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Impact of Distributed Ledger Technology in Global Capital Markets
17 May 2023
The Global Financial Markets Association (GFMA) together with Boston Consulting Group (BCG), Clifford Chance and Cravath, Swaine & Moore LLP, have today published a new report highlighting the potential transformative benefits of Distributed Ledger Technology (DLT) for capital markets and calling for market participants to proactively shape its future use, as well as for greater regulatory clarity from policy makers. The report, “The Impact of Distributed Ledger Technology in Global Capital Markets” evaluates the opportunities and risks of DLT and DLT-based securities and assesses the applicability of existing legal, regulatory, and risk management frameworks. To illustrate the potential of DLT in capital markets, the report examines three emerging use cases: collateral management; tokenization of assets; and sovereign and quasi-sovereign bonds. The report finds that DLT could unlock transformative cost-saving and operational efficiency benefits (for example, approximately $20 billion annually in global clearing and settlement costs) and innovation-led growth, broader market access, and new liquidity pools when operating at scale (e.g., approximately $16 trillion global market for tokenized illiquid assets by 2030). Despite the growing momentum in developing DLT use cases, the report also acknowledges that, there is still no widespread adoption in securities markets, with most DLT-based issuances to date largely experimental exercises due to the challenges identified. GFMA therefore sets out five calls to action, for industry participants and regulators, to overcome existing barriers to adoption and advance the development of DLT-based capital markets: · Harmonize global regulatory and legal frameworks for clear and unambiguous definition of the key terms and risk mitigants required to support the development of a transparent, disciplined, risk-focused, and effective digital market infrastructure. · Enable interoperability by building consensus on common standards and vision for DLT-based markets to guide market linkages with traditional market infrastructure. · Drive faster adoption by prioritising resources in asset classes where DLT has the most upside potential to help pool and deepen liquidity, particularly for illiquid assets. · Collaborate on the advancement of DLT to promote technical solutions, including around scalability, cybersecurity and regulatory compliance. · Continue the development of DLT-based payment solutions, such as tokenized commercial bank money and deposits, to facilitate safe and efficient settlement processes. The GFMA has developed an approach to the classification of digital assets that reflects the principle that the treatment of digital assets should be underpinned by a clear methodology for identifying different types of digital assets’ risk. This will allow for tailored regulatory treatment, to mitigate reputational risks caused by conflating different use cases of DLT, as well as promoting legal clarity and confidence for asset managers, investors, and issuers.
European Green Securitisation Regulatory State of Play: Obstacles to growth and opportunities for leadership
12 Dec 2022
AFME has today published a new report entitled "European Green Securitisation Regulatory State of Play".The report sets out a comprehensive overview of the current European regulatory landscape for green securitisation, highlighting the challenges preventing it from fully contributing to Europe’s green transition, as well as the full scale of its potential growth by 2030. The report shows that the European green securitisation market is lagging behind other global jurisdictions, including: In the course of five years, only 24 securitisation transactions with ESG characteristics have been issued. Although Europe is a leading region for green and sustainable bonds, Europe’s green securitisation market remains subdued. For instance, between 2019-2022 green securitisation issuance represented only 1.4% of total European green issuance, whereas it accounted for 8.1% in China and 32.3% in the US. The report also examines the potential scale of future green securitisation issuance by 2030 providing estimates for growth based on data from S&P Global Ratings. The findings are: Residential mortgage loans on energy-efficient properties: Gross green mortgage lending could reach €125 billion annually across eight European RMBS markets, i.e. Belgium, France, Ireland, Italy, the Netherlands, Portugal, Spain and the U.K. Lending for green home renovation: If residential buildings reach a 3% renovation rate by 2030, this could generate an annual funding requirement of about €75 billion, which may partly be addressed by further mortgage advances that are securitisable. This figure assumes a fully-funded typical renovation cost of about €17,000 per property, and considers the same eight European RMBS markets mentioned above. Electric auto financing: In respect of new battery electric vehicles, securitisable financing could reach €80 billion annually, while there could be a further €30 billion in annual financing required for used ones. These estimates concern only the five major European auto ABS markets, namely France, Germany, Italy, Spain and the U.K.
State of Cloud Adoption in Europe: Preparing the path for cloud as a critical third-party solution
6 Dec 2022
AFME and Protiviti have published a new report entitled“State of Cloud Adoption in Europe - Preparing the path for cloud as a critical third-party solution”,outlining four key barriers holding back the pace of cloud adoption within the financial services sector. The reportfinds that while cloud can clearly be an enabler for financial services innovation, some key barriers are currently making it harder for firms to adopt and fully leverage its potential. The paper sets out four key challenges that financial institutions are currently experiencing, including: Concentration of Cloud Services Globally, 65% of Cloud services are provided by just three entities, whose dominance is raising concerns among financial regulators, highlighting the risk of concentration in the Cloud marketplace. Regulatory Complexity Regulatory fragmentation, uncertainty and the time required for regulatory approvals is preventing financial institutions from innovating, slowing the pace of Cloud adoption. FIs are also subject to multiple different regulators that may ask for the same information in different formats and through different channels. Data Localisation The forthcoming EUCS certification framework could have far-reaching negative implications if the proposals to achieve “immunity against third-country law” via EU control requirements are adopted. Management of Disruption in the Cloud Several high-profile Cloud service outages have highlighted the need for greater visibility and confidence in Cloud providers’ abilities to predict, manage and communicate disruptions to their Cloud services. Regulators expect FIs to have primary responsibility for resisting threats to operational resilience, to guard against service disruptions and to recover from incidents. The paper provides nine recommendations for policy makers in order to help address these challenges.
Into The Wild: Why nature may be the next frontier for capital markets
30 Nov 2022
AFME and EY have today published a new report“Into the Wild: Why nature may be the next frontier for capital markets”.The report, published in the lead up to the COP15 UN Biodiversity Conference, explores how finance can be channelled to help address nature loss. With more than half of global GDP dependent on nature, natural capital financing is rising up the agenda for policy makers, investors and the financial services sector. The global biodiversity financing gap has recently been estimated at USD 598-824 billion per annum. While growing investor demand is creating new opportunities to develop nature-related financing products, the report finds banks and other market participants face challenges in mainstreaming and scaling nature finance products. Key challenges include a lack of verifiable data and common metrics for nature and biodiversity. The report also provides an overview of the natural capital finance products currently in the market and showcases a number of case studies of innovative practices currently being used by AFME members. The report concludes by examining the current regulatory landscape and makes five key recommendations for policy developments that can help direct capital towards solutions to conserve and restore nature: Gathering and translation of nature-related data into decision-grade data for financial services; A strong global nature reporting framework; Agreement on how to define measurable, meaningful impact on biodiversity through metrics and key performance indicators (KPIs) Standardisation of product classifications; and Development of a currency for nature.
Research Report: Impact of the SA Output Floor on the European Securitisation Market
22 Nov 2022
This research paper examines the impact on the European securitisation market of the introduction by regulators of the Standardised Approach (SA) Output Floor. This rule change forms one of the final elements of Basel III. It requires that advanced banks, those which calculate regulatory capital based on the Internal Ratings Based Approach (IRBA), hold the greater of (i) IRBA capital and (ii) a percentage of the capital one obtains when the alternative SA is employed. Our findings are as follows: 1. For the regulatory wholesale asset class: i. Corporate securitisations, both for large corporates and SME portfolios, will be largely eliminated by the introduction of the Basel SA Output Floor as currently envisaged. This could contribute to a significant reduction in the availability of bank funding to European firms. ii. Existing transactions done for risk management purpose, especially corporate ones, are likely to fail the EU Significant Risk Transfer (SRT) test applied by supervisors and, hence, will have to be terminated. Some of the negative effects of the SA Output Floors on existing transactions would be substantially mitigated if IRBA banks were required to evaluate EU SRT tests only under IRBA, at transaction level, even if the aggregate SA Output Floor is binding. iii. The impact of Basel and EU rule changes will be felt at a time when securitisation as a capital management tool would likely otherwise be more widely used owing to the rise in capital for corporate lending implied by the SA Output Floor. 2. For the regulatory retail asset class: the SA Output Floors regime will encourage greater securitisation activity in residential mortgage and other retail loan portfolios because the increase in capital for loans held on balance sheet will exceed, sometimes disproportionately, that of securitised assets. These findings suggest that implementation of the SA Output Floors will disfavour one asset class substantially while benefiting another asset class with no clear rationale based on policy priorities or risk sensitivity. This is a consequence of adopting regulatory rules that are not soundly rooted in an understanding of the relative riskiness of different asset classes. While provisional adjustments can moderate some foreseeable effects on securitisation transactions, a more profound reform of the regulatory treatment of securitisation is needed for this financial technique to contribute to the development of the European economy.
Comparing CB, ABS and Corporate Bond Liquidity
8 Nov 2022
This study examines the relative liquidity of Asset Backed Securities (ABS), Covered Bonds (CBs) and Corporate Bonds (Corps). The measure of liquidity that we employ is half the bid-ask spread divided by the mid-price. This equals half the round-trip cost of buying and selling the security per unit of value of the position as reflected in current market quotes. We focus on Investment Grade (IG), GBP-denominated securities and senior ABS. We compare the liquidity of different categories of ABS, namely Simple Transparent and Standardised (STS) versus non-STS ABS. To compare the liquidity of any two categories of security, we compute the cost of an average transaction for all individual securities. For this, we utilise all the observations available on Bloomberg for the period March 2012 to June 2021. Transactions costs are defined as half the bid-ask spread, divided by the mid-price. Key findings are as follows. Mean transactions costs are very similar for AAA and AA-rated ABS and CB. Mean transaction costs for Corps with equivalent ratings to those of ABS or CBs are somewhat higher. Looking at detailed comparisons based on quantile plots, up to 2016, AAA-rated CBs appear more liquid than ABS. From this point in time, however, ABS are more liquid. When all IG ABS are considered, ABS again appear more liquid than CBs post-2016. Although they do appear equivalent in liquidity around the time of the onset of the pandemic. Corps are clearly less liquid than CBs over the whole sample period of March 2012 to June 2021. Corps are more liquid than ABS in 2013 but, thereafter, ABS are more liquid. Comparisons of the liquidity of STS and non-STS are only possible from the end of 2019 when the required data became available. Differences are relatively small. The data suggest that the most liquid non-STS are more liquid than the most liquid STS ABS.
MiFIR 2021 Sovereign Bond Trade Data Analysis and Risk Offset Impact Quantification
13 Oct 2022
AFME and Finbourne Technology have published new data on EU sovereign and public bond trading highlighting the importance of a carefully calibrated deferral regime. Among the key findings are: There is a high degree of trade transparency in EU sovereign bond markets, especially when compared to corporate bond markets, with a significant majority of EU government bond trades (76%) currently being made real-time transparent (compared to 8% of corporate bond trades). However, the quality of the sovereign data set is materially worse than the corporate bond data set due to a high level of distortion caused by the inconsistent use of some flags, among other issues. This needs to be addressed by ESMA. The majority (60%) of government bond-related trades on EU venues are non-EU bonds from the US, UK and other countries. This means it is currently hard to have a clear view of the trading of EU-based issuers with the large amount of trading in the EU by non-EU issuers clouding the picture. AFME believes improvements could be made, for example, by narrowing the scope of MiFIR trade reporting to only cover EU-issuers, which would then be the basis on which deferrals should be calibrated. This re-focus would further support an EU fixed income consolidated tape focused on EU markets. Trade out times (the time it takes for a bank to move risk off its balance sheet) vary significantly for various issue and trade size categories, ranging from a few minutes to well over a year depending on the issue and trade size category.