Graham Bishop/Paula Martín Camargo
Organised by the Centre for the Study of Financial Innovation (CSFI) with co-presenterConor Foley (Norton Rose Fulbright) and Catherine McBride (IEA).This blog covers the key subjects since our last meeting that I hoped to cover but, as always, we ran out of time to deal with them all. As a Friend, you can watch the 32nd `structured’ CPD web-cast with CISI. These Notes may be read to record a further 30 minutes of `structured CPD’, including a dipping into the links to the underlying stories.
Highlights from the “Brussels for Breakfast” meeting
323 days to go…always the starting point of the Breakfasts nowadays but the understandable interest in Brexit must not divert attention from the continuing flow of financial services events around the EU. Anything that influences the chances of a good outcome for “the City” must be considered but the minutiae of the Irish border issue can become overwhelming! However, a recurrent theme is the sense of running out of time… not just for Brexit but for the EU’s legislative process in the life of the 8th European Parliament and the current European Commission.
The window for proposing significant new legislation is now virtually closed – realistically until the new Commission takes office in October 2019. However, the Commission is preparing 30-40 legislative adjustments to deal with the risk of a no-deal, hard Brexit across all sectors.
The European Parliament has published a useful guide to the vexed subject of “equivalence” and MEP Hayes has published an own-initiative report that underlines that the equivalence concept is designed for a process where regulations of the EU and the third country are converging rather than the divergence that seems likely between the EU and UK over a period of years rather than at the moment of Brexit.
CCPs have come back to the forefront of attention again given their huge significance in a financial crisis. The £96 TRILLION of euro contracts alone in the UK are about 50 times GDP. The Bank of England has suggested a legislative fix in both UK and EU to ensure continuity but can it be done before the EU legislative window shuts? Are the potential problems of CCPs really a worry? The BIS thinks so as its report highlighted for some CCPs “serious issues of concern and warrants immediate attention.”
The problem of non-performing loans re-appeared – firstly as the EBA consults on a template for reporting so that analysts can really asses the true state of each bank. But then it seems that IFRS9 has opened the way to some banks aggressively selling off bad loans (good!) but “disguising” the capital hit (bad) by taking full advantage of the 5-year transition.
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Key items from the rest of the month
The complexity of the issue of the land border in Ireland – which has put at risk the Brexit talks, - made Theresa May put forward a handful of options to avoid a hard border along Northern Ireland’s lines, among which a hybrid customs plan with the EU is the most favoured by the Prime Minister herself.
May’s so-called “new customs partnership” would mirror EU customs rules and collect tariffs on behalf of Brussels on goods ending up in the EU through a very complex method that has been branded “magical thinking” by European officials. But May’s inner Brexit cabinet committee narrowly rejected this model– Eurosceptic ministers deemed it “unworkable” -, which forced the Government to postpone the decision.
This insoluble conundrum might lead Theresa May’s minority Government to collapse: a letter signed by as many as 60 Tory Brexiteers has warned the PM that accepting a customs partnership with the EU would mean she can’t deliver a clean break from the EU, and therefore they may withdraw their support to her Brexit Bill.
May’s options could be boiled down to a choice between “bad and worse,” Bloomberg co-founder Michael R. Bloomberg said, recognising that Theresa May knows that Brexit talks have “gone wrong” and remaining in the customs union after Brexit, of creating a new tailored customs relationship, is the least worst option for Britain after repealing full EU membership.
Lords have inflicted a shock, new defeat to May’s plans, amending the Bill to force a vote over UK’s membership to the European Economic Area– effectively over remaining in the Single Market. Endless rebellion in Parliament has made a ‘no deal’ Brexit less likely, Labour policymakers said, and MPs could very well ultimately force the Prime Minister to renegotiate the terms of the future UK/EU relationship, prompt a general election, or even call for a People’s Vote on the deal , according to the Institute for Government.
People voted for Brexit but they didn’t know beforehand the exact terms of what the future would look like and should have a vote on the final deal, according to 'People's Vote' campaign group, which launched on April and aims to capitalise the general mood, with voter confidence that Brexit talks will end successfully at a new low.
Meanwhile the Brexit clock keeps ticking: with 323 days to “go”, EU chief negotiator Michel Barnier reminded London that it must produce its “vision” for a clear post-Brexit trade relationship if it wants negotiations to move forward swiftly. Not a simple task for a Government that will have to disentangle the country from a 300 million consumers trade bloc and its unified trade accords, and British business have sounded the alarm over a possible ‘bonfire of EU rules’ that would mean more costs than benefits for them, while AFME warned against new barriers to the effective flow of personal data between British business and the EEA that the impending departure from the European Union might erect.
Although some countries outside the EU said trade after Brexit could resume smoothly - Norway has agreed to align itself with the UK’s desire to roll over European trade deals with non-EU countries during the transition phase, whereas Canada PM Justin Trudeau said they would sign a larger and “more impactful” trade agreement with Britain than its deal with the EU, - others don’t share that upbeat assessment. China ambassador warned that they won’t sign an FTA with Britain in a cliff-edge scenario, while Japan acknowledged that Japanese firms established in the UK as a gateway to Europe and that there won’t be a deal better with the UK than the single market, and India’s government warned it wouldn’t prioritise an agreement with Britain over one with the EU. The odds aren’t good for a deep trade relationship with the US either: an in-depth report by the Commons’ International Trade Committeewarned that London would have to choose between a comprehensive deal with Washington or with Brussels because of the trading powers’ contradictory regulation in some points.
The rush to maintain financial stability in the EU after the departureof one of Europe’s financial heavy weights, particularly if no deal is reached between officials in London and Brussels, has prompted the Commission to issue dozens of legal proposals on Brexit over the last month that would give institutions such as ESMA bigger powers to prepare the bloc for a sharp break from the UK. The ESAs review is setting tighter rules for the delegation of key functions to third-country entities, seeking to prevent letter-box firms operating, but ESMA has responded to criticism by the US asset management industry and the UK’s FCA by removing its requirement for national regulators to wait for ESMA’s approval before granting delegation rights to individual fund managers – an FT’s report hinted.
Good news for the UK’s £8tn fund management industry that provides services for overseas clients, but tough battles remain ahead: the sector of derivatives contracts in Britain requires an urgent fix to provide clarity and assurance for a 96 trillion pounds’ worth industry, the FCA and the Bank of England claimed; and bankers located in The City are trying to secure the majority of trades in EU operations with the permission of the ECB to deploy “back-to-back” securities arrangements.
European officials haven repeatedly warned London’s financial services that they will lose their unlimited access to trading across the EU, thus making executives and financial supervisors in Britain turn to equivalence as a rather poor substitute of their current status – a model that is currently being revised in Brusselsto adapt to post-Brexit reality and was saluted by ECMI’s Karel Lanoo as “a proportional prudential regime for investment firms”. “Equivalence has proven to be a pragmatic solution that works in many different circumstances, and it can work for the UK after Brexit as well,” the Commission Vice-President Valdis Domvroskis said. But the EU’s Brexit negotiator-in-chief quashed the UK’s hopes for a bespoke financial services deal, saying that mutual acceptance of each other’s rules wouldn’t be enough to operate in Europe, if Britain didn’t abide by EU’s authorities and standards.
In the end, Britain may strike a deal with the EU, but who will enforce it and provide that rules are respected? The Lords' EU Justice Sub-Committee called on May’s Government to propose an effective system for dispute resolution and enforcement in respect of both the proposed withdrawal agreement and the future UK-EU relationship. For the UK-EU trade agreement, the options for dispute resolution mechanisms proposed in a briefing by the Senior European Experts include “making use of the Court of the European Free Trade Association or the establishment of a new court specifically for this agreement.”
Brexit might be “one of the saddest moments in 21st-century European history,” as European Council President Donald Tusk described it, but discussions in Brussels revolve around how to move forward with EU reform. French President Emmanuel Macron called in Parliament for monetary revamp and pushed for a digital tax. A recent CEPR Policy Insight on European reform proposed by seven German and seven French economists was discussed by economists at VoxEU, who argued that the liquidity of solvent member states is more important than fiscal stabilisation, and that deepening EMU requires a coherent and well-sequenced package. The Bank of France's Villeroy de Galhau suggestedpractical solutions tothe three old clichés that are paralysing the debate and that policymakers must put behind them to move forward in the euro area. Finally, authors at Bruegel wrote thatthe banking union and the establishment of an EMF should include markets in their risk-sharing.
Banking
The adoption of global standards that seek to pre-empt a new financial crisis worldwide is proving too slow: the Basel Committee urged full, timely and consistent implementation of Basel III post-crisis reforms, noting that limited progress had been made in the implementation of the standardised approach for measuring counterparty credit risk exposures and the capital requirements for bank exposures to central counterparties and for equity investments in funds. One of the elements that will be introduced as a Pillar 1 standard to supplement the existing risk-based capital requirements is the leverage ratio, examined by economists at VoxEU as a macro prudential policy instrument. AFME commissioned the most comprehensive study to date on how banks have actually responded to regulations 10 years on from the global financial crisis.
The phase-in of the new global accounting standard IFRS9 has permitted South-European banks to front-load vast amounts of their NPLs portfolio “to improve their NPL coverage while not weakening their regulatory phased-in common equity tier one ratios,” analysts said, in what has been dubbed as a “have cake and eat it” moment that has surprised officials at the ECB. The drive follows calls by Germany, who according to Luxembourg Wort, is pushing for higher targets for the sale of NPLs by European lenders. CEPS Director Daniel Gros analysed the effects of non-performing loans (NPLs) on the broader Italian credit and banking sector, with a specific reference to France and Germany. A more prominent role for the ESM in the process of cleaning up non-performing bank loans and unsustainable sovereign debt levels in Europe may be a possible solution, according to the assessment by members of the ESFRC.
The Single Supervisory Mechanism has asked Germany’s largest bank to estimate how an exit from significant parts of its operations would affect its capital markets and derivatives business, as part a global trend in financial supervision. The ECB move followed advice from the Bundesbank’s Andreas Dombret to merge its watchdog duties with the European Banking Authority.
A suggestion that might fall on deaf ears: ECB official Sabine Lautenschläger, in charge of supervision at the Central Bank, pushed for a “harmonised regulatory framework” in order "to reap the full benefits of the banking union." Political negotiations on completing the banking union were entering a “critical phase,” Europe’s top financial services official Valdis Domvrovskis said, while the head of the European Stability Mechanism Klaus Regling urged member states to compromise.
Part of the discussions is about the establishment of a European Deposit Insurance Scheme (EDIS), as signalled in a recent ECB paper, whose main point was supported by VoxEU in a column that argued that proposals to maintain national compartments in a new European Deposit Insurance Scheme are self-defeating, as such compartments can be destabilising in times of crisis. Commission Vice-President Domvrovskis said that the EU’s “ambition is to possibly agree on the principles of how EDIS could be introduced in phases, and to start political discussions on legislation for the first phase” in June.
The EBA consulted on its Guidelines on disclosure of non-performing and forborne exposures and on the exposures to be associated with high risk.
The second Payment Services Directive is set to change the future of the banking sector, Pini Yakuel recognised, urging traditional banks to streamline their back-office IT systems but also the way they communicate with custumers. The Commission aims to extend the benefits of an effective Single Market in payments and proposed that fees charged for cross-border payments in euro are the same as those that would be charged for equivalent domestic payments in the local currency in non-euro countries.
Fintech can bring about real gains for consumers – the Bank of England announced that the first non-bank payment service provider has directly accessed the UK’s payment system– but it must be watched closely to provide a safe environment for businesses and clients. Financial regulators in Europe and the US are starting to pay more attention to how supervising online storage services, which hold information from the world’s biggest banks and may be subject to cyberattacks. Moody’s has also warned against the disruption that blockchain can produce, with the British banking system among the most at risk in the world.
Capital Markets Union
The push for such a structural endeavour as the Capital Markets Union project keeps facing major challenges. Authors at Bruegel suggested that capital markets will only evolve into a true Capital Markets Union with concrete action and that ESMA reform should be a priority but cannot be the only one. A VoxEU column argues that progress has been slow and that a more ambitious vision is needed to achieve true Capital Markets Union. The EU needs deeper capital markets to help replace emergency ECB funding for businesses, World Economic Forum’s Huw van Steenis told the FT.
The ECB is seeking new powers to handle crisis originated by the multi-trillion-euro clearing market in the US and The City after Brexit - data by ESMA shows the Exchange-Traded-Derivatives industry is worth approximately €200tn in Europe, with the UK being the largest market. The ECB's Coeuré warned that “any recovery and resolution planning for individual CCPs requires an EU wide systemic risk assessment and a strong co-ordination at global level.” A stance welcomed by ESMA, whose chair SteveMaijoor stressed the importance ofthe condition that “any resolution tool based on public financial support to a CCP in resolution should be used as a last resort”.
CPMI and IOSCO issued more granular guidance on supervisory stress testing of central counterparties, while continuing monitoring the implementation of the Principles for financial market infrastructures (PFMI), which shows that, despite ongoing progress, some central counterparties still lag on risk management and recovery planning.
ISDA published a new academic paper on margin requirements for the non-cleared derivatives market, while the FSB published a second consultation on unique product identifier governance.
ISDA, the EBF, ICMA and ISLA recommend that EMIR be amended as part of the Regulatory Fitness and Performance Program, or REFIT, to exempt transactions resulting from post-trade risk reduction services from the clearing obligation, or to empower the European Securities and Markets Authority to do so.
The grace period to implement MiFID II rules is coming to a closeand fund managers are fretting about coming to terms with the new disclosure requirements. The regulation will shine a light on trading relationsand produce very useful information for traders, but it is causing a cut-throat war to compete for research pricing and boutique research houses unable to stand the pressure have asked to be entirely excluded from MiFID II inducement rules. ESMA has asked the European Commission to clarify the ancillary activity test under MiFID II.
The EBA consulted on its guidelines interpreting the STS criteria in securitisation, whereas
ESMA published the responses to its Consultations on Securitisation.
Asset Management
The European Commission issued a study on the distribution systems of retail investment productsthatshows the difficulties that consumers in the EU face when trying to buy the most suitable investment fund, life insurance or private pension. It also reported on Pensions Adequacy and stated that more needs to be done.
ICMA’s Asset Management and Investors Council (AMIC) and AIMA commented on the Commission’s proposals for investment firms detailed in the ESAs review: the AMIC underlined the importance of fund delegation to the asset management business modeland the threat from the proposals, while AIMA and the Alternative Credit Council (ACC)put forward detailed amendments addressing key issues identified by their members.
Financial Services Policy
The latest report on risks and vulnerabilities by the Joint Committee of the European Supervisory Authorities(ESAs) found that the securities, banking and insurance sectors in the European Union face multiple risks deriving from Brexit, asset repricing and cyber-attacks key risks.
Members of the Parliament voted to fully disclose the true ownership of companiesas well as to regulate virtual currencies to prevent them being used for money laundering and terrorism financing, in a bid to tighten rules on money laundering after banking scandals from Latvia to Malta.
New technologies are intruding strongly into the financial sector and EU institutions have moved to regulate the way they are used and to safeguard financial stability: the ECB set in motion the first European framework for testing financial sector resilience to cyber-attacks,TIBER-EU.
Along these lines, the Commission proposed a European approach on Artificial Intelligence. Despite their excitement about this latest hype banks are being cautious, a Financial Times survey of 30 leading banks’ use of Artificial Intelligence revealed.
Insurance
Ferma called for balancein the European Commission’s collective redress proposals,whereas Insurance Europe stated that the proposal failsto follow the Commission’s own recommendations against potential abuse.
EIOPA's Risk Dashboardfor the fourth quarter of 2017 showed that the risk exposure of the European Union insurance sector remains stable. The Authority published its supervisory convergence plan for 2018-2019 for the insurance sector, focussing on the implementation of Solvency II and conduct of business supervision.
Corporate Governance/Accounting
Better Finance commented on the Shareholders Rights Directive Implementing Acts, and said that the revised Directive itself unfortunately only provided limited improvements to shareholders' rights.
The IESBA released a completely rewritten Code of Ethics for Professional Accountants.
Nearly 80% of jurisdictions worldwide have adopted International Standards for Auditing for mandatory audits, while more than 60% have fully adopted the international Code of Ethics for Professional Accountants, according to a study by IFAC complemented by an update of Accountancy Europe’s report on Member States’ implementation of new EU audit rules as of April 2018.
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