The Post notes that “everywhere, economists are wondering how Canadian banks managed to avoid most of the crummy securitized debt that is crippling other democracies’ financial institutions.” This is not to say that Canada should be too self-congratulatory, mind you, as the country’s financial system has hardly been immune from the delights of securitization – asset backed commercial paper was a home-grown fiasco.
The comments which caught our eye, however, were the concluding paragraphs.
“International observers have noticed that Canada’s ‘principles based’ financial regulation takes a very different form from the ‘rules based’ style prevailing in the United States.
Down South, lenders are engaged in a constant chess game with the government. Here, the bank executives and regulators have absorbed each other’s values to such a great degree – both taking the view that, quite simply, the first goal of the Royal Bank of Canada is to ensure that there is still a Royal Bank of Canada 100 years from now – that internal audit procedures are tougher than any regulator would dare demand, and arguably more effective than any regime created solely by a narrow, politically shifting rule set. Plain old-school snobbery plays a role too. Only by a means of noblesse oblige can you staff a modern banking system, as we have, without dangling big short-term rewards in front of top executives and doing away with substantive board oversight.
Unfortunately, it’s not going to be easy for any foreign banking institution to import Canada’s banking culture without having had Canada’s history. But, hell, they could at least adopt some of the maxims. Toronto-Dominion’s CEO told Marie-Josee Kravis that he pulled TD out of the game of buying securitized debt products years before the crisis, for one simple reason: the instruments had become inscrutable. “If I cannot hold them for my mother-in-law,” he said, “I cannot hold them for my clients.” Given the “in-law” part, that’s not setting the consciousness bar very high – but it is higher, at any rate, than where many foreign institutions put it over the last decade.”
Regulation will, of course, be front and center for both hedge fund managers and hedge fund investors over the coming months. The debate over rules based or principle based regulation, however, is unlikely to be solved any time soon – principles lack specificity so we need rules; rules create loopholes, so we need principles. This is one of the insoluble conundrums of our age.
Perhaps the point of this article, however, is to remind us that rules ultimately regulate people, not inanimate corporations. What we need to think about, then, is the motivations of the decision makers ultimately subject to regulation. To put it simply, if people are motivated by short term cash and have no longer term responsibility - which is unfortunately a fairly common theme in this financial crisis - then the tighter the rules the better, because tight rules are the only way to reign in self-interested behavior.
On the other hand, if decision makers have a sense of accountability and an eye to the future, then we come back to the maxim that people can regulate themselves better than any government can. Governments are concerned by re-election - which often puts their time horizon not much further out than the quarterly earnings cycle which preoccupies so many business executives.
Against this background, we continue to believe that, in the hedge fund space, focus - and by focus we mean investor pressure - needs to be on alignment of interests between investors and managers. At the very least, changing incentive fees to a longer time horizon with clawback mechanisms etc. will create more accountability and something of a longer term time horizon in the manager community. Ultimately, that may well be far more effective at protecting investor interests than the regulatory rulebook.
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Hedge Fund Operational Due Diligence
