About Capital Markets
Afme Annual Review
Annual Review 2019
Annual Review 2018
How we work
Senior management team
Who we are
Women in finance charter
AFME Coronavirus updates
30 Mar 2020
Divisions and committees
Equity Capital Markets
AFME Due Diligence Questionaire 2021
Public Policy and Advocacy
Recovery and Resolution
Spanish FTT – Indemnity Protocol
Technology & Operations
AFME Coronavirus updates
30 Mar 2020
Financial Transaction Tax
Standard Forms and Documents
Views from AFME
AFME Press policy
GFMA Weekly Updates
AFME Coronavirus updates
30 Mar 2020
AFME Events Calendar
Foreign Exchange Membership
Register for AFME Members newsletter
Views from AFME
Share this page
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
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”. 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
+44 (0)20 3828 2709 Fiona Willis Associate Director, Policy
+44 (0)20 3828 2739
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.
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.
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.
Capital markets key to EU recovery after Covid-19
4 Jun 2020
Following the hard-hitting impact of the Coronavirus lockdown, Europe’s economy is facing an unprecedented challenge. The European Commission has forecast the euro area economy will shrink by 7.75% this year. The depth of the recession and the strength of recovery will be uneven across the EU. During this difficult period, the effectiveness of the recovery will be shaped by how well the banking sector, capital markets and authorities can work together to support European businesses. When EU countries emerge from the Covid-19 crisis, it is expected that they will have to shoulder higher levels of debt as a result of the support provided to entire sectors closing down under the lockdown restrictions. Although European governments and banks have responded rapidly with the liquidity to fund companies, a robust and sustainable post-pandemic recovery cannot solely rely on bank funding. It is important to mobilise the entire range of options and solutions in the single market, including the investment capacity and interest available across Europe and beyond. Therefore, now more than ever, Europe needs to promote market-based finance. In this respect, equity finance should be especially important in supporting the EU’s recovery. Funding via Initial Public Offerings, private equity, venture capital and crowd funding are going to be crucial vehicles to support businesses. Corporates and SMEs, particularly those looking to invest in new technology, to hire staff for rapid expansion or to re-finance existing loans post-pandemic, will require affordable, appropriate funding to facilitate their future growth. Equity finance is well-suited to this as it can be raised from a diversity of investors even amid volatile market conditions. Businesses with high growth potential will be the backbone of the future European economy and supporting them will be key to a resilient post-pandemic recovery. There is significant room for growing Europe’s equity markets. In 2019, European exchanges saw 106 companies go public, while over the same period, the US saw 196 IPOs. Improving and converging key regulatory requirements governing the IPO process could help to reduce the cost and execution risk for companies going public and widen the pool of interested investors across Europe. Another way to support European businesses during the recession is to foster a well-functioning securitisation market. Bank loans will continue to be the primary funding tool for many businesses and households. Securitisation can provide funding for companies in a tight credit environment by enabling banks to free up their balance sheets and capital needed to lend to SMEs, corporates and households. Yet, while a robust securitisation market would aid Europe in its post-crisis recovery, over the past year, growth in the market has been stagnant. This can be attributed to an excessively complex and restrictive regulatory framework that has deterred many investors. Reviewing this framework should enable more investors to enter the market and allow for greater financing of EU businesses. Of course, while immediate relief measures are needed to rebuild the economy, we must also ensure the recovery is sustainable. There are growing calls for a “green” recovery – one that accelerates progress in building a sustainable and carbon neutral economy. In this respect, the EU's green recovery mustbe based on the EU taxonomy - which aims to encourage investors and consumers to identify economic activities that can unambiguously be considered environmentally “green”. As Europe navigates one of its greatest ever challenges, it cannot afford to neglect how important capital markets will be in aiding its recovery. How banks, authorities and capital markets work together to fund EU businesses will not only determine how quickly it recovers, but how sustainable Europe’s rebuilding will be. Later this year, when the European Commission reviews its priorities for the next phase of the Capital Markets Union – a long-term project intended to unlock funding across Europe - the strengthening of certain criticalareas of capital markets must be top of its agenda. With a global recession on the horizon, EU businesses are going to need to consider every available source of debt and equity capital to bounce back stronger. This opinion was originally published in Les Echoson 4 June 2020
Is Europe doing too little too late again?
15 May 2020
The covid-19 pandemic has led to tragic personal loss and wreaked economic havoc on a huge scale across the globe. On the economic front in Europe, the ECB’s estimates for Eurozone GDP this year range as low as -12%. Governments have rushed to support their people and economies through a wide range of different measures. Central Banks including the ECB have also joined the battle offering lending facilities at ultra-low interest rates and promising secondary market purchases of large amounts of corporate bonds as well as a significant proportion of the €1-1.5trillion government debt likely to be issued this year to pay for national European support programmes. Banks so often blamed for past crisis are now seen as part of the solution to this one and have been enlisted by national authorities to channel some €1.5trillion of Eurozone government guaranteed lending to where it is needed, fast. To help them do this, the flexibility built into the prudential regulatory framework has been triggered allowing banks to draw down on their substantial capital and liquidity buffers. These had been built up after the last financial crisis against such an eventuality as we are now facing. Recognising that scarce human resources might be needed elsewhere banks have also been allowed to postpone certain other obligations and pragmatic solutions have been found to permit markets to continue functioning in the new lockdown environment. More recently the European Commission has sought to provide banks with additional lending capacity by introducing targeted changes to the existing Capital Requirements Regulation. These are a mixture of substantive and timing changes. Amongst other measures, substantive changes have been made to ameliorate the capital impacts from IFRS 9 which governs the accounting treatment of provisioning for prospective credit losses and also allow the exclusion of banks’ holdings of Central Bank deposits from their leverage ratio exposure measure. The EC has also sought to bring forward beneficial measures including the application of favourable capital treatments for software assets and SME and infrastructure lending which were originally slated to come into force next June. The question is are these changes going to be sufficient to furnish banks with enough capacity to provide the support to their customers that is going to be needed in the coming downturn, let alone the recovery? We are not so sure that they will. According to ECB statistics, demand for funding in March - before the full severity of the economic downturn has been felt - was already at a record high with non-financial corporations borrowing nearly €120bn, more in that month than the whole of last year and higher than at any time in the last twenty years. ECB lending surveys point to similar very strong demand in the coming months. Net lending to euro area corporates (EURbn) Source:ECB Euro area statistics: BSI.M.U2.N.A. A20.A.4.U2.2240.Z01.E The ECB has estimated that banks using their capital buffers and changing the capital composition of their so-called pillar 2 requirement will free up €120bn of capital, enough to support €1.8 trillion of additional lending. Yet a quarter of this depends on the banks managing to issue new AT1 or T2 debt instruments and despite a few banks recent foray into the market this will take some time. Moreover, it is far from clear whether this lending capacity is truly new or includes substantial committed facilities which will need to be fully capitalised once they are drawn down and come onto banks’ balance sheets. Banks may also be unwilling to fully run down their capital buffers for fear that this could trigger restrictions in making payments on their AT1 debt which could cause a significant disruption in this market and negatively impact on the availability and pricing of future capital raising. A recent BIS bulletin from the 5thMay also raises questions on the reliability of the estimated lending capacity in the EU. It suggests that in a severe adverse (but in this case realistic) scenario releasing bank buffers would only generate between $1.1 and $2.6 trillion dollars on a global basis suggesting that the capacity figure in the Euro area may be overestimated. It is perhaps not surprising therefore that the ECB’s SAFE survey conducted between March and April this year and which covers expectations for access to finance in the Eurozone in the next six months is sending a significantly negative signal. Businesses expect a sharp decline in bank lending for the next 6 months Expected availability of bank loans according to euro area large firms and SMEs (for the next 6 months) Source:Source: ECB SAFE survey, Question 23. Net (increased minus decreased responses) - Excluding not applicable responses. Horizontal axis shows the month in which the survey was undertaken The other problem with relying on the ECB’s estimate is that it does not appear to take account of the fact that all the extra lending will only be possible if banks have sufficient capacity to finance it under both their non risk based leverage ratio measure and their risk based capital requirements. Whereas under risk based capital requirements banks are not required to hold capital against government debt (including the relevant portions of most government guaranteed loans) this is not the case for the leverage ratio measure which requires such exposures to be included at their full nominal value. As a result, banks wanting to make markets in government debt or advance government guaranteed loans may find that they have insufficient headroom in their leverage ratios to do so. In summary our concern is that the capacity available to banks in terms of capital headroom will be insufficient to meet the demand for it. The solution to this is to make further targeted and time limited changes to the EC’s CRR proposal. We have made several suggestions including ensuring that the benefit from an exclusion of Central Bank deposits from the LR exposure measure is effective now rather than in twelve months’ time. We also think that consideration should be given to the exemption of government guaranteed loans from the leverage ratio for a limited time. Both these adjustments have been made in several other jurisdictions and would strike an appropriate balance between providing banks with additional lending capacity and ensuring their continued robust solvency in the current stressed environment. Regrettably, the need for speedy legislative change and entrenched national positions has led to a reluctance to broaden the proposal currently on the table in the manner required. As has been the case during this crisis, EU Member States, while agreeing the common challenge have struggled to formulate solutions acceptable to all. The last time there was a crisis Europe was, by common consent, both late and timid in its solutions. Let us hope that history is not repeating itself.
The fight against money laundering and terrorism financing: What needs to change?
14 May 2020
While the EU might be embroiled in the struggle against Covid-19, there is another fight ramping up: the fight against money laundering and terrorism financing (AML/CFT). The EU AML/CFT framework has suffered from persistent deficiencies over a number of years, as highlighted by the European Commission last summer in their AML package. Whether it is a high-profile scandal or compliance failings, the EU has faced obstacles in capturing the illegal flow of money across Member States. This has in part been due to the difficulty of harmonising laws across different jurisdictions whose authorities have varying supervisory powers, tasks and responsibilities. However, in 2019, important steps were made to clamp down on the illegal activity. As part of the European Commission’s ambitious proposal to strengthen EU-wide Anti Money Laundering supervision, greater supervisory powers were given to the European Banking Authority (EBA). This has given the institution the power to lead, coordinate and monitor the AML/CFT efforts of all EU financial service providers and competent authorities. Since the expansion of the EBA’s responsibility, there have been important signs of progress. In February 2020, the EBA published a report on national authorities’ approaches to AML/CFT. The report indicated that most national authorities in the yearly sample were taking significant steps to strengthen their approach to supervision. However, the report also noted that not all countries were able to cooperate effectively with domestic and international stakeholders. This includes financial institutions, authorities and law enforcement. This inability to further harmonise the supervisory framework, both internationally and domestically, indicates that there is still work needed to improve how EU AML standards are applied. Currently, the EU’s approach to AML/CFT remains fragmented and struggles to keep pace with new developments, with a fifth version of a directive that acts more as guidance for EU Member States and which is far from being an enforceable rule. One option would be to replace (part of) the current Directive by a Regulation, which would set a harmonised, directly applicable regulatory and supervisory framework in the European Union. It could also give the EBA greater capacity to enforce harmonised AML standards. Additionally, steps need to be made to ensure that the responsibility for harmonising EU approaches does not fall solely on the EBA. Greater information sharing needs to be encouraged and facilitated amongst financial institutions, supervisory authorities and law enforcement authorities. To achieve this, developing a public-private ecosystem within and across Member States will be crucial. Technology could also provide the key to facilitating industry collaboration. For instance, strengthening the coordination mechanism for Financial Intelligence Units (FIUs) could be achieved with a proper use of a single digital system collecting, sharing and analysing information across Member States. This way FIUs could suitably support each other without duplicating their efforts. The EU’s collaboration internationally, domestically, and technologically will be crucial in the fight against money-laundering and the financing of terrorism. If no proper steps are taken now, the EU could find itself with another controversial list of money laundering scandals and the industry criticism that will accompany them. Read our discussion paper for further highlights on how industry collaboration can better strengthen and harmonise the EU’s supervisory framework in the AML/CFT space. AFME Contacts Richard Middleton Managing Director, Head of Policy
+44 (0)20 3828 2709 Hélène Benoist Manager, Advocacy +32 2 788 39 76 Aleksandra (Ola) Wojcik Senior Associate, Policy, Technology and Operations +44 (0)203 828 2734