The financial regulatory reforms being implemented in wake of the crisis of 2008 are likely to impose costs on businesses and individuals not directly targeted by the reforms. Being aware of this phenomenon, Senators Lincoln and Dodd wrote in 2010 to clarify that the Dodd-Frank Act does not impose new collateral requirements for derivatives end-users and that regulators should not do so even indirectly.
But there is nothing stopping banks and other regulated firms from passing on the costs of regulation. A Financial Times story by Tracy Alloway from early 2012 noted how the Volcker Rule banning bank proprietary trading could end up imposing costs on clients:
David Viniar, chief financial officer of Goldman Sachs...said on Wednesday that the [Volcker] rule could end up increasing profitability at banks since firms might be able to command more money from clients in return for executing their trades....Mr Viniar suggested that the rule might lead to banks buying assets and then selling them to their customers at a higher price, in an effort to compensate for the added risk of holding the positions.
But investment bank trading clients are not alone. The potential for new bank capital regulations to be passed on to hedge funds was also noted in the June 2012 edition of the European Central Bank's (ECB) semi-annual Financial Stability Review. In the course of analyzing bank prime brokers' relationship with their hedge fund clients, the ECB noted on page 60 that
Anecdotal evidence...suggested that owing to new liquidity and capital requirements, at least some prime brokers were considering passing higher financing and trading costs on to hedge fund clients, although reportedly none of the prime brokers wanted to be the first to make such a step.
The new liquidity and capital requirements come courtesy of the Basel III reforms, which require banks to hold more capital to ensure solvency and meet new liquidity standards to reduce short-term funding risks.
Given how profitable and competitive is the market for servicing hedge funds, prime brokers are unsurprisingly reluctant to charge hedge funds for new regulatory burdens. Nonetheless, the foregoing shows that the costs of financial reform are likely to be borne throughout the financial system, including by investors, since firms that have costs passed on to them are likely to pass at least some on to their own clients.
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