In the era of light-touch regulation, the same story played out with the introduction of each new initiative. Something bad happens, the legislators and regulators form new rules to prevent it happening again and firms immediately set about finding loopholes that allow them to carry on as normal.

The only variable was the degree of success that each side enjoyed. This game of cat and mouse is not played out with undue cynicism. Indeed, firms have little choice but to sail close to the regulatory wind in highly competitive financial markets.

Banks would not be able to offer their services at competitive prices if they engaged in expensive practices that were not required by regulators, such as holding larger capital buffers or providing additional oversight.

It is the role of the regulator to set reasonable rules that protect markets without imposing unnecessary costs. If they carry out their role properly, everyone benefits.

The progress of the Alternative Investment Fund Managers (AIFM) directive provides a microcosm of the state of the modern regulatory process http://bit.ly/1beImdO>.

The European Commission was concerned about the risk to investors from problems occurring in entities that they have not chosen or able to monitor, such as sub-custodians. It was decided that depositary banks should be held liable for such problems, as they appoint sub-custodians and various other entities and have deep enough pockets to provide compensation if things go wrong.

The problem was that this exposes depositary banks to potentially huge liabilities and, in reality, little real ability to conduct due diligence on a subcustody network of perhaps 200 entities scattered around the world. Banks set about looking for the most efficient way of complying with the letter of the coming new law.

The loose and conflicting language in the AIFM directive left open a few ways of mitigation liability and businesses have understandably been organising themselves accordingly. This is the point at which our modern regulatory tale parts company with the usual script.

The European Commission seems determined to apply liability in accordance with the strictest interpretation of the directive. It says that this was always its intention, but the fact this point was discussed at a meeting hosted by German regulator BaFin and is on the European Securities and Markets Authority’s (Esma) radar suggests that no one outside Brussels’ hallowed halls enjoyed such certainty.

Confusion reigns in the market. The AIFM directive, and presumably Ucits V when it is finalised, will impose tougher rules on depositary banks than they currently expect. The commission has already shocked the market once in 2012 when it decided to go much further than the official advice, based on extensive consultation, provided by Esma. Prepare to be shocked again.

Since the publication of this letter in the December issue, Global Investor/ISF has learned that confusion over the loosely-worded article in the AIFM directive has resulted in a sudden rewording of the corresponding section in the Ucits V draft <http://bit.ly/1ivCdnt>.