Keith Clark is managing director and
international general counsel of Morgan Stanley. He has
responsibility for the firm's Institutional Securities
Law groups in Europe and Asia, and generally oversees
legal matters outside the US.
Clark joined Morgan Stanley early in 2002 from
Clifford Chance, where, as the firm's chairman, he
oversaw its groundbreaking merger with Rogers &
Wells in the US and Pünder Volhard Weber &
Axter in Germany. Prior to that Clark spent periods as
senior partner, head of the banking division and
partner responsible for business development at the
European lawmakers should talk more with the industry and
take a closer look at the costs of new legislation. That is the
message from Keith Clark, Morgan Stanley's international
In the face of the change visited upon bankers by the
Financial Services Action Plan, there is little point in
quibbling over details, he says. Europe's directives are a step
towards the global integration of capital markets and will
benefit both issuers and intermediaries. But the pace of
transformation is too quick. And arguments over the details of
proposed legislation could be avoided with more thorough
consultation. Here Clark talks to IFLR about how his firm is
handling the pressures of such rapid reform.
Rob Mannix: Can you begin by telling us which
regulatory issues you are focussing your attention on
Keith Clark: On one hand, we are required
to react to initiatives taken by the regulators, such as the
Spitzer enquiries in the US. On the other, there is a proactive
agenda, particularly in Europe, which is in the act of creating
a complete new infrastructure for the financial markets. So our
work with the regulators falls into two streams: the first,
responding to requests for information, and the second,
cooperating on a whole range of different initiatives that are
aimed at changing the way that the financial markets operate in
Europe and globally.
Are there specific parts of Europe's Financial
Services Action Plan that you would identify as especially
It is difficult to ascribe different levels of importance to
different directives because they all interrelate. You start
with the harmonization of accounting principles, which is
absolutely fundamental to the ability to operate a single
transparent marketplace. The benefits of that are carried into
how firms go out to solicit investment in new products under
the Prospectus Directive. Then you have the Transparency
Directive covering how you update information to investors on a
The way the financial markets operate overall is essentially
addressed by the Markets in Financial Instruments Directive
(Mifid), which is requiring a large amount of attention right
now. The Financial Conglomerates Directive is a huge issue, and
will bring in Basel requirements across the whole of our
business in a way that has not been the case to date. For us as
a firm the Financial Conglomerates Directive, Basel and the
Capital Adequacy Directive are massive issues. The strength and
depth of the change that this brings for an organization such
as Morgan Stanley in a relatively short space of time is
What is your opinion of the legislative approach
taken by Brussels?
One of the big issues is deciding what the right level of
detail should be in legislation. Should you rely on fairly
high-level principles and then leave the implementation to the
local regulator? Or is it more important to get absolute
harmony between the member states and therefore to set more
prescriptive measures at the level of the Committee of European
Securities Regulators (Cesr). I think within our organization
we feel that the detail has gone too far. We would prefer the
balance to be struck more in favour of high-level policy.
Can you give some examples of the practical problems
that very detailed rules can cause?
You have to ask whether it is right to have a detailed
conflict policy for all your wholesale customers and to have to
communicate that to 250,000 highly professional investors.
Should you have to get them to sit down and sign up to an
agreement in the same way that might be appropriate for smaller
companies or retail investors? What you need for the retail
sector does not necessarily make sense in a large wholesale
How has Morgan Stanley changed the way it does
business as a result of the regulatory focus on conflicts both
in the US and Europe?
Morgan Stanley has always gone about trying to do first
class business in a first class way. The recognition of the
importance of managing conflicts is ingrained at the centre of
how we have always operated.
For example, during the whole intensive investigation in the
US in relation to the independence of equity analysts, not a
single instance was found in relation to Morgan Stanley
analysts where any of our analysts published anything other
than their own strongly held personal views. But some of this
is about restoring trust and about industry taking a lead in
demonstrating it aspires to the highest standards. For example,
we have sought to bring requirements into fixed income research
similar to those in equity research.
What has been the effect on the industry of the
Spitzer settlement in the US relating to conflicts in equity
Clearly the Spitzer requirements were very detailed about
creating demarcation lines between investment banking and
equity research. If you talk to people in the marketplace, the
chill effect of those requirements has shown that the
imposition of detailed rules can lead to an exaggerated
response. There are a lot of 'I's being dotted and 'T's being
crossed to evidence the distinction between research and
investment banking. In some areas, this has led to the severing
of quite innocent and quite helpful communications. I think
over time it will be recognized that it may be sensible to
reengage some of the interaction between investment banking and
There has been much controversy over trade
transparency requirements in the Markets in Financial
Instruments Directive. What is your view on these?
Article 27 of Mifid, which deals with pre-trade
transparency, is a political compromise driven by all the worst
elements of European lawmaking. It is quite difficult to
reconcile the requirements of France and Italy, which have
historically had difficulties with off-exchange trading, with
the internalization approach that has worked well in the US and
which we would have preferred to have been the model in
The consultation coming out in the next few weeks on Level 2
implementing measures for Mifid is going to be a critical
phase. There are exemptions built into Article 27, such as
price improvement exemptions, to facilitate wholesale markets.
If those get pushed in the wrong direction it will be
problematic. If they get clarified in a helpful way we will be
Some of the people on the opposite side of the fence from us
really do want to reintroduce the concentration rules, so they
won't be happy with anything that achieves less than that.
How will the Prospectus Directive affect your
Whenever you have requirements under either the Prospectus
Directive or the Transparency Directive to put information out,
you have potential liability. You have to work on the
assumption that investors will base investment decisions on
that information. The potential liability regimes in the
different European member states differ. There is not clarity
as to what rules operate with regard to potential
But it has to be good that you can use a single form of
prospectus to carry out issues of securities and that it is
clear which regulatory authority will address the
appropriateness of that document. Given that Cesr is working
pretty effectively, there is some hope of greater coordination
between the regulators as to how they will approach the
approval of prospectuses.
What are the long-term benefits for the
There is more to be done, and some of that depends on how
the regulators carry out those functions. But you can
reasonably hope that the Prospectus Directive will simplify the
issue of shares, which is a major achievement. You can carp
about the division between equity issues and debt issues. But
if you stand back I think the broad thrust of what has happened
with the Prospectus Directive is extremely helpful for the
European capital markets.
It puts us one stage closer to the goal of trying to
synchronize the US and European markets. It would be so much
better for a company seeking to raise capital to be able to
access the US and European capital markets at the same time
using the same methodology and documentation. The costs of
raising capital would be reduced dramatically. Achieving single
methods of operating throughout Europe is an important initial
step towards getting that convergence between the US and
European capital markets. That is why we welcome the working
arrangements that have recently been set up by the SEC and
What do you think of the compromise brokered in the
Prospectus Directive to protect the wholesale Eurobond
We were very aware with the Prospectus Directive of the
irony of the Eurobond market being dismantled to achieve
something better perhaps for the equity markets. We strongly
backed the UK government's stance to get exemptions on the bond
side because it was silly to dismantle something that was
already an effectively functioning and efficient single
Brussels came up with this document without consulting and
if they had bothered to check with the markets they could have
come up with a far better first draft. Instead it turned into a
battlefield with the UK yet again painted as being the awkward
customer of Europe.
Does Brussels consult enough on new
There are two principles that the UK's Financial Services
Authority (FSA) has been extremely able in laying down as
foundations for its work. These are in the process of being
taken up in Brussels and we would like them to be taken up and
totally endorsed there. The first is consulting with the
industry before developing any proposals in any detail, and the
second is carrying out a cost benefit analysis. It doesn't make
any sense to bring forward an agenda for change if the benefits
are swamped by the costs of doing it. I think the FSA has been
quite scrupulous in following those two lines of action, which
have been very helpful for London over the past few years.
Brussels has certainly improved in terms of consultation, but
there is considerably more that can be done in terms of cost
How will the Market Abuse Directive affect your
Parts of the Market Abuse Directive, such as the requirement
to maintain detailed lists of insiders, are difficult to tie up
with the realities of how things actually happen. People are
also unsure what the consequences of getting rid of the regular
user test in the UK will be. The industry fought long and hard
in the UK to get that type of objectivity built into the regime
only for it to be superseded by new European requirements. It
is a bit like getting a new pair of shoes and getting
comfortable in them only to be told you have to take those of
and put Wellington boots on. You are not quite sure how it's
going to feel but you know it's going to feel different.
For us it means training, training and retraining. We
trained off the back of the English regime. Getting people to
get their heads around the differences with the new regime is
going to take up a lot of time and a lot of effort.
You mentioned earlier that Basel II is changing the
way you work. Are you happy with the Accord?
Basel I was basically designed for the money centre banks.
It was successful. But it was a relatively blunt instrument,
certainly blunt in terms of different types of credit risks.
Basel II has fine-tuned a lot of these credit risk weightings
to make the allocation of capital against risk more accurate.
The desire is to apply that across all different financial
institutions including the investment houses.
But Basel II has been formulated by a committee that still
reflects the interests and needs of money centre banks. The
SEC, for example, is not part of the Basel Committee group. The
extension and maintenance of credit off the back of investment
bank business is different from money centre banking business.
The length of time that your risk is outstanding is usually
much shorter. The collateral that you have in relation to that
risk is very different.
We feel that changes need to be brought in to the Basel II
Accord. It is overly draconian in terms of the capital
allocations for some of the risks in investment banking. A
joint working party between the International Organization of
Securities Commissions (Iosco) and the Basel Committee that was
established earlier this year is addressing these issues. I
think there is agreement that amendments are needed but exactly
how those will be identified and the timetable for bringing
that into the operation of Basel II is still unclear.
How are you preparing to deal with the capital
adequacy requirements for operational risk in Basel
Because the fine tuning of the capital allocations in Basel
II has meant a decrease in the overall capital to be allocated
based on credit risk, the Basel Committee's objective was to
retain similar amounts of overall capital within the system and
so the need to back operational risk with a capital allocation.
You may ask why. An operational glitch will tend to lead people
to look at that glitch and remedy it. The incentive to resolve
the defect is born out of the defect itself.
Whatever the philosophical rights and wrongs, the Basel
Accord has set up requirements to allocate capital against
operational risk. In any event it has to be helpful to the
industry to set up sophisticated methodologies to identify,
manage and control operational risk. In a few years the science
of operational risk management will have been developed in
similar ways to the science of managing market risk and credit
Lastly, what issues do you expect to dominate your
attention for the next two to five years?
First of all, this year we have begun to see a real upsurge
in economic and business activity. Secondly, we see market
unification and convergence continuing, both within Europe and
in Asia. We hope also to see convergence between the major
international markets in the practice of capital raising.
And thirdly there will be continuing work to deal with
regulatory investigations. A lot has been done already by the
industry participating with regulators both in the US and
Europe to look at business practices. There is another year or
two of that still in the pipeline.
The way organizations such as ours operate, behave and make
decisions is changing. The market in which we operate is
changing a lot. And the pace of change is very fast. If you
stand back and ask whether it should take longer, then yes it
should. But it is understandable that things are put on
concentrated timetables because politically you have to try and
make a substantial change rapidly.
There was originally a consensus not to bring forward major
new legislative change until the Financial Services Action Plan
was in place. But another reasonably large agenda for change
has emerged, whether in the area of corporate governance,
investment management, the potential supervision of hedge funds
or the supervision of credit rating agencies. There are still
many issues on the legislative table.