The benefits of US regulatory reform

US regulatory reform, such as the SEC’s plan to restore the uptick rule and the Volcker rule to restrict proprietary trading, are a step in the right direction for those advocating transparency. Amanda White explores the story with the chief executive of Principal Global Investors, Jim McCaughan, and head of research, analysis and strategy at Man Investments, Thomas Della Casa.

On March 10, the Securities and Exchange Commission and chairman of the Financial Services Committee, Barney Frank, announced plans to restore the uptick rule – a rule which curbs short sales of a stock after it falls 10 per cent in one day, requiring short sellers to exceed the highest bid for the remainder of that trading day and the next in short sales of that security.

The reasons to reinstate the rule centre on market confidence and banking sector stability, but for practitioners it’s around liquidity and transparency.

Principal Global Investors manages about $60 billion in equities, about half of which is in the US market. Its chief executive, Jim McCaughan, welcomes the partial re-introduction of the uptick rule advocating it will bring more transparency and with it liquidity in the long term.

His argument is that for managers such as Principal, with large institutional clients in the public sector, equity markets must be fair and transparent, and this rule helps instil that.

“Markets need to be fair because in defined benefit markets your clients are ordinary people. Unless you can say markets are fair and not run for insiders there’s a problem,” he says.

McCaughan believes in the past few years equities markets have been “less fair” pointing to proprietary trading, growth of unregulated hedge funds and insider trading.

“Markets have become less fair, the dark pools have meant less transparency,” he says. “There has been high frequency trading abuse by hedge funds, and much of that is because of the elimination of the uptick rule three years ago,” he says.

“More regulation and transparency will lead to hedge funds with a genuine skill and an information advantage doing well,” he says.

In devising the new rule, the SEC was attempting to protect legitimate short-selling and the liquidity such sales bring to the market and protect against “potentially manipulative or abusive short selling,” its chief, Mary Schapiro, said.

Man Investments is the world’s largest provider of alternative investments, and its head of research, analysis and strategy at Man Investments, Thomas Della Casa agrees that regulation can effective if it is “common sense”.

“As long as it is common sense, regulation is very much welcomed as it increases the quality of the industry overall.”

The issue of regulatory reform highlights the importance of choice of provider. For instance Man Investments, with $44 billion is the largest provider of alternative investments in the world, is listed, and Della Casa says that dictates that they are already heavily regulated.

Other regulatory reform, effecting financial services providers, is the advice from the Group of 30, led by Paul Volcker, which advised that regulators impose capital limits on proprietary trading and bar large banks from running hedge funds and private equity firms that mix their own and their client’s money.

Volcker’s report calls for clear distinctions between institutions, such as former investment banks, that deal mainly in capital markets, and commercial banks that take deposits and make loans.

McCaughan believes the Volcker rule, essentially restricting proprietary trading, is important not just because of the need for safety in banks but also to provide clarity that customer information is not used for the bank’s benefit.

“In the near-term you might lose liquidity but in the long-term there is more liquidity in a transparent market,” he says.

McCaughan believes  US regulation has drawn a line in the sand between long-only traditional funds managers and hedge funds.

“The hedge funds and investment banks would say my position is against their religion, but managers like us, for the mass market, would have a similar opinion to me.”

But Della Casa points out that although the detail has to be carefully thought out, broader types of regulation such as the restriction on proprietary trading can be good for hedge funds because the alpha will be divided by fewer players.

One of the other much-touted issues around hedge funds is the lack of transparency. But Della Casa says there is plenty of transparency, “maybe too much”.

“Investors have to be able to assess all the data.”

McCaughan predicts US equity markets will return up to 20 per cent for the year and the sectors to watch are technology, manufacturing, and even with the Volcker rule, “financials are fine, as there is less money but more transparency”.

In addition McCaughan says the different levels of access have endangered the long-term viability of markets and the market will be better, and more liquid, if more participants were encouraged.