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Richard Hopkin
AFME “call to action” for active transition of LIBOR linked securitisations
6 Jan 2021
Less than 12 months now remain before the continuation of panel-based LIBOR can no longer be guaranteed. The UK authorities have stated that it is “in the interests of financial markets and their customers that the pool of contracts referencing LIBOR is shrunk to an irreducible core[1] ahead of LIBOR’s expected cessation, leaving behind only those contracts that genuinely have no or inappropriate alternatives and no realistic ability to be renegotiated or amended.”[2] Such contracts are commonly referred to as “tough legacy” transactions. AFME calls on all market participants to join us in actively transitioning as many transactions as possible to identify and reduce the stock of “tough legacy” securitisations to this “irreducible core” well in advance of the end of 2021. If not already done, we urge issuers and investors to contact each other via established channels (set out in transaction documentation) in order to identify and implement the required practical next steps for the bonds affected. AFME (and other trade associations) have been engaged in this subject for some time and stand ready to help facilitate cross-market discussions where required. While draft legislation has been laid before Parliament to assist in the resolution of “tough legacy” transactions, the UK authorities have made clear that “Parties who rely on regulatory action … will not have control over the economic terms of that action. Moreover, regulatory action may not be able to address all issues or be practicable in all circumstances …”.[3] The FCA has further pointed out that although it may be given the powers to facilitate a “synthetic” LIBOR to be developed and used, it will not be bound to use such powers. In view of the potential deterioration in liquidity in LIBOR-based instruments and other financial and non-financial risks associated with inaction, including the loss of control over economic terms, if there is any solution for such transactions that enables active transition to the relevant risk-free rate to be effected then AFME urges that that solution should be considered as a matter of urgency in line with the FCA’s expectation that market participants should effect a material reduction in the stock of outstanding LIBOR-based FRNs by the end of Q1 2021. AFME will continue to work with its members, other trade associations and all market participants to further this goal and we welcome engagement from the broadest set of stakeholders. AFME Contacts: Richard Hopkin Anna Bak [email protected] [email protected] +44 (0)20 3828 2698 +44 (0)20 3828 2673 [1] AFME emphasis. [2] Statement of H. M. Treasury, 23rd June 2020. [3] Ditto.
Pablo Portugal
The new framework for on-balance-sheet securitisation
18 Dec 2020
When the European Commission unveiled its Covid-19 capital markets recovery package in July 2020, a much welcomed measure was the proposal to extend the framework for simple, transparent and standardised (STS) securitisations to cover on-balance-sheet securitisations. On-balance-sheet securitisation can be a vital tool in the current economic environment. The mechanism is especially helpful in managing credit risk and capital requirements in relation to corporate and SME loans, which are both capital-intensive when held on balance sheet and difficult to securitise in the traditional securitisation markets. A well-designed framework can therefore make it easier to lend to new borrowers, including homeowners, consumers, SMEs and entrepreneurs, and help support Europe’s economic recovery. A new regulatory framework must always be prudentially sound and provide strong levels of investor protection. But it must also be economically viable and attractive for its targeted users; in this case, it must provide the necessary incentives for banks and investors to use this type of securitisation. Following the political agreement recently announced by EU legislators, has the right balance been achieved between these objectives? A better capital treatment, improved standards and integration of sustainability considerations In order to encourage the use of the STS label and increase bank lending, EU legislators have introduced preferential risk weights for the senior tranche of an on-balance-sheet securitisation which is retained by the originator. Subject to supervisory approval of the risk transfer, this frees up capital for the originator bank to continue making new loans to other borrowers. The new framework will also further increase transparency in relation to on-balance-sheet securitisation and, in time, will lead to greater standardisation in a way which conforms to what are seen as "best practice" standards. Greater standardisation will also make it easier for investors to compare transactions across different originators and jurisdictions. Another positive element in the legislation is the introduction of provisions to integrate sustainability into the wider securitisation framework. Standards will be developed to report on the sustainability of securitisation products and the European Banking Authority will draft a proposal for a dedicated framework for sustainable securitisation.An appropriate framework can do much to support the market for green securitisation, which is in early stages of development. Could some new requirements undermine the effectiveness of the framework? Extensive analysis of EU on-balance-sheet securitisation markets since 2008 shows that, even without the availability of the STS label, this portfolio management tool has been widely used by banks in many jurisdictions across the EU, and that these securitisations have experienced extremely low loss rates. In particular, there have been virtually no losses affecting the senior tranches of on-balance-sheet securitisations which are retained by the originator. A number of additional safeguards included will preserve and strengthen the prudent use of this mechanism. However, some provisions introduced by the legislators are likely to increase complexity and make the framework more expensive to use. One example of this is the requirement for the investor to have recourse to high-quality collateral to secure repayment of their investment. These requirements are more onerous than those generally used in existing on-balance-sheet securitisations, and will add cost and complexity to transactions. Another concern stems from the newly-introduced requirement to risk weight synthetic excess spread expected to be made available for future periods, particularly as this applies to all on-balance-sheet securitisations, regardless of whether they achieve the STS label. These requirements risk undermining the economic viability of future transactions, including those involving the European Investment Fund when it acts as Protection Seller which have recently provided vital support to thousands of SMEs across the EU. Much will depend on how the EBA approaches the implementation of this requirement through the development of technical standards in this area. It would indeed be unfortunate if these requirements lead to a more limited use of the new STS label or make many on-balance-sheet securitisations transactions uneconomic at a time when they are most needed. In conclusion, EU legislators should be commended for fast-tracking this initiative intended to support bank lending to European businesses and households through very difficult times. It is, however, too early to draw conclusions on how effective the framework will be in meeting these objectives. The design of the technical standards will be an important consideration. The success of the framework will ultimately depend on whether a good balance has been achieved between the necessary regulatory safeguards and incentives for market participants to make use of, and invest in on-balance-sheet securitisations.
How Have Europe’s Capital Markets Evolved Since the Launch of the CMU Project?
9 Dec 2020
(This article was originally published in The International Banker on 1 December. ByAdam Farkas, Chief Executive Officer, Association for Financial Markets in Europe (AFME) In October, AFME, in partnership with 10 other organisations, published areport1that provides context and evidence on how Europe’s capital markets performed in the first half of 2020. Statistics used in this piece regularly reference this document. As we reach the tail-end of 2020, it is important to reflect not only on how Europe’s economy has coped during an unprecedented period but also how financial markets have evolved. At the beginning of the year, the European Commission’s (EC’s) overarching goal was to produce policies that supported growth, competitiveness and transition to a low-carbon economy, with a particular focus on helping small businesses. During the COVID-19 crisis, these social priorities have become only more pronounced and so, too, has the role of Europe’s capital markets. Since its inception, the European Union (EU) has aspired to create a single market for capital, but the road to achieving this goal is still a long one. Progress has been slow in achieving one of the core objectives of Europe’s Capital Markets Union’s (CMU’s) project to build deeper and more integrated capital markets. In fact, this year, the Commission released its new CMU Action Plan in a bid to accelerate this process. The health of Europe’s markets is pivotal as they must play a central role in funding Europe’s sustainable transition and supporting new innovative businesses. Therefore, now more than ever, it is crucial to have data-based evidence on how Europe’s CMU objectives are being advanced and to ensure that momentum is maintained in building a fully integrated CMU. Equity markets: resilient but still undersized Europe’s equities markets are an important source of funding for businesses. Corporates and SMEs (small and medium-sized enterprises) especially require affordable funding to facilitate their future growth, and the diversity of equity-finance options makes them well suited to fulfilling this role. Fortunately, in the first half of 2020, EU27 corporates benefited from an unprecedented amount of funding from capital markets. Large levels of funding were seen from equity markets, reaching €45.8 billion in equity-issuance volumes. However, despite an increase in funding for corporates, there is still a serious lack of progress in providing equity to SMEs. The proportion of new equity risk capital for SMEs declined from 2.5 percent in 2019 to 1.8 percent in the first half of 2020. This was driven by a large increase in bank lending, while levels of risk capital remained relatively unchanged from prior years. Crucially, to boost funding levels, securities markets require a more integrated and competitive ecosystem. The Commission has already outlined its intention to review the MiFID 2/R (Markets in Financial Instruments Directive 2) framework as well as to revisit IPO (initial public offering) listing rules. However, more work is required to ensure that the securities market structure is fit for purpose in the post-Brexit environment. A diverse and well-regulated capital market better supports the needs of investors and consumers’ pensions and savings. A positive development for European capital markets over the past six months has been that the COVID-19 crisis has not significantly disrupted European cross-border funding. Indicators show an increase in intra-European integration over the last five years, which has not been reversed by the pandemic. Importantly, 96 percent of European debt offerings were marketed within Europe in the first half of 2020, rather than being marketed globally. This was a 3-percent increase from last year and a substantial rise from 2007. Innovation:the key to future growth As Europe looks to recover from the pandemic, it cannot ignore the importance of investing in innovation. To remain globally competitive, Europe not only needs to boost investment in research and development (R&D) but also foster the emergence of fintech (financial technology) unicorns that could be significant resources of job creation and growth. On this front, in the first half of 2020, Europe performed resiliently. A total of €3.6 billion was invested into European fintech companies over the period. However, more should be done to strengthen Europe’s innovation landscape. For instance, while valuations of fintech unicorns in Europe have continued to grow, more could be done to support the emergence of new unicorns. To help reduce barriers to further R&D investment, positive progress has already been made to harmonise national authorities’ approaches to regulating new technologies across Europe. Over the past year, European supervisory authorities (ESAs) launched the European Forum for Innovation Facilitators to help them share views and experiences and to develop a common approach to fintech regulation. Importantly, the Commission has also recently published its Digital Finance Package, which seeks to harmonise rules on operational resilience and bring forward an EU-wide framework for crypto-assets. This is an important step forward in creating a regulatory environment that is fit for purpose, creates legal certainty and ensures Europe is in a position where it can attract further investment and lead in the digital age. Going forward, the task of policymakers will be to ensure that its policy of harmonisation is widely adopted across the EU27. Maintaining the lead in sustainability Europe, for a number of years, has been considered the global leader in sustainable finance. In the first half of 2020, Europe consolidated this position by reaching €71.8 billion in sustainable bonds issued by June 2020. If this rate of funding is maintained, by the end of the year, volumes should surpass Europe’s record year of issuance (2019). This growth has seen the emerging popularity of social bonds—bonds that raise funds for projects with positivesocialoutcomes. Nearly one-third (27 percent) of sustainable bond issuance in Europe in the first half of 2020 was categorised as social, the largest proportion of the sustainable market in any half-year to date. Crucially, the dominance of Europe in global environmental, social and governance (ESG) markets in 2020 is also reflected by the fact that 52 percent of all global sustainable-bond issuances are taking place in the EU. However, despite its high issuance levels, Europe needs to be wary of complacency. While Europe’s sustainable-finance activity is on the rise, levels of activity vary significantly across the EU. Nineteen European countries have been active in the sustainable-finance market, but new entrants are becoming increasingly rare. Moreover, some countries have not yet tapped the market for sustainable finance. While Europe, as a whole, is pushing forward in utilising sustainable finance, it needs to be a priority of policymakers to ensure that it isn’t pushed by just a few active countries but is instead embraced by the entirety of the EU27. Establishing a harmonised regulatory approach to defining sustainable activities would help reduce barriers to the adoption of sustainable finance across Europe. As Europe absorbs the economic and social hardships during the second wave of the COVID-19 pandemic, European capital markets will again be called upon to support EU businesses. Looking at the performance of European capital markets during the past six months, there has been progress in areas such as sustainable finance, but there has also been a relative decline in areas such as raising capital for SMEs. Europe’s capital markets are still being held back by regional fragmentation and inconsistent legal frameworks. To overcome these challenges, the CMU project now requires ambition and political momentum to achieve the next level of integration. As Europe’s capital markets continue to evolve in the wake of COVID-19, key national stakeholders cannot afford to stand still.
Michael Lever
European banks’ reach record-high core capital: time to resume dividends
19 Nov 2020
European banks continue to be well positioned from a solvency perspective to support households and businesses during this period of abnormal economic stress. Having entered the Covid-19 crisis with the highest solvency ratios on record, European banks have further increased their capital buffers during 2020 reaching a new record high in core CET1 capital in 3Q 2020 through a combination of profit generation, regulatory support, and balance sheet adjustments. European Global Systemically Important Banks (GSIBs) core capital ratios (CET1 ratio) were 14.18% in 3Q 2020 on a weighted average basis, 55bps above the level reported at the end of 2019 and 418bps above the ratio observed in 2013. Some of the main drivers of the record high in core capital ratios are discussed in this blog. Ban on 2019FY dividend distribution: +30bps on CET1 The ECB and the BoE’s PRA recommended that Euro Area and UK banks suspend their planned 2019 dividend distributions in order to preserve capital and support lending to their customers, thereby helping to cushion the negative economic impact form the Covid-19. According to AFME estimates based on European GSIBs’ public disclosures, compliance with the regulatory request of withholding 2019FY dividend distribution contributed 30bps to banks’ CET1 ratio as at 3Q 2020. Although the dividend ban, which remains in place, has moderately helped to improve banks’ capital ratios, the benefits have come with associated costs. The ban on dividends was implemented across the board and although this avoided potential stigma from some banks being forced to suspend dividends while others were excused from doing so, it did prevent banks with large buffers above their Maximum Distributable Amount (MDA) thresholds from making distributions which they could well afford. Banning dividend payments also disrupted the flow of income to bank investors, life companies, pension funds and retail investors. As such they risked negatively impacting on consumption and further penalising certain parties that are already suffering from the consequences of a crisis that is not of their making. Moreover, withholding dividend payments has significantly depressed bank share prices, increasing their potential cost of equity and inhibiting their ability to use their paper to undertake any corporate activity. It has further disturbed the established relationship with regulators and the processes by which distributions were previously agreed. The intervention may therefore lead to more lasting damage given the precedent created which may result in bank investors imposing an “uncertainty discount” on share ratings to reflect the risk of future unexpected regulatory interventions. Regulatory relief: +24bps on CET1 Recognising the scale of the pandemic, on 28 April, the European Commission proposed targeted changes to the Capital Requirements Regulation (CRR) to maximise the capacity of banks to lend and to absorb losses related to the pandemic. The package mitigates the capital impacts of IFRS9 expected loss accounting and contribute to banks’ capacity to continue to support the economy during the pandemic and through recovery. The measure also included the advanced application of SME and infrastructure supporting factors to facilitate lending to those sectors. The regulatory relief complemented other supervisory guidance that banks should draw down their capital buffers. These regulatory relief measures have contributed to improve banks CET1 ratios by 24bps as at 3Q of 2020 according to AFME estimates based on European GSIBs public disclosures. Earnings retention: +36bps on CET1 Banks have continued to generate internal capital through profit retention, accumulating a total of 36bps on CET1 according to AFME estimates. Most recently, some banks have provided investor guidance by pre-announcing the expected amount of 2021 dividends to be distributed (subject to regulatory approval). The 2021 dividend distribution has been excluded from the contribution of retained profits on CET1. Any future dividend distribution is subject to supervisory approval as the current dividend ban has been recommended by the ECB until 1 January 2021, although the policy measure will be reviewed in December 2020. Any decision on the resumption of dividends is likely to take account of a number of factors but in particular the visibility that banks have of their future capital needs in the context of their prospective levels of non-performing loans. RWAs variation: -10bps on CET1 Most banks have reported an increase in RWAs during the year, predominantly due to the record increase in loan origination and from a rapid growth in market risk RWAs. Market risk RWAs have risen due to the significant increase in market volatility and trading activities during the year. The reallocation of business capacity to support companies during the pandemic has resulted in a negative contribution of 10bps on CET1 ratio. This impact excludes the regulatory support measures which, particularly the introduction of the SME and infrastructure support factors, reduced the risk weights on loan origination for those sectors. Change in CET1 ratio by components in 2020 (1Q-3Q) (%) Source: AFME with data from European GSIBs earnings reports. *RWAs excludes impact of regulatory relief on RWAs. While the full effects of the Covid-19 induced economic downturn are still somewhat uncertain, banks remain very strongly capitalised and willing and able to support all viable customers while at the same time absorbing an inevitable increase in non-performing loans. As we move into 2021, they should be allowed to resume cautious distributions in support of their shareholders.
AFME CEO urges ESG harmonisation
19 Oct 2020
When the International Monetary Fund (IMF) meeting is held remotely this year, there is no doubt that Covid-19 will be at the top of the agenda. Following the economic shock generated by the pandemic, the world is facing its deepest ever recession. This will require financing to keep businesses afloat and fund the global economic recovery. However, to ensure global markets remain resilient in the future, the economic recovery must be environmentally, socially and also financially sustainable. The EU has set a target to become climate-neutral by 2050. To achieve this and drive sustainability on a global scale, it is even more important to accelerate the low-carbon transition and embed environmental, social and governance (ESG) standards across all industries. No individual sector can be the sole driver of the change, and sustainability policy needs to be pushed in political synchrony across both the financial and the real economy. Economic sectors and markets are interconnected and, while the financial sector will drive forward the funding of Europe’s ambitious transition, it also has the challenge of supporting industries that are still in their sustainability infancy. Europe’s ESG goals cannot be achieved through ambition alone. It is going to require a cohesive approach that incentivises organisations to take greater risk to make Europe’s sustainable economy a reality. Striking the right balance One of the challenges of the sustainable transition is ensuring that the ambitious sustainability targets are within the capacity of the real economy. This is vital in evaluating whether an organisation is capable of radically changing its operations in the short term and can determine the best approach to incorporating ESG as part of its core business model. While some organisations might have already taken great strides to become more sustainable, others might still be in a period of transition. Penalising investment into sectors that are in the process of change would be inappropriate as it might deprive them of the capital they need to complete this process and thus undermine the ultimate end goal. For organisations that can prove they are trying to become more sustainable, a realistic and just approach is necessary to accompany them in this critical transformation. To overcome the challenge of accelerating the transition across different industries, establishing clear and measurable targets in Europe’s sustainable transition roadmap will be key. While the Paris Agreement presents a clear end-goal for major EU industries, the roadmap to reaching this is less well-defined. Different industries will experience different challenges and therefore warrant different targets. Including steps and milestones for each industry will help create practical strategies, giving clear signals if and when certain economic activities need to be phased out to meet the objectives of the European Green Deal. This will give industries clear short-term and long-term objectives to be measured against, and ensure no sector is left out of the transition. Funding the transition To help industries reduce barriers when accessing finance through sustainable investment, co-operation between public and private sectors is going to be key. Particularly in the post-Covid-19 environment, where capital markets alone might not be able to supply all the necessary capital to support organisations’ sustainability journeys – establishing incentive and risk-sharing mechanisms through a partnership of public and private sectors will be required. This will prove important in the support of early-stage research and innovation projects, as well as projects that are in the process of scaling up. Support could come in the form of public programmes and financial instruments that streamline application processes and thus lower barriers to private investment into projects. Equally, support could also come in the form of grants, debt or equity, including structured finance, that are tailored to the different stages of a project’s development. Any grants should include incentives where additional funding will be provided as organisations hit their sustainability targets. Moreover, equity financing could be provided through a dedicated EU Green Deal Fund that is contributed to by the EU, national and regional capital, while also allowing private investors to participate. Crucially, no single sector or type of financing should be seen as the sole catalyst for the sustainability transition. If governments want to foster innovation to aid the transition, the same innovation will need to be shown on their side to maximise the funding to support sustainable projects. Working from the same sheet To accelerate Europe’s low-carbon transition and prevent misleading claims on the environmental nature of investment products (‘greenwashing’), there is a need to better identify sustainable investment opportunities and evaluate the embedded risk. In recent years, there has been a rapid growth in financial products linked to sustainability; yet their full uptake and mainstreaming requires a breadth of corporate ESG data that is not currently available. This information is needed to establish how ESG considerations affect risk and return of investment and lending activities. So far, a big challenge has been the proliferation of unstandardised approaches on reporting, collecting and analysing ESG data. This makes it difficult for investors and lenders to compare and evaluate an issuer’s or a borrower’s ESG profile. Moreover, the lack of harmonisation in sustainability reporting frameworks and ESG rating methodologies dramatically increases the cost for firms, both corporates and investors, that operate across borders and have to engage with multiple reporting standards and ESG rating methods. This has resulted in ESG data being largely incomplete and insufficient to encourage widespread ESG investment. Making ESG reporting standards mandatory as the first step, rather than voluntary, would go a long way to alleviating these challenges by helping promote the availability of useful information for decisions. In addition to making reporting approaches more standardised, it is also necessary to establish an accessible global reporting framework (or a few key frameworks) that all organisations and jurisdictions can work with. The overall EU framework for sustainable finance is complex, and could benefit from simplification to encourage wider adoption and international uptake. For example, significant expertise is required to analyse and understand the technical criteria of the EU taxonomy for sustainable activities, particularly when it needs to be supplied under tight deadlines. Considering that the current sustainable finance landscape is not static, with organisations also needing to navigate new rules, the challenge is only going to become greater. A reduction in the complexity around the new requirements and terminology used would help industries better understand their obligations, adjust their corporate strategies and act on plans towards the sustainable transition. The role of technology A key to overcoming these challenges could lie in embracing new technologies. Technology such as artificial intelligence and machine learning present additional avenues for gathering ESG information, such as geospatial data, as well as the capacity to process information faster. For example, this could include the scanning of online news articles, identifying information that might affect ESG scoring. Moreover, the implementation of digital data sharing spaces, where organisations can share their information, would allow different industries to learn from one another and better enable firms to assess their ESG risks and impacts, and meet their sustainability objectives. From a product standpoint, digital tools, such as distributed ledger technology, could present more opportunities to co-financing local sustainability projects. This could be applied to green bonds that would open up ESG investment to new markets, allowing more citizens and firms to participate in the sustainable transition. However, to ensure that the financial sector can harness new technologies, it is important that future regulation is technology-neutral and innovation-friendly. A cross-sectoral approach to ESG data sharing should be embraced and supported. Currently, digital tools and platforms operate mainly at a domestic level. There is a need to remove any potential barriers against using these digital platforms and tools across borders. Doing so would further encourage their use. This should not only be facilitated on a European level, but also globally. Climate change and other ESG challenges are global in nature and require harmonised global action. Translating ambition into action As the world gathers for its first remote IMF meeting, while the focus will be on establishing the pathway for the global economic recovery, it should also be viewed as an opportunity for advancing the sustainability agenda. Covid-19, despite having created global challenges on an economic and social level, also holds the impetus to accelerate the sustainable transition. As jurisdictions rebuild, never has the importance of human wellbeing inherent in ESG principles been more relevant. Investment in products with ESG focus has been growing and there is no lack of ambition in building more sustainable economies. The objective now is to translate this ambition into a harmonised roadmap that all industries can understand and work towards. Ambition alone is not enough to achieve the goals to combat climate change and support societies. Barriers need to be broken down, not only across borders and sectors, but also in politics.Sustainability is a not separate agenda; it must permeate all our policy-making. This article was first published in The Banker:5/10/2020
Pablo Portugal
Time to deliver on the Capital Markets Union
25 Sep 2020
The European Commission has unveiled its long-awaited new Action Plan for Capital Markets Union (CMU). Featuring 16 sets of actions with their respective timelines, the Action Plan outlines the strategy for the next phase of the CMU and expected legislative initiatives on capital markets through 2023. The current juncture provides a renewed sense of purpose and urgency to the CMU. EU capital markets must be fit for the challenge of promoting long-term economic growth and a recovery from the severe impacts of the Covid-19 crisis. The new CMU strategy should also respond to the implications of Brexit and support the EU’s competitiveness on the global stage. Importantly, the Action Plan has also reinforced the link between the CMU agenda and the digital and green transitions. Strong capital markets must play a central role in mobilising the investments to advance the EU’s digital strategy and fulfil ambitious climate change targets. Promoting investment and re-equitisation Are-equitisationof Europe’s companies and financial landscapeis one of the immediate priorities in the face of the Covid-19 crisis. It is important to see a commitment from the Commission to apply the flexibility embedded in Basel III to ensure the appropriate prudential treatment of long-term SME equity investments by banks, , together with a pledge to assess possibilities for promoting market-making activities. More generally, we hope that the forthcoming CRR3 proposal will reflect the CMU objectives in promoting liquid capital markets, such as the implementation of the FRTB, the CVA, and SA-CCR. The review and simplification of listing rules, on the basis of careful analysis, will be another fundamental workstream to promote access to public markets, particularly for SMEs. Another key project will be the establishment of a EuropeanSingle Access Point(ESAP) to improve access to company financial information across the EU. Further work should be undertaken to ensure synergy and compatibility between reporting obligations at the EU and national levels and the information to be submitted to the ESAP. Enhancing efficiency, connectivity and competitiveness in securities markets There are several work areas envisaged in the Action Plan to improve the functioning of EU securities markets. European authorities must redouble efforts to bring to fruition aspirations such as the introduction of a common EU-wide system for withholding tax relief at source and the establishment of an EU-wide definition of “shareholder”, as well as other actions intended to improve legal and operational consistency in the single market. The upcoming review of the MiFID 2/R framework will also be fundamental in advancing the CMU objectives. A strong and competitive equities trading ecosystem is clearly essential to promote re-equitisation and enhance the attractiveness of EU capital markets. It is encouraging that the Commission intends to take forward the establishment of an effective post-trade consolidated tape for equity instruments. While there are challenges to address, a well-designed infrastructure has the potential to democratise access to European markets by providing all investors with a comprehensive and standardised view of the European trading environment. There will be other major issues to consider in Europe’s securities markets structure, not all mentioned in the Action Plan. A central guiding principle of the future MiFID 2/R review should be supporting positive outcomes for EU investors who, let us not forget, are the ultimate beneficiaries of capital markets. A diverse and well-regulated capital market, with a range of trading mechanisms and not reliant upon one category of trading venue, better supports the needs of investors and consumers’ pensions and savings. The Action Plan notes that the EU needs to develop its own critical market infrastructure and services while remaining open to global financial markets. It will be important to see how the concept of “open strategic autonomy” is applied in future workstreams. We should recall that international investors and firms headquartered outside the EU can also play an important role in generating investment and growth opportunities for EU stakeholders. Restoring a well-functioning European securitisation market It is very positive to see the Commission’s intention to carry out a comprehensive review of the EU securitisation framework for both simple, transparent and standardised (STS) and non-STS securitisation in order to scale-up the securitisation market in the EU. Securitisation can be a vital mechanism to support the financing of the real economy, particularly for SMEs, and the management of the expected increase in levels of NPLs, among other functions. It can also be an important tool in supporting ESG investment. The CMU High-Level Forum provided well targeted and prudentially sound recommendations to adjust the securitisation framework. They should be implemented to their full extent. Policymakers must seize the opportunity The importance and urgency of the CMU project hasneverbeenmore obvious. While this is a long-term project, the combined challenges of Covid-19, Brexit and the green and digital transitions should focus minds and provide momentum towards achieving far-reaching measures in this EU legislative cycle. Policymakers should now take advantage of the unique political context to work towards a fully-fledged and globally-competitive CMU with the potential to support growth, sustainability and transform the EU capital markets landscape.
LIBOR Transition: Views on Client Communications
14 Jul 2020
On 25 June, AFME and Simmons & Simmons hosted our second panel/webinar with the Financial Conduct Authority (FCA) discussing LIBOR conduct and compliance risks. This session focussed on client communications. First, the implications of the UK Government’s decision to enhance the FCA’s powers under the Benchmark Regulation were discussed. Although this decision will be significant in helping to ensure an orderly wind-down of critical benchmarks such as LIBOR, the FCA emphasised that industry participants should remain focused on active transition (of which client communications plays a big part), urging the industry “Please don’t take your foot off the gas, this remains a priority”. On the topic of Covid-19, it was appreciated that it has had an impact on the interim transition timelines for firms and clients. The FCA understands the short to medium-term challenges faced by firms and delays to some aspects of transition caused by the pandemic, and have been operating with pragmatism during this period. However, the FCA noted that communications will need to be ready for when the time is right for clients and importantly, that the deadline that firms cannot rely on LIBOR beyond end 2021 for LIBOR [MR1]remains the same. In fact, the FCA emphasised that client communication strategies may need to be accelerated, particularly if they were due to have been progressed earlier in the year, and firms should expect supervisory engagement in this regard. Panellists noted that the impact of Covid-19 on communications has varied depending on the client segment. For instance, some firms might be more likely to continue having conversations with large corporate clients, but conversations with SME clients might have been delayed. This slowdown has also impacted the roll-out of alternative rate products and consequently the build-up of liquidity in the alterative rate market. However, despite the slowdown, it was acknowledged that in recent weeks there have been positive signs of progress. As with Covid-19 communications, a tailored approach across client segments and product lines is important, but flexibility should also be built into communication strategies to allow for market developments and client needs evolving over time. Understanding the client base will be key to effective communication on LIBOR transition and this will involve gaining as full a picture as possible of clients’ exposures. Firms could consider a number of factors when devising communication strategies: Knowledge, understanding and experience of the intended audience. E.g. large corporate clients compared with retail mortgage holders. The type of product. E.g. Different contracts and currency might have varying levels of complexity when being amended. The geographic location of the customer and any market-specific considerations. E.g. some markets do not have a forward-looking term rate. Firms must also take cross-border rules into account when advising clients in different jurisdictions. Determining the most effective means of engaging with clients for different communications. E.g. Phone, email, website. There was some discussion of the requirement to ensure that client communications are “clear, fair, and not misleading”.[1] The FCA noted that information should be presented in good time, to enable clients to make informed decisions. Additionally, for products referencing LIBOR which mature beyond 2021, firms will need to properly explain to clients what may happen to the rate and how the fallbacks operate. It was highlighted that the best way to avoid additional LIBOR-related conduct risks is to offer alternative products that do not reference LIBOR. However, it is important that wherever alternative options are presented for new products or to change existing products, firms will need to make sure they are reasonably presented, including their benefits, costs and risks. Panellists agreed that communication strategies and the terminology used need to be considered, taking into account the level of sophistication of certain clients. For less sophisticated clients a balance should be struck between keeping communications as simple as possible, while not forgoing the use of important terminology when discussing the topic, which in itself could be confusing if firms switch to using different terms from those widely used in the market. For example, firms should consider whether the term ‘risk-free rate’ could be misunderstood (notwithstanding that it is a term which is widely used in some parts of the market / industry) and consider providing further context and detail. Panellists pointed to helpful resources such as the Factsheet published by the Working Group on Sterling Risk-Free Reference Rates, which can assist in client education. In a similar vein, front office and supporting staff also need to be trained as staff need to build up their awareness and understanding of the implications of LIBOR transition for clients. Firms may wish to begin by educating all relevant staff on the topic in a broader context and then build on this with more tailored training dependent on the function (e.g. front office, legal, compliance). Training could be facilitated through various methods such as E-learning, webinars, or daily updates. For more specific training, and particularly where staff engage directly with clients, more classroom style- training where scenarios can be discussed may be most effective. Finally, panellists discussed the need to monitor the effectiveness of their communication strategies. Communications should be measured against their intended purpose, for example firms could monitor whether information published on their website is getting the high footfall that might be expected for such a public medium. Firms should consider how they collect data on their communications in such a way that it can be aggregated for use as Management Information, both to inform the evolution of the strategy and to validate the work that the firm is undertaking. Panellists also discussed possible ways to record the client communications that have taken place, for example by using already existing record keeping systems and making adjustments where necessary for the purposes of LIBOR transition (whilst at the same time not introducing record keeping requirements which are inappropriate). As proceedings drew to a close, the take-away message from panellists was that it is never too early to start LIBOR transition communications. While the deadline might seem far away, firms will need ample time to regularly update their staff and clients on what is a constantly evolving process. While acknowledging ‘first mover’ reluctance, there is a risk in waiting too long. Communication plans need to be detailed, dynamic and ramp-up as we move ever closer to the end-2021 deadline. To read in more detail about the practical guidance for firms in their approach to client communications, read the full AFME and Simmons & Simmons paper. Watch the webinar, clickhere AFME Contacts Richard Middleton Managing Director, Head of Policy [email protected] +44 (0)20 3828 2709 Fiona Willis Associate Director, Policy [email protected] +44 (0)20 3828 2739
James Kemp
Returning to Office - The Next Phase of Compliance for Investment Banking
25 Jun 2020
After many months of lockdown and having had only 5-10% of staff in the office, investment banks are now looking to phase a fuller return to offices. This has been a hugely challenging period and, being very careful to avoid complacency, banks can take pride in how they have performed so far. Having shifted to remote working in what felt like only a few days, banks have shown their resiliency by continuing to service markets and clients, during a period of real volatility, with few operational issues. Underpinned by a broader strategy of increased digitalisation and adoption of new technologies, how banks now continue to harness technology will be key as they navigate their next challenge; striking the right balance for a ‘new normal’ as staff return to offices. One of the main factors that will influence return to office is how well staff have worked remotely. The majority of staff have been working away from the main sites with many working from home; only a small percentage of key workers, predominantly trading staff, have continued to work from the office. Compliance and control obligations have been maintained through the use of remote infrastructure to access central trading systems, the use of always-on virtual trading room software, recorded chat facilities, and mobile phone voice recording. This has helped counter the loss of line-of-sight and day-to-day oversight that compliance officers would typically have when working on the same floor as traders. The resulting smooth transition to remote working means that organisations may have less pressure to return to the office. What is clear at this stage is that any return will be cautious, phased and geared towards staff safety. It is likely we will see more of the front office moving back first, with middle and back-office teams continuing to work remotely for longer. This phased return means banks will need to judge whether their remote trading environments are “controlled” enough and if additional technology solutions need to be implemented. This may include the greater adoption of cloud-based software to support offsite workers and the potential use of new monitoring solutions to better enable the outsourcing of certain operations. Importantly, in determining return to office procedure, banks will need to ask themselves how long they believe the pandemic’s operational impact will last. If the impact is only expected to be a few months, the return to work might mean that many pre-pandemic processes can be retained. However, if the implications are longer-term (e.g. 6-24 months), internal procedures are likely to need to be further revised. For instance, this could include re-developing processes to train graduates remotely or rolling out new “hybrid” surveillance systems. Moreover, if the company is in the process of a business-wide technology transformation, this might need to be catered for with staff rotational patterns that enable teams to be gradually onboarded. Another change that could arise from remote working is how organisations address work-life balance. While it can be expected that most traders will eventually return to the office, the lockdown has proven that they have to a large extent successfully performed their jobs remotely, where previously it was perhaps judged too complicated – and risky – to set up the correct controls from home. This could afford organisations greater flexibility in allowing traders to work from home more frequently, knowing that it will improve their quality-of-life without impacting the bottom-lines. Going forward, one potential benefit of having this more flexible work culture might also be to help organisations in recruiting and retaining diverse talent. As the world navigates this unprecedented period, a “new normal” for businesses is likely to emerge that may look very different from the past. Banks have had to react quickly to the threat of coronavirus, and the new working environment is evolving rapidly along with the technology to support it. However, despite this change, so far banks have again proven themselves resilient. Even though the duration of the lockdown and the future of the office workspace remains unclear, there is no doubt that banks are prepared for the challenge.
Madeline Taylor
The role of crypto-assets in the digitisation of financial services
11 Jun 2020
On the 3rd of April 2020 the European Commission published its ‘Digital Finance Strategy’, which set out an ambitious vision for the transformation of financial services through increased digitisation. Technologies such as Cloud, Artificial Intelligence, Distributed Ledger Technology (DLT), and a growing focus on the value of data-sharing, will play a central role in transforming financial services. The global response to the recent COVID19 pandemic has illustrated the importance of technology to increase the resilience of financial infrastructures. Technology has played a key role in enabling remote working and allowing financial markets to continue to function during the crisis. The role of crypto-assets, types of digital financial assets, is consequently expected to accelerate in importance as financial services become increasingly digital. It is therefore essential to recognise the various use-cases, features, benefits and risks of different types of crypto-assets in order to clarify their regulatory treatment. By bringing crypto-assets within the regulatory perimeter, regulators can further support innovation in this area. What are crypto-assets and how are they different from traditional financial assets? Crypto-assets are financial assets that are represented digitally using Distributed Ledger Technology (DLT) and cryptography. It is the use of these technologies that differentiates them from traditional financial assets: Distributed Ledger Technology (DLT), such as blockchain, is used to create a decentralised network for recording and storing information in multiple locations, without the need for a central administrator (such as a financial intermediary). Cryptography is a method of encryption that is used to create ‘digital keys’ to manage ownership or control of a crypto-asset, providing security for the recorded information to prevent tampering or theft. Crypto-assets have a wide range of current and potential use-cases in financial services, such as securities trading (as shares or bonds) or improving post trade processes (such as settlement and recording ownership). Crypto-assets also have a wide range of features. For example, some crypto-assets, often referred to as ‘stablecoins’, have built-in price stabilisation mechanisms that link them to other financial assets or algorithms (a programmed sequence of executable instructions). Other crypto-assets are programmed to automate key functions like dividend pay-outs, or contain smart contracts that automatically execute all or part of a legal agreement when programmed to. It is important to understand the various use-cases and features of different crypto-assets because they are associated with different levels of risk. For instance, some crypto-assets (e.g. tokenised securities) are issued by regulated financial institutions and are essentially digital, cryptographically secured versions, of traditional financial assets and subject to existing regulations. However, other crypto-assets (e.g. cryptocurrencies) currently fall outside of existing regulations and may contain features (such as anonymity and unrestricted access) that may make it difficult, or even impossible, to conduct the controls necessary to protect investors, consumers and financial markets. There are multiple benefits that crypto-assets can provide compared to traditional financial assets, such as: Allowing for increased efficiency and cost-savings by reducing the need for financial intermediaries; Increasing investor access to asset classes through fractional ownership (where an asset is split into smaller investments); Providing a more secure and accurate store of information (by creating tamper-resistant records); Distributing information between multiple participants in real or near-real time (to mitigate risks such as single points of failure); and Increasing the speed and efficiency at which capital can be provided (for instance by allowing for faster post trade settlement). The potential benefits of crypto-assets can be understood in the context of the recent COVID19 pandemic, where European capital markets have played a vital role in supporting the economic response, and recovery, required. The benefits of crypto-assets (such as increased efficiencies and improved resilience of financial services) will become more pronounced as their adoption continues to increase and where other disruptive events, such as the current crisis, occur. Even so, increased adoption and further innovation for crypto-assets remains hampered by a lack of clarity on their exact regulatory treatment. This lack of clarity stems from two main factors: Crypto-assets have a variety of features and use cases: There are many different types of crypto-assets that are used to conduct a wide range of activities, with varying features and risks; and There is no commonly used global taxonomy: There is no globally accepted taxonomy for classifying crypto-assets, to take account of these variations and to help identify the appropriate regulatory treatment. It is therefore essential to establish a global taxonomy, that distinguishes these different activities and features, to encourage innovation, realise the potential benefits and appropriately manage any associated risks. Why are crypto-assets so difficult to define and classify? Crypto-assets, whilst evolving at pace, remain at an early stage in their development and use within financial markets. Therefore, identifying the appropriate regulatory treatment has proven difficult as current regulations were not developed with crypto-assets in mind. For example, existing regulations are generally built on the basis of ‘bilateral relationships’ (a linear relationship between the seller, intermediaries, and buyer respectively), whereas crypto-assets are able to facilitate multiple interactions between decentralised parties. This has resulted in a fragmented approach to crypto-assets regulation across EU Member States (and globally). This creates uncertainty for market participants as to which rules will apply to the issuers of crypto-assets and related service providers (such as those providing exchange or custody services). Clarity on what rules will apply is necessary for encouraging crypto-asset adoption and innovation. The need for a global taxonomy to classify crypto-assets In December 2019 the European Commission issued a public consultation for the development of a comprehensive regulatory framework for crypto-asset markets in Europe. This framework will be an important step towards harmonising crypto-asset regulation in Europe and creating a common baseline of understanding for market participants. However, a global crypto-asset taxonomy is still required due to the global nature of financial markets; and particularly for those market participants engaging in cross-border activity. This global taxonomy must be high level in order to remain flexible as crypto-assets continue to develop, but detailed enough to provide the regulatory clarity required to encourage innovation. Industry collaboration across the EU, and globally, will be essential in achieving this taxonomy and in realising the benefits of crypto-assets, whilst mitigating any risks. AFME initiatives In support of a European, and global, crypto-assets taxonomy, AFME (as part of the Global Financial Markets Association, GFMA), has developed an initial approach for the classification of crypto-assets. We believe this approach provides an important basis for a future global taxonomy and that it can support the collaboration required between financial market participants and regulators to achieve this aim. The approach we developed is based on the principle that the regulatory treatment of crypto-assets should be underpinned by a clear understanding of the existing features of crypto-assets and their associated risks. We believe this approach will support the development of an appropriate framework for crypto-assets regulation in Europe, and globally, as crypto-assets continue to evolve and new offerings are created. You can find our approach here, in Annex A (p 10-12) of our response to the BCBS Discussion Paper on Designing a Prudential Treatment for Crypto-assets. You can find our response to the European Commission public consultation on An EU Framework for Markets in Crypto-assets here.
Pablo Portugal
Capital Markets Union – will the opportunity be seized?
10 Jun 2020
The economic shock generated by the Covid-19 pandemic has amplified the need for deep and well-integrated capital markets in the EU in virtually every area. As Europe faces its deepest ever economic recession, itis clear that arobust post-pandemic recovery and sustainable long-term growth cannot be funded solely throughgovernment support programmes and the provision of bank loans.Strong capital markets are needed to channel the EU’s significant savings pools and private investment resources to where they are most needed. The implications of Brexit, meanwhile, remain a key driving force behindthe Capital Markets Union (CMU) project. The way EU businesses and market participants interact with the City of London – Europe’s deepest financial centre and wholesale markets hub – is set to be reshaped at the end of the Brexit transition period, even if optimistic scenarios for equivalence determinations and the future relationship materialise. The question facing CMU is therefore not if it is needed, butwhether policymakers will nowseizethe opportunity to generate the momentum to undertake the reforms needed to fulfil the objectives of this critical single market project. Established in November 2019, the European Commission’s CMU High-Level Forum (HLF) brought together a diverse group of experts from different sectors tasked with the preparation of recommendations that were ambitious and game-changing, but also concrete and actionable.Its long-awaited report, published this week, identifiesmany of the measuresthat need to be taken forward. Placing equity markets and retail investors at the heart of the CMU Are-equitisationof Europe’s companies and financial landscapeis one of the immediatepriorities in the face of the Covid-19 crisis. Public and private equity risk capital remain the most appropriate mechanisms to finance manybusinesseswith high-growth potential, aiming to rapidly expand or to invest in frontier technologies. Supporting them is vital to the recovery. Theyrepresent riskier investments but are alsolikely to bethedrivers of post-crisis growthand job creation.Well-functioningequity markets should also allowestablishedcorporates tostrengthentheir balance sheetsin the face of a very sharp downturn in business activity. TheHLF Report puts forwardanumber ofrecommendationsto bolsterequity markets. These include adjustments to the prudential frameworks for banks and insurers to increase institutional investor capacity, the establishment of a EuropeanSingle Access Pointto improve access to company financial information across the EU,as well astargeted modifications of the prospectus, market abuse and MIFID/R regulatory frameworksto make public listing more attractive in particular to SMEs. Some topicswill require further assessment anddiscussion. For example, while promoting equity research coverage on SMEs is avery legitimateaim, creating a bespoke treatment for SMEswith exemptions from theMiFIDII unbundling rulescouldlead tofurther regulatory complexityand other drawbacks. Another central priority is the expansion of retail investor participation in EU capital markets. A large part of the wealth of European householdscontinues to be placed incash deposits with currently negative real returns.This must change if we are to unlock thetrue potential of the CMU.Increasing the supply ofinvestable capital is one of the conditions to supporting businessesand mobilisinginvestmentsto help mitigate the impact ofclimate change. A further important recommendation in the HLF Report istosupportthe introduction of auto-enrolment systems to stimulate adequate pension coverage across all Member States. Experiencein some jurisdictionssuggests that auto-enrolment schemescan lead to very significant growth in pensions savings over a relatively short period of time, thereby increasingthe pool of capital available for investment.The implementation of such schemes has the potential to be atrue game-changerin several countries. Revisiting pastCMUinitiatives – can theybesuccessfully delivered this time? The framework for simple,transparentand standardised (STS) securitisationrightlyconstituted one of the building blocks of the initial CMU Action Plan. Yet the potential of the STS framework and the ambition to promote a safe and expanded European securitisation market are so far not being achieved.Over a decade on from the financial crisis, issuance in Europe is still at a fraction of the level it once was(figure below).This is in part due to an excessively complex regulatory framework and an overly conservative treatment of securitisation that continue to discourage a meaningful recovery of the European market. TheHLF Reportprovidesa set of clearly defined recommendations in this area. Itrightly concludes that a review of the securitisation rules should seek to simplify the process for significant risk transfer, adjust the prudential treatment of securitisation for banks and insurers, support the development of synthetic securitisation, reconsider the eligibility of securitisation under liquidity regulation and simplify disclosures. These are the right measures. Policymakers must now prioritise the adjustments needed to ensure that Europe can benefit from well-functioning securitisation markets and the possibilities offered by the “best in class” STS label. There islong history of European initiativeswhich haveaimed totackleinstances of fragmentation intaxation regimes, insolvency procedures and legaldefinitions.Progress in these areas has been slow and challenging due todivergentnationallawsand legal systems. Yetsuchlegalframeworks are fundamental inunderpinning the functioning ofcapital markets and building a true CMU. One can only hope that Member States will find the willingness to implement the HLF’s recommendations to overcomedeep-seatedinefficiencies and legalimpediments to capital market integration. Theintroduction ofa standardised system for relief at source of withholding taxshouldcertainlybeone of thepriorityactionsto addressacostlysource of friction in intra-EU business. The securities markets structure – inefficiencies need to be tackled EU markets have shown resilience in the recent period of high stress and volatility, with financial firms and infrastructures continuing to fulfil their core functions without major systemic disruptions. However, further work is needed to improve the effectiveness of the securities market structure, which is central to the future success of the CMU. Capital markets needcost-effective channels for the issuance,distributionand trading of securities for the benefit of investors and non-financial companies. They need well-calibrated transparency regimes that support liquidity and market confidence. For thisreasonthe upcoming reviews of the MiFID II/MiFIR framework should be pursued in alignment with the CMU objectives to strengthen the capacity of EU capital markets and enhance their efficiency and connectivity. The priorities must include addressing – and removing – deepinefficiencies in Europe’s equity market structure. Chief among thesearethe share trading obligationand the double volume caps system,whoseeffects have not been positive for Europe’s markets.Another focus area should be tacklingpersistent problems regarding the high cost of market data, which is a fundamental concernto many market participants. As regards post-trade market infrastructures, the HLF hasregrettablymissed an opportunityto recommend a review of the CSDR settlement discipline regime in order to remove the mandatory obligation on investors to execute buy-ins, despite putting forwardtargeted recommendationson other aspects ofthe CSDR. Thisobligation,which is due to go livein February 2021,willrestrict the ability of investors to manage their trading and settlement processes, risking damage to liquidity, greater costs and higher barriers to investing.It is unfortunate that theHLFwas not able to reach a consensus on this point. Conclusion The importance of the CMU project hasneverbeenmore obvious.The upcoming reviews of key legislations – MiFID/R, CSDR, Solvency 2, the Securitisation Regulation and the bank prudentialframework, among others – must be pursued with ambition andaclear focus on the CMU’s aims toexpand, integrate and make more efficient the EU’s markets. The impact of the Covid-19 crisisshouldserve as a catalyst to overcomenational differences and legislative discrepancies thathaveweakened pastinitiatives.As the EU navigates one of its greatest evereconomic and socialchallenges, the hope is thatall partieswill seethevastpotential of a fully-fledgedCMU in aiding economic recovery and supporting sustainable growth.
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