Outlook for 2018: The year ahead in the financial markets space

Published on April 4, 2018 by Ramesh Tunga

As the first quarter of 2018 draws to a close, we can only imagine the source of the next big surprise – which could be a major technology fad, or a gradual paradigm shift in the global economy, or the unintended consequences of increased regulation. Let’s look at some key anticipated events for 2018 and some views of the likely impact on the financial markets.

Brexit negotiation: The EU and the UK will continue to negotiate what each believes to be a better outcome for each other. The power balance continues to be shifting between the UK and Europe with some of the main issues being:

• Movement of people between the EU and the UK

• Access of UK firms (passporting) in European markets

• Tariff-free and beneficial trade terms for firms operating in the UK

• Ireland arrangements

• Financial settlement for the exit, and

• Regulatory framework between the EU and the UK, especially money laundering and terrorist funding rules

Negotiations are expected to take place in two phases. The first phase will focus on an agreement on financial settlement for the UK exit from the EU, EU 27 and UK citizens’ movement rights, and Ireland arrangements, and the second phase will focus on future relationships, trade tariff structures, and transition period dynamics, etc. We expect some details around the negotiation to be out towards early-Q2 2018. A no deal or a bad deal will impact both the parties as the UK may lose free access to the world’s largest economic bloc and the EU’s exports may get affected as it enjoys a trade surplus with the UK.

We can expect tough negotiations to continue but a final settlement may provide a win-win solution for both parties to work together – a transition plan for an orderly exit with a free trade deal between the UK and the EU could be one of the possible solutions. Regardless of the deal’s outcome, we may see a majority of organizations ensuring physical presence within the EU in 2019. This will raise logistical and regulatory challenges both for firms and European regulators.

MiFID II: Markets in Financial Instruments Directive (MiFID II) came into effect on January 3, 2018. This revised regulation will have an effect on the EU and other global financial institutions operating in the EU as they have to meet certain compliance requirements. This legislation impacts many areas, such as accessing and paying for financial research reports and services, processing KYC, data management, record keeping, and best execution.

Listed below are key outcomes of the regulation…

• A shift of stocks, bonds, and derivatives from dark pools to lit pools, which enables investors to see the price on offer

• Level playing field for research providers where fund managers pay for research services

• Additional reporting requirement to enable transparency

• Consistency in investment activities like KYC, record keeping, and data management practices

followed by key outcomes after the implementation of the regulation

• As per many independent research reports, not all global fund managers will fully comply with this regulation, and there may not be any regulatory intervention for the next 12-18 months

• No major dip in public trading volumes have been noticed, suggesting that there will be no major negative impact

• MiFID II allows exchanges to apply for a delay from the regulator; as of now, Deutsche Borse, Hong Kong Exchange, and Clearing and Intercontinental Exchange (ICE) have received approvals for this, which means these exchanges will not have to comply with the regulation until July 2020

• Demand for sell-side research reports does not seem to be falling as dramatically as predicted, but more time may be required to analyze and suggest a trend

We believe MiFID is still a work in progress and many participants are at various stages of readiness. Regulators understand that organizations have to complete enormous work to become fully compliant, so they will not take immediate action against any organization that has not met all requirements. However, regulators will not tolerate deliberate leniency. Also, many experts believe accepting and complying with the rules sooner will differentiate winners from losers.

GDPR: General Data Protection Regulation (GDPR) will come into effect on May 25, 2018. It is an improved data protective directive giving consumers more control of their data in a digital- and data-driven economy. Failure to comply with this regulation could result in a hefty penalty.

As GDPR aims to harmonize data privacy laws across Europe and with businesses handling large amounts of personal data distributed across many systems, adhering to this regulation and meeting compliance standards will likely become tougher and costlier. Therefore, organizations will be spending additional capital and putting in extra effort to fully comply with the regulation.

Ring-fencing of banking operations in the UK: The large banks (those with core deposits of more than GBP 25bn) in the UK will have to run their retail banking operations independent of their investment banking and overseas operations. This will ensure smooth operations in both segments even if either one faces trouble.

We expect the final rules of separating core banking operations from other associated risky businesses to come into effect at around January 2019. However, this ring-fencing effort in the banking sector may commence at around mid-2018. The judiciary will rule on each bank’s plan, implying that banks may have to restructure and separate their core assets from the riskier ones over the year in order to receive approval and to be prepared when the rule becomes effective.

US mid-term elections: The US will go to the polls for mid-term elections at around November 2018. Historically, it has been observed that the ruling party performs well and the opposition loses more seats in the senate. Depending on the results, we believe a favorable win by the ruling party will introduce and expedite more reforms. However, a failure of the ruling party could lead to less reforms and a political gridlock, which may threaten global financial markets.

Regulating virtual (crypto) currencies: The market cap of virtual or crypto currency trading and the size of initial coin offerings (ICO) have increased multi-folds over the past two to three years. As a result, financial ministries and regulators around the globe have been reviewing their operations and have decided to make concentrated effort and progress around their regulations. We can expect an announcement from regulators during the year.

Other noteworthy developments include Packaged Retail Investment and Insurance-based Products (PRIPS) Directive, Insurance Distribution Directive, streamlining Volcker rule regulations, cyber security-related regulations, G20 Buenos Aires Summit, technology changes driven by FinTech companies, and Ireland elections.

References:

https://www.cisi.org

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