The storm clouds of the next financial crisis are building and we must know where they are and how fast they are approaching. Our preparedness on all fronts must improve in 2014.
The investment community is continually challenged by a politically entrenched bureaucracy and aggressive commercial opposition to nearly all global regulatory changes. Record investment management industry profits as well as record market highs belie the fact we remain truly exposed to complex financial products and services not yet fully restrained since the crisis of 2008.
Three things in particular should concern all of us who are stakeholders in the finance industry as we move into the new year.
First is complacency that another crisis can't happen because we have fixed the gaps in regulation.
Nothing could be further from reality and the list of unfinished regulatory business is long. This unfinished list includes final regulatory details for the mammoth cross-border derivatives market, reducing the size and risks associated with so-called too-big-to-fail banking institutions, and ensuring a properly implemented Volcker rule.
The lack of progress toward a properly functioning Financial Stability Oversight Council and Office of Financial Research, two vital pieces of systemic risk oversight, is particularly troubling. Designed to be our early warning system for building systemic risks, FSOC members have yet to settle on key systemic initiatives around derivatives and money market regulations, often bickering about which agency should take the lead. The OFR, a group of supposedly independent, highly skilled market data specialists, barely exists and recently fell flat on its analysis of whether the investment management industry poses a systemic risk.
Second is investment management industry overconfidence that it is back in control. We in the industry perceive ourselves as having rectified our inability to see building counterparty, leverage and liquidity risks, masked through Federal Reserve policy by the unorthodox government support of financial markets and the nearly 10,000-point move in the Dow Jones industrial average since the financial crisis.
Systemic risks are still building, undetected. Transparency is not increasing and the unwillingness or inability to remove government support in the markets is unprecedented. Oddly, this has all transformed into a feeling by many practitioners and investors of normalcy. It seems almost as though financial complexity and opaqueness are back in vogue and that client focus and professional ethics are once again bordering on lip service.
Finally, we in the investment management profession seem totally nonchalant about the current state of our existing regulatory system. It is alarmingly outdated, under-resourced and no match for the complexity of markets in the 21st century. To be clear, we are not talking about the new regulations addressing the crisis, rather the basic requirements of our present regulatory structure. It is seriously deficient in proper funding for oversight of investment advisers and insider trading detection as well as oversight of the selling of financial products and strengthening an enforcement process that actually serves as a deterrent to other bad actors. In a world where new and complex financial instruments, high-frequency trading and exotic exchange-traded funds rule the landscape, regulators should not be forced to ad-lib.
Properly calibrated and regulated, financial services are the engine of progress for developed markets and the hope of nations still emerging. The industry is of vital benefit to global society when functioning appropriately.
Kurt N. Schacht is managing director of the CFA Institute's New York office. He oversees the CFA Institute's Code of Ethics and Standards of Professional Conduct, the Global Investment Performance Standards and the Asset Manager Code of Professional Conduct. He serves on the Securities and Exchange Commission's Investor Advisory Committee and on the Public Company Accounting Oversight Board's Standing Advisory Group.
