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Increased regulation likely to lead to more outsourcing and/or redundancies in the financial services sector
In the wake of the financial crisis in 2008, the on-going Eurozone crisis and the recent LIBOR scandal, the financial services sector has seen (and will continue to see) increased regulation and scrutiny including the EU Markets in Financial Instruments Directive/regulation II (“MiFID II”), amongst others.
Although MiFID II is not scheduled to be introduced until 2014, the final draft of the legislation is due to be published shortly and banks and other financial institutions are beginning to anticipate the impact that it will have on the shape of their organisations and their staffing requirements.
Effect of MiFID II
MiFID II extends the equity model of MiFID I to other instruments, and so for example will bring trading in over the counter (“OTC”) derivatives, central counter-parties (“CCPs”) and trade depositaries within the same regulatory framework as equities. This will hasten the move towards electronic trading of these types of products and mean increased reporting requirements, mandatory clearing and far greater restrictions on proprietary trading and (along with the beefed up capital adequacy rules) how capital to support these operations is allocated. All this will be topped off with a new regulator, the European Securities and Markets Authority (“ESMA”) and an enforcement regime with much sharper teeth.
It is likely that many workflows within OTC derivatives and other affected instrument classes will need to change as a result of the increased regulation. Electronic trading, real-time collateralisation and “live” reporting will necessitate moving what are currently considered ‘back office’ tasks into the ‘front office’, requiring significant investment in communications infrastructure and IT to handle this change in process. Most financial institutions are likely to have to make significant investment in their IT as a result.
Much of the work is likely to be outsourced to large or specialist providers, due to the complexity, delivery timescales and decreased margins available.
Impact on the workforce
- Many traders (or desk managers) will find that their front office duties are very different from in the past, with greater responsibility for record keeping and reporting, ensuring sufficiency of funds and capital. This requires a very different mind-set (and skill set).
- Given the squeeze in profits following the financial crisis of 2008, many financial institutions have already cut costs by making redundant senior IT and back office staff who will now be required to oversee such a huge re-shaping of functions and processes.
- The cost involved may force some businesses to shut down business lines which are not cost effective, as witnessed with the recently-announced closure by UBS of its fixed income activities.
UBS attributed the winding down its fixed-income activities to “new capital rules on riskier businesses introduced since the financial crisis”. The bank said that these divisions had been "rendered uneconomical by changes in regulation and market developments".
- Given the anticipated likely sharp reduction in proprietary trading, long-term future prospects for a large proportion of staff engaged in these functions appear rather mixed.
- The change in OTC derivatives from voice-based to electronic trading and extensive changes in other instrument classes will mean that much more sophisticated communications systems are required. At present, institutions lay trading lines directly to their clients. However, given the regulatory changes, the institutions will need to provide information to each other, to trade depositaries and to CCPs, which could be a communications nightmare. Given the complications involved, institutions are almost certain to consider and in many cases implement an outsourced solution.
This outsourcing may have implications both for the service provider and the financial institution under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (“TUPE”), which protects employees whose work is outsourced. Employees of the financial institution who are assigned to the IT or communications services being outsourced would transfer automatically under TUPE to the service provider with their terms and conditions and length of service preserved. Depending on the location of the service provider to whom the employees are transferred, this may lead to further redundancies.
Weighing the balance – outsourcing benefits and employment law related costs
Anticipated cost saving benefits from outsourcing in the new world will need to be weighed up against any redundancy, TUPE and other employment law-related costs at an early stage in what is likely to be a complex planning process.
For more information, please contact Kathryn Dooks