Increased regulation on the cards

Ian de Lanage of Seed Investments writes that the biggest global bond manager, US based Pimco, which manages over a $1 trillion, recently had their annual secular forum, where they internally discuss a three to five year outlook for the global economy and markets.

Part of what joint chief investment officer, Mohammed El-Erian noted as the bottom line, and in a continuation of their theme of a New Normal, he stated, “Through a series of transitions, collisions, and trade-offs (the journey), we are heading to a world that is re-regulated, de-levered, and growing less rapidly in the industrial countries (the destination). “

The re-regulation of the world, especially but not exclusively in the banking sector, is high on the political agenda and is likely to stay that way for some years to come. Just this past weekend we saw leaders of the G20 meet in Toronto, where banking regulation was a major topic.

While the official communiqué speaks to unity on various issues, one report noted that “The G20 meeting amounted to a parting of the ways as ministers effectively agreed that countries should decide themselves what to do on issues like ….financial reform..”

The official communiqué noted that “we are building  a more resilient financial system that serves the needs of our economies, reduces moral hazard, limits the build up of systemic risk and supports strong and stable economic growth.”

Getting to a global consensus is not easy and for this reason there has been a relaxation in the timetable for tighter capital requirements of banks. Previously the target date for new capital requirement laws was to be achieved in 2012 but this has now been delayed and it looks like it could be set by country or region.

Currently the core tier one capital of a bank to its risk weighted assets is 2%. This is expected to double and perhaps go even further, but with only tentative signs of the global economy picking up, politicians are treading more cautiously.

As a general rule higher taxes, more regulation, tighter capital adequacy, a firming of cross border trade etc all serve to escalate the cost of doing business and dampen the returns of the owners of equity. These additional costs will need to be factored into the return expectations.