DealBook: Europe’s Debt Crisis Stymies Financial Overhaul

Minh Uong

LONDON — As the Continent grapples with the sovereign debt crisis, financial regulatory revision in Europe has been put on the back burner, with some rules delayed until at least 2013.

The changing priorities have left investment banks, hedge funds and even nonfinancial companies in a holding pattern about compliance and costs, a situation that is weighing on earnings prospects.

“It’s the uncertainty that’s killing everybody,” said Anthony Belchambers, chief executive of the Futures and Options Association, a trade organization based in London for companies involved in the derivatives markets. “No one can measure the scale or cost of the regulation until it’s finalized.”

In the aftermath of the financial crisis in 2009, European regulators outlined the broad aims of a financial overhaul. But policy makers dragged their feet in the months that followed, unable to come to a consensus on critical areas like derivatives trading. Now, rule-making has been all but forgotten as they deal with teetering economies like Greece and Spain.

Most European rules won’t be in place before 2013, more than a year behind the original deadline, according to the Financial Stability Board, an international body tasked with strengthening the financial markets through improved regulation. Policy makers in the United States, which has faced its own delays, are on track to complete the bulk of their regulations by next year, with some already approved.

The biggest problems on the Continent center on how to wrangle the $600 trillion global derivatives markets. Negotiations have largely pitted Britain, which favors looser regulation, against France and Germany, which want stricter limits placed on markets.

France and Germany, two euro zone heavyweights, argue that only over-the-counter trades should be reported to central repositories that collect the data and be cleared through central counterparties. Britain, which handles 75 percent of such trading in Europe, says that would put London at a disadvantage to rivals in Paris and Frankfurt. Britain’s chancellor of the Exchequer, George Osborne, has fought to extend regulation to all derivatives, including those traded on electronic platforms.

The debate comes as Germany’s Deutsche Börse stands poised to become the world’s largest platform for derivatives trading if its planned merger with NYSE Euronext receives regulatory approval. Under the European Union’s current proposal, Deutsche Börse and Europe’s other electronic platforms would face less regulatory oversight than Britain’s over-the-counter financial dealers. British officials fear that would hurt London’s dominance as Europe’s financial capital if businesses leave in search of trading centers with fewer regulatory costs.

On Oct. 4, both sides reached a basic compromise. Initially, the European Union will regulate only over-the-counter derivatives starting in 2013. The rules will eventually expand to include electronic-traded derivatives, although no time frame was given.

“The whole process has been very disjointed,” said Sean Sprackling, a director at the consulting firm PricewaterhouseCoopers in London.

For European companies, the protracted legislative process has made it difficult to know what compliance and risk management structures they will need to develop — and at what cost.

Under the European proposal, Siemens, Philips, the British supermarket giant Tesco and other nonfinancial businesses will be exempt from reporting their derivatives transactions to trade repositories and clearing them through central counterparties. But the plan has added a caveat. When the rules take hold, those so-called end users whose derivatives trading operations reach a certain threshold will have to comply with regulations governing trade repositories and clearinghouses. Details on the threshold, however, have yet to be agreed on.

End users that rely on investment banks to develop and execute their derivatives — rather than in-house teams — may still have to expand their compliance teams despite working through a financial intermediary. That would be an extra cost that would hit earnings just as Europe’s nonfinancial companies are struggling to respond to a renewed slowdown in the global economy.

“A number of end users will be captured by the full regulation even if they’re dealing through a licensed firm,” Mr. Belchambers of the Futures and Options Association said.

Banks and other financial institutions have threatened to move their operations elsewhere if the changes in the United States and Europe become too onerous. But those fears are overblown, according to Barnabas W. B. Reynolds, head of the financial institutions advisory practice at the law firm Shearman Sterling in London.

For one, the derivatives rules in the United States and Europe are expected to have broadly similar objectives. So even though there will be a gap when the two regions have different regimes, it is unlikely to be long enough for companies to benefit from any regulatory arbitrage.

And analysts also say they believe it is unlikely that companies will seek out regulatory-friendly markets in Asia like Hong Kong and Singapore. Mr. Reynolds said New York and London simply provided greater stability during periods of turmoil.

“The pecking order of financial centers will remain the same,” he said. “In a time of uncertainty, there’s always a flight to quality.”

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