial Centers (OFCs) for example must immediately enact legislation to prove that they have an "equivalent level of regulation", to protect their auditors that audit offshore companies with EU listings from being subject to a tough European oversight regime.

Otherwise, auditors and audit firms from "third countries" have to be registered in the EU and to be subject to oversight, quality assurance and sanctions.
Under Article 45(1) of Directive 2006/43/EC the competent authorities of the Member States are required to register third-country auditors and audit entities that conduct a statutory audit on certain companies incorporated outwith the Community whose transferable securities are admitted to trading on a market regulated within the Community.

Article 45(3) of Directive 2006/43/EC requires Member States to subject such registered third-country auditors and audit entities to their systems of oversight, quality assurance systems and systems of investigations and penalties.

The European Commission is required under Article 46(2) of Directive 2006/43/EC to assess the equivalence of third country oversight, quality assurance and investigation and penalties systems in cooperation with Member States and make a determine on it.

If those systems are
recognised as equivalent, Member States may exempt third country auditors and audit entities from requirements of Article 45 of the Directive on the basis of reciprocity.

Basel iii and Regulatory Arbitrage

It is very interesting to monitor the regulatory differences that will definitely lead to regulatory arbitrage.

One more time, Basel iii looks like a menu approach, and counties will be able to do more or less, sooner or later.

Basel iii will again become something like a dream, and the national interpretation of Basel iii will become the law, which is going to be different from country to country.

Some important issues

The definition of the Tier 1 Capital.

new definition has a huge impact for healthy (under Basel 2) banks. For years, some banks rely on types of hybrid equity that may now not meet the new Basel iii requirements.

For example, there is a form of non-voting bank capital in Germany, known as
"silent participations”, which do not absorb losses as long as a bank is still in business.

For this reason the Basel Committee excludes them from banks' Tier 1 capital, which could
force German banks to raise billions, as a quarter to a third of the capital reserves of German savings banks, cooperative banks, private banks and landesbanks come in the form of silent participations. We speak about 50 billion Euros.

If banks are unable to raise equity on capital markets, it could lead to a shortfall in loans to companies and municipalities in Germany of 300-400 billion Euros.

Investors will be scared.

If Tier 1 capital is less than 9%,
banks will not be allowed to pay out dividends to shareholders.

In good times, banks have to allocate another 3%. It simply means that in good times banks need Tier 1 capital of 12% in order to be able to pay dividends.

If we add 4% Tier 2 capital, we reach an interesting number: 16% (6 percent Tier 1, plus 4 percent Tier 2, plus 3 percent conservation buffer, plus 3 percent anticyclical buffer).

And, remember,
we have a more (very strict) definition of Tier 1 capital. Hybrids are out.

Hedge funds could plan to short certain banks.

Investors try to understand how much capital banks may need to raise in order to be able to pay dividends.

The Basel iii regulatory changes that require banks to hold more capital for risky assets will hit some banks that have large investment banking divisions especially hard.

And, this is
just one area or regulatory arbitrage opportunities. If we add the differences in SIFIs, the banks that will be forced to sell insurance and securities subsidiaries...

One of our Regulatory Arbitrage presentations (233 slides) is part of the Certified Hedge Fund Compliance Expert (CHFCE) - Distance Learning and Online Certification Program

Certified Hedge Fund Compliance Expert (CHFCE)  

The Cost: US$ 797
What is included in the price:

The official presentations we use in our instructor-led classes (5387 slides)

We will send you:

A1.  Compliance for Hedge Funds Around the World
- 710 slides

The Sarbanes Oxley Act: What you need to know 
- 410 slides

A3.  Understanding the Frameworks: COSO and COSO ERM - 110 slides

A4. Understanding the Frameworks: COBIT - 272 slides

The Basel ii Accord and the new  international standards in credit, market and operational risk Part A - 354 slides

A6. The Basel ii Accord and the new  international standards in credit, market and operational risk Part B
- 448 slides

Financial Stress Testing- 437 slides

A8. Understanding the European Sarbanes Oxley - the 8th Company Law Directive, the Market Abuse Directive and the Transparency Directive of the European Union- 370 slides

A9. The Markets in Financial Instruments Directive (MiFID) - the European Union's harmonized regulatory regime for investment services across the 30 member states- 557 slides

A10. Undertakings for Collective Investment in Transferable Securities (UCITS III / UCITS IV): What is important- 327 slides

A11. Regulatory Arbitrage after the Basel ii framework and the 8th Company Law Directive of the European Union- 233 slides

A12. The Financial Conglomerates Directive of the European Union- 183 slides

The Dodd Frank Act and the major changes in corporate governance and risk management
- 976 slides

Up to 3 Online Exams

You have to pass one exam.

If you fail, you must study the official presentations and try again, but you do not need to spend money. Up to 3 exams are included in the price.

To learn more about the exam:

C. Personalized Certificate printed in full color

Processing, printing, packing and posting to your office or home

D. Membership to the Association, Networking and Exposure to the Market

You will receive a monthly newsletter to stay current with new developments and opportunities

E. The Dodd Frank Act and the new Risk Management Standards (976 slides, A13 above)

The US Dodd-Frank Wall Street Reform and Consumer Protection Act is the most significant piece of legislation concerning the financial services industry in about 80 years.

What does it mean for risk and compliance management professionals? It means new challenges, new jobs, new careers, new opportunities.

The bill establishes new risk management and corporate governance principles, sets up an early warning system to protect the economy from future threats, and brings more transparency and accountability.

It also amends important sections of the Sarbanes Oxley Act.

For example, it significantly expands whistleblower protections under the Sarbanes Oxley Act and creates additional anti-retaliation requirements.

To learn more: