Regulation relief in markets considered a touch premature

This year's global markets surge owes much to relief that governments show no sign of redrawing the map of world capitalism in response to the credit crisis. But taken together, national reforms may yet dampen the rebound.

Almost a year after the failure of Lehman Brothers last September threatened a collapse of the financial system and global economic depression, early talk of a coordinated regulatory backlash to cut global finance down to size seems to have been off the mark.

Beyond somewhat marginal changes to rules on transparency, risk management and accountability, there appears to be little or no desire among major governments to re-engineer a capitalist system which they have relied upon to generate prosperity.

The near-V-shaped recovery of financial markets this year - the MSCI index of global equities has regained about 40 per cent of the losses from its 2007 peak - has been supported by relief that a much-feared regulatory hammer did not come crashing down.

What is more, many authorities seem to be itching to reverse their huge and necessary intervention in key sectors such as banks, finance and autos.

Richard Betty, investment director at Standard Life fund managers in Edinburgh, said "over-regulation" and "excessive government interference" had always been risks to world growth - growth which is now necessary to repair budgets damaged by emergency bailouts and rescue packages.

"But we haven't discerned any appetite in the long term or even medium term among governments to be bigger direct players in finance or business," he said.

"The 'grand plan', to the extent there was one, was to intervene to support the system, and they will all want to unwind out of that as soon as the market can function again on its own two feet."

The regulatory debate has been dominated by European attempts to seek consensus on limiting bank bonuses, and a US push for tougher bank capital standards.

These measures are not the stuff of reinventing world finance or rethinking capitalism - a point not lost on financial markets, which in recent months have become remarkably bullish again on the investment outlook.

But some senior bankers and experts say it may be dangerous to assume that global financial behaviour will or can revert to pre-crisis norms.

"To say it is business as usual again does not match the facts," Deutsche Bank chief executive Josef Ackermann, who chairs the Institute for International Finance, a cross-border banking lobby, said on Thursday.

Mr Ackermann told a conference in Frankfurt that an industry-wide trend to withdraw from foreign subsidiaries in order to strengthen a parent company's capital base at home posed a threat to internationalisation of financial markets.

Governments' efforts to re-nationalise supervision of financial markets posed a similar threat, he said, adding that regulations in various jurisdictions might not be compatible, creating a risk of "regulatory arbitrage" or market fragmentation.

Avinash Persaud, chairman of Intelligence Capital and a frequent adviser to regulators and governments on financial risk, also highlighted the build-up of national regulation.

He said he doubted any overarching, multilateral plan would emerge to regulate global markets, but added that it was too early to dismiss the possibility of fundamental change.

"Global markets have been looking up in the sky for some big global arrangement. They're sceptical about it happening anyhow, but they can't see (it) now and they're feeling good," he said.

"But they are missing what they may be walking into on the ground - a build-up of quite significant 'host country' rules."

Mr Persaud argues the regulatory fallout from the crisis will have a big impact on how banks and financial institutions operate overseas.

As soon as broad principles are agreed among countries, national regulators will go back and interpret them for their domestic financial institutions and, even more importantly, for foreign banks operating on their soil.

In the past, national regulators acted as champions for their domestic institutions and interpreted international accords and standards in ways that were most advantageous for their own companies. This encouraged regulatory arbitrage - financial firms flocked to the loosest regulatory regimes.

But in the wake of the crisis, there appears to be a shift towards tighter "host country regulation". Icelandic banks in Britain, for example, will be regulated and have capital requirements set by British regulators as subsidiaries and not just branches of Icelandic parents.

Similarly, banks may become unable to sell Swiss franc mortgages in Hungary, for example, unless they are registered and regulated in Hungary, and subject to the host country's assessment of their viability.

Smaller global capital flows, fewer big international banks and higher costs in cross-border banking may then take their toll on world growth. It could be years before policymakers can assess whether the price of greater financial stability was worth paying.

"Global finance is being threatened - but it is being threatened by something very arcane," said Mr Persaud. "Host country regulation is a huge challenge to global finance and will shrink the amount of cross-border activity."