www.eurofi.net VIEWS THE EUROFI MAGAZINE APRIL 2021

JOÃO LEÃO Minister of State for Finance,

We must spare no efforts until we achieve a sustainable and inclusive recovery

M. CENTENO Building upon the integration leap we experienced with the crisis

M. MCGUINNESS Strengthening the European financial system after and the Covid crisis

A. ALDER Key issues for global regulators post-Covid VISIT OUR WEBSITE WWW.EUROFI.NET

for our latest publications on the conditions for relaunching growth post-Covid and on-going trends and policy developments in the financial sector

EUROFI POLICY NOTES

PUBLIC AND PRIVATE SECTOR VIEWS THE EUROFI VIEWS MAGAZINE

APRIL 2021

This bi-annual Views Magazine comprises contributions from a wide range of public and private sector representatives on the challenges and conditions for relaunching growth post-Covid, on-going industry trends such as digitalisation and ESG and key on-going policy initiatives in the financial sector. EDITORIAL & OPENING INTERVIEWS

1. POST-COVID CHALLENGES AND PRIORITIES

Post-Covid economic and financial priorities ...... 30

EU Recovery Package implementation ...... 34

Fostering more investment in the EU ...... 42

2. FINANCIAL RISKS AND STABILITY CHALLENGES

Key financial sector vulnerabilities...... 52

Lessons from Covid on Non-Bank Financial Institution (NBFI) risks ...... 60

EU Anti Money Laundering (AML) policy redesign ...... 68

3. GLOBAL OUTLOOK

Global fragmentation ...... 74

Post-Brexit prospects ...... 78

4. BANKING AND INSURANCE REGULATION

Challenges faced by the EU banking sector ...... 86

Basel banking standards evolution ...... 96

Policy priorities for the EU banking sector ...... 102

EU Bank crisis management framework ...... 108

Solvency II review ...... 114

Insurance sector global issues ...... 122

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5. FUTURE STEPS OF THE CMU

New CMU action plan ...... 130

AIFMD and ELTIF reviews ...... 138

Retail investment ...... 144

Equity funding ...... 150

Securities and derivatives clearing ...... 154

Securities post-trading ...... 158

Consolidated tape and single access point ...... 164

Relaunching securitization ...... 170

6. DIGITALISATION AND PAYMENTS

Digital Finance Strategy ...... 176

Financial data space and cloud infrastructure ...... 182

Adapting the financial framework to digitalization ...... 186

Crypto-assets and stablecoins ...... 190

Cross-border payments global roadmap ...... 194

EU retail payment initiatives ...... 198

7. ESG AND SUSTAINABLE FINANCE

ESG global and EU standards convergence ...... 208

EU sustainable finance taxonomy ...... 216

Climate-risk implications ...... 222

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 5

EDITORIAL

CHALLENGING TIMES FOR THE EU AND ITS FINANCIAL INDUSTRY

The April 2021 Eurofi High Level Seminar organized virtually in association with the Portuguese EU Presidency and the publication of this Magazine are taking place at a particularly challenging time, since the pandemic is not over in the world and in .

The responses to the Covid-19 crisis, how to relaunch growth in the EU and the role that the financial sector may play in this regard will provide major topics of discussion during this event and this Magazine offers a wide range of views on the related challenges and opportunities.

The “Next Generation EU” Recovery plan in particular is a significant step towards more fiscal cohesion and solidarity, but money alone will not ensure recovery. One particular challenge at this point in time is the relaunching of productive investment DIDIER CAHEN and sustainable growth in the EU. Indeed, major investments are needed for supporting the post-Covid recovery, the EU Green Deal and digital transformation. However real growth and productivity gains in the area have failed to catch up with the US, China and Japan over the past two decades and lasting low interest rates develop a preference for liquidity over productive investment among potential investors.

Potential risks to global and European financial stability are another challenge. Near term financial stability risks are contained by massive monetary, fiscal, regulatory and supervisory support. But we are not out of rough waters. At the top of the list of threats lie high levels of public and private debt in a number of Member States, which cannot be alleviated by monetary policy. In addition, pushing too hard and too long on the monetary pedal may generate further vulnerabilities and eventually create the conditions for future crises. More structural policies are also needed in order to enhance fiscal sustainability.

In terms of opportunities, major EU initiatives launched before the Covid crisis, such MARC TRUCHET as the Banking Union, the , the sustainable finance taxonomy and new initiatives such as the Digital Finance Strategy have the potential to provide the EU with the vibrant for financial services that is needed for funding the EU economy. However, these projects still need to become a reality. How to implement these initiatives in an effective way will be at the centre of the discussions of this event.

In preparation for these debates, the Eurofi secretariat has prepared several papers on these issues that can be found in the April 2021 issue of the Eurofi Regulatory Update and the speakers participating in this event have been invited to express their views on these questions in this Magazine.

We are grateful to the 180 public and private sector representatives who have provided us with input on these issues, and we are sure that you will read their thoughts and proposals on these challenging questions with great interest.

JEAN-MARIE ANDRES EDITORIAL

DAVID WRIGHT President of Eurofi

Sadly, it is not possible for EUROFI to meet in person in Lisbon more than such bold policy making in these exceptional, given the prevailing pandemic situation in Europe. However, stressful times. Citizens will witness an EU evidently on- it will not prevent us from having many thought-provoking the-move; investors will see and seek more opportunities debates virtually as at our previous event in Berlin and, as to invest; EU leadership on sustainable development will be usual, it will be a very busy and intense two days and a half. assured; uncertainty about the EUs’ near-term future will decline, confidence will grow and European identity will be I would like to thank the Portuguese Presidency for their strengthened. The key ingredient needed is political leadership excellent cooperation and assistance in helping this and much more of the solidarity that delivered the impressive event and our EUROFI members and partners for continuously European Recovery Programme. supporting our unique events which is thoroughly appreciated. We have over 200 distinguished speakers from the public and What are the vital areas to accelerate? I have five to suggest: private sectors participating this time all of whom I also thank for their dedication, their time and their effort. And we are 1. Vaccination expecting over 1000 people to be listening to our debates. This of course depends on supply where there have been My message for this edition of the EUROFI meeting is simple. evident difficulties but assuming the supply situation will It is this. Given the gravity of the health, economic, financial, improve over the spring and summer the inoculation process environmental and social challenges facing the European should be 24 hours a day, around the clock, the equivalent Union we have to accelerate decision taking now across of top military planning with fair dosage distribution to all the board. What Philip Stephens of the FT has described as Member States. This is essential for economic recovery and the the continuance of “...defensive incrementalism...” is simply return to normalcy. inadequate to deal with the size and multitude of the tasks the faces today. Piece by piece, drip by drip 2. Banking Union policy making, surely, we cannot meander timelessly along as if we are in normal times which can only result in the European How many more years will be needed to complete the job? Union falling further and further behind the United States, These delays are seriously hampering the structural reform, China and other Asian countries in the global development scaling up and competitiveness of European banks who provide and competitiveness stakes. This is what is happening. The the vast bulk of European corporate and consumer financing. A United States, for example, is projected to grow twice as fast as delivery date should be set. the EU this year, possibly even more. Banks must also prepare and provision responsibly now for the Of course, I do not advocate not respecting our Treaty expected increase in NPLs expected in the months ahead as based and National democratic processes, not at all. What public COVID support measures taper off. I am advocating is material, substantive acceleration, using emergency procedures where available, fixing trilaterally 3. Capital Markets Union between the , and ambitious dates for delivering the necessary The Commission has a good new 16-point plan on the table. policy measures and rigorously tracking the delivery of them. But the December 2020 ECOFIN Council conclusions only Nothing in my view could galvanise the European Union state that about 1/3 of the measures are priorities for the

8 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net A MESSAGE FROM THE EUROFI PRESIDENT

DAVID WRIGHT President of Eurofi

Commission to make a proposal on by the end of 2021. The 5. Sustainable development rest are on even slower timeframes - some are “medium term”, like making progress on insolvency procedures or simplifying The EU has carved out impressive leadership on many aspects withholding tax administration which investors always point of sustainable development and the future green economy. But to as hampering and seriously damaging EU capital market more actors are entering the scene so the EU needs now to development. cement its policy leadership quickly - on disclosure rules, the application of the ESG parameters, sustainable finance, green In short this is all too slow after years of stasis. And it really bonds and its essential, impressive taxonomy work. As in many does matter because the European Unions’ laudable top policy areas, many countries in the world will want to follow the political objectives - leading on sustainable development and EU if its standards are timely and the best in class. The EU must the green economy, digital renovation, massive infrastructural seize this immense opportunity and not let it slip from its grasp. investment, pension reform and social cohesion, CANNOT be delivered without a vibrant ecosystem of EU capital Finally, BREXIT markets, integrated and local. This is what is at stake. In the last few weeks alone, continuing the trend of decades, we have Sadness is hardly the right word to describe the deteriorating seen some brilliant, new, dynamic SMEs founded by some state of relations between the EU and the . It outstanding Europeans from different Member States head is urgent, politically and economically to stop this dangerous off, once again, to the U.S to list or to seek big amounts of bickering which is already causing some serious collateral development capital. With it goes the business and European damage and to settle down rapidly to cooperative decision- intellectual property. These new frontier SME businesses must making based on trust, confidence and in full conformity with be developed in the EU in the future, many on public markets, the Trade and Partnership Agreement negotiated. Including on to become world-beaters. financial services where a policy vacuum is neither healthy, nor will facilitate economic growth, nor help spread new economic Real CMU should translate also logically into reviewing the hub opportunities to all segments of society. and spoke distribution of regulatory and supervisory powers between the ESAs and National Competent Authorities, I favour an open, predictable approach to building Capital including the enforcement needed for a single rulebook. Markets Union but one which ensures that the real, potential systemic risks to the EU are managed inside the EU and the 4. Post Covid structural reform same for the United Kingdom. I believe this approach will result in the quickest and best CMU possible drawing on Building on rigorous Member State plans to deploy efficiently optimal international best practice and encouraging inward and urgently EU Recovery Funds, a continuous effort has to investment into the EU. be made for many years thereafter to build Member state economic resilience, sustainable control of public expenditure, Finally, I do not think future EU-U.K. financial services relations along with a renovated growth and stability pact that can be built solely on the recently negotiated MOU and 2 way, needs to be respected at all times by all EUROZONE members. independent equivalence determinations. More certainty EUROFIs’ distinguished Honorary President Jacques de is needed and more imagination, including consideration Larosière has commented elsewhere in this edition on these of a longer-term, cooperative Treaty based solution in the crucial policy issues. economic and financial interest of both sides.

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 9 OPENING INTERVIEWS

Q&A JACQUES DE LAROSIÈRE Interview of Jacques de Larosière conducted by Didier Cahen on 30 March 2021

Views on the responses to the Covid-19 crisis

A little over a year ago, China sealed off the city of - Some advanced countries that have seen their GDP fall sharply, by around 10%, include (-8.2%), (-8.9%), Wuhan. This was the starting point of an exceptional (-11%) and the UK (-9.9%). global health and economic crisis. One year later, - Other advanced countries that have experienced a decline half what is your perspective on this crisis? as strong, such as (-5. 3%) and the United States (-3. 5%).

- And emerging countries, with GDP down 2.4% apart from It is a crisis that has been exacerbated by our unpreparedness. China, the only major country to have maintained some Many expert reports had been highlighting the high probability growth last year (+2.3%). of a pandemic for decades. But short-term concerns prevailed over long-term ones. We had not taken any preventive For the year 2021, there are still too many uncertainties to measures. As a result, we have approached this crisis like all make solid forecasts: mutations of the virus, effectiveness and the other major health crises in history, including the Middle distribution of vaccines, social reactions, etc. But economic Ages. With the same tools. The focus was on trying to contain activity will generally remain below the pre-crisis level in 2022, the risk of contagion, confining the population as much as or even 2023 for the most vulnerable countries. However, possible, managing the availability of hospital beds even if it taking official forecasts projected growth in the U.S this year means arresting the economy. will be nearly twice that of the EU.

This extraordinary crisis has been treated not in an extraordinary way but mostly in an ad-hoc way like a crisis of the past. That said the scientific community has reacted Why has the economy suffered so much more impressively fast to develop vaccines, but their distribution is in some countries than in others, now provoking some ugly nationalism and greed. notably emerging ones?

Can we measure the damage caused to the world For one simple reason. Although emerging countries have economy at this point of time? taken advantage of globalization to expand their exports, they are less integrated into globalization, and the virus has often been less prominent or percolating in their countries. They have also been protected from a very different “virus” attacking Again, we reacted because we had not sufficiently acted advanced countries: financialization. preventively. Many companies stopped trading, with very high economic cost. The State has stepped in to pay workers. We Over the past 30 years, credit has grown faster than business, have an unprecedented budgetary shock, commensurate with a development that will eventually be understood to be our unpreparedness. Overall, global GDP has fallen by almost dangerous. Emerging and developing countries have not had 3.5% in 2020, according to the latest OECD estimates (March the luxury of catching this “virus”, as markets do not lend 2021), with three groups of countries: money easily to them.

10 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net Q&A JACQUES DE LAROSIÈRE

Why is the economic performance different between of zero-interest rates. We must therefore stop advocating an indefinite period of zero interest rates if we want to revive advanced countries, such as Germany and France, economic growth. History (notably during the 19th century) as well? shows that growth always implies work and the remuneration of risks: Adequate remuneration for risk is of the essence for fostering long term investment. Fiscal policies can also be used to promote investments for the future (research, Germany is an industrialised country, France a country in infrastructure programmes, …) but to do so, it is necessary to the process of de-industrialization. In 20 years, the share of have the means to do so, i. e. to reduce non-productive current manufacturing industry in France’s GDP has fallen from 15% public expenditure. to 10%, while it has remained at almost 25% in Germany. In a pandemic crisis, however, an industrialized economy is We must stop this psychodrama of so-called austerity, which more resilient, relying on cutting-edge technologies. This is is said to have weakened certain States of the Union. In fact, it not the case with a service economy, which has been affected is the fiscally virtuous countries that have best prepared their by a shutdown of normal neighbourly activities, such as economies for the challenges of the crisis. tourism in all its forms: airlines, hotels, hospitality industries etc with major knock-on and negative economic multipliers. We can see how much the policy, particularly in Germany, of Because of de-industrialization, de-specialization, distribution reducing the public debt-to-GDP ratio to the level prescribed rather than production, the Covid crisis has accelerated the by the Maastricht rules, has paid off. Starting with 60% of weakening of the French economy – the consequence of “forty public debt, compared to more than 100% in other countries, years of bewilderment.” Germany has been able to embark on a massive programme of aid to the economy while its neighbours did not have the same margin for maneuver. Furthermore, the German economy is projected to return to its pre-pandemic size much sooner this What role does the pandemic play here? year than for example Italy and Spain.

In countries with too much debt, decisions must now be It is a triptych revelator, accelerator and eye-opener. made to stop « heads in the sand » syndrome and to reduce, sustainably, unproductive and inefficient public spending. Let’s take the case of France: on the soft pillow where we This is the only way to release the necessary resources to too often rest, we were under the impression that we had an the productive sector. Such fiscal policy requires a spirit of economic system capable of withstanding any exogenous shock cooperation among the different political parties and on a bi- having a very efficient health system. The coronavirus has been partisan basis, and examples abound in the Northern European a rude awakening. Secondly, it is an accelerator, because the Member States. epidemic affects have impacted less on a healthy economy than on an obese one. With a public debt of around 100% of GDP and a ratio of public spending to GDP of 54% at the end of 2019, France is in the obese category compared to Germany at 60% As in 2008, central banks have been at the forefront of and 44% respectively. It is the condition of the patient before this crisis. Have they performed well? the pandemic struck that is important.

I have said for a long time that the excessive issuance of money How can we explain that EU countries have suffered is leading us to an unsustainable situation. If interest rates are more from the crisis than the US and China and are to remain at zero for an indefinite period of time, a depressed view of society is created. Let me explain: few people have slower to get back on track? noticed it, but for several years now, productive investment has been collapsing. Why, when you can borrow money for nothing? The reason is investment project managers are discouraged Indeed, the economic crisis is more severe in Europe than in from investing in a zero-rate environment synonymous with the US, and China which are now bouncing back more strongly low growth; they tend to focus on remunerative, buy-backs than in the EU. China quickly contained its health crisis with and speculative assets. fairly radical methods. As for the United States, the economy remains very flexible and the State has been very active in its Moreover, as a result of zero interest rates, household savings federal interventions (including vaccination). in Europe have shifted to liquid, non-risky assets, mainly bank accounts. This makes perfect sense when making investments no longer earn any interest because of zero interest rates and taking into account that retail savers in Europe are risk * adverse. This is what Keynes already called the “liquidity trap”. The decisions made have resulted in no longer remunerating investor risk and so turning away from risky long-term projects. How can we encourage a return to healthy growth in a Today’s monetary policy makes tomorrow’s economic decline. zero-interest rate environment, in European economies A society that no longer invests is a society with no future. that are often over-indebted? What role for monetary The accumulation of very high public debt, negative interest and fiscal policies? rates and massive repurchases of public and private securities against the backdrop of an accelerating ageing population has been experienced for many years by Japan (47% of outstanding A priority is to re-establish financial markets that function on public debt is held by the BOJ), which shows that it is the basis of market forces and not according to the prescription inseparable from a sharp fall in potential growth.

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 11 OPENING INTERVIEWS

You have previously emphasized the dangers of Another disadvantage is that the natural result of money creation in an environment of over indebtedness and monetary policies that remain accommodative for depression due to the prospect of zero interest rates for a very too long. Can you remind us of those dangers? long time, is the spiking of financial assets, not real assets.

The impact of excessively accommodative monetary policy Could the monetisation of public spending by central - with interest rates at zero or even negative for a long time banks, if not accompanied by a control of public spending - on the stability of the financial system is unfortunately too well documented: by Member States, lead to a break-up of the euro zone?

- enhanced incentives to borrow more and increase financial leverage; - weakening of the banking system; What threatens the break-up of the zone is the disparity of the eco- - deterioration of the accounts of pension institutions whose nomic policies and performance of the Member States and their liabilities remain subject to contractual obligations but whose lack of coordination. The Covid crisis is amplifying these dispar- fixed-income assets no longer yield sufficient returns; ities between northern and southern members of the Eurozone. - proliferation of zombie companies in an environment where interest rates no longer play their necessary, selective “quality This is something which is very obvious and is connected with signaling” role; the structure of economies, the weight of the services sector, of - a strong disincentive for governments to undertake structural tourism, or the average size of companies. Another additional reforms since borrowing “no longer costs anything”. element is the fact that the fiscal space available was different in every country at the start of the crisis. Let us not underestimate the importance of this loss of benchmarks - zero interest rates blur risk premiums (one This heterogeneity, these structural fault lines are bound to of the characteristics of the 2008 crisis). In such a monetary increase with the further increases in public spending during environment, the market does not play its allocative function this crisis. If Member States whose public debts are already among different types of assets due to the massive asset excessive do not make a more serious effort to reduce public purchase of the central bank. Indeed, the universal buying expenditure not justified by imperative and urgent needs, the of sovereign securities eliminates the normal functioning of problem of the Eurozone’ centrifugal forces can only worsen. market forces between savings and investment and brings interest rates to levels close to zero which, as we have already For the time being the ECB equalizes interest rates through seen, encourages the holding of liquidity to the detriment of very heavy interventions. But if structural reforms are not productive investment. implemented in the “southern” countries, it will be difficult for the Central Bank to intervene forever, which should not be How can free markets assess value in these conditions? How allowed by the . do productive economic projects distinguish themselves from sheer, speculative financial profit opportunities in the search for investment capital? What mechanisms can Europe use to correct the growing heterogeneity of economic performance And regarding financial stability? between euro area countries?

The present situation does not augur well for financial stability. The Next generation EU recovery package is a significant fiscal deal and a welcome EU step forward. But the EU mechanisms The Financial Times has recently reported that “the riskiest to correct this growing heterogeneity remain limited and borrowers in corporate America are making up their largest the name of the game for mitigating the risk of further share of junk bonds sales since 2007. From the start of 2021, economic divergences will remain national. It needs to be more than 15 cents of every dollar raised in the US high-yield implemented quickly. bond market have been issued by groups with ratings of triple C or below”. And I would add that, according to a gauge of This means implementing structural reforms to strengthen produc- “cross-asset complacency” from JP Morgan, investors are tivity and lift potential growth rates, mitigating failures of healthy feeling the least fearful and most complacent since the dotcom firms, ensuring a smooth re-allocation of resources, improving the bubble. This sounds familiar and should be taken seriously by functioning of markets and public administration, reorienting fis- those who are responsible for monetary stability and still feel cal policies towards sustainable and digital investment…. comfortable with the present monetary expansion.

A monetary policy that massively increases indebtedness as a response to insufficient inflation accumulates all the When should the ECB prepare the markets for a disadvantages: it is paradoxical to hope that inflation normalisation of its monetary policy and what are the (“business”) will take off again not so much on the basis of favourable economic expectations but as the result of even expected benefits? more public and private debt. However, given the extremely high levels of this debt, it is illusory that an additional dose of over-indebtedness will result in an increase in investment Once the health crisis is truly under control, the ECB must projects. This could lead to an increase of delinquencies and prepare the markets for a gradual normalisation of its through a contagious “Minsky process” to broader contagion. monetary policy.

12 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net Q&A JACQUES DE LAROSIÈRE

Central banks would become more flexible and would regain At what point should Member States withdraw the room for manoeuvre: public opinion would begin to realise that zero interest rates for an indefinite period (perhaps a decade exceptional fiscal support that has been granted or two) would become unrealistic; in so doing, the illusory to companies and households? What precautions dynamic: “zero interest rates for an indefinite period, supposedly a factor in the recovery of investment” would be replaced by a should be taken in this regard? more effective and more traditional paradigm: “the markets remunerate savings invested over the medium and long term in accordance with the supply of, and demand for, capital”. Given the scale of the recession caused by the pandemic crisis and given the direct and extensive role played by Finally, financial stability can only benefit from such a governments in supporting companies and activities, this normalisation of monetary policy because asset bubbles should budgetary support will have to be maintained for some tend to stabilise or shrink. time. But the quality of expansionary fiscal policies must be improved without delay. The continuation of excessive current expenditure appears very dangerous.

Does such monetary normalization require a revision A public debt rate of 120% does not have the same effects of the inflation target of the central banks? if it covers current expenses or if it finances productive investments that will generate future revenues. In the first case, the budget sinks into cumulative deficit. In the second case, the deficit eventually stabilizes or even narrows in line Indeed, central banks should relax their inflexible inflation with investment income. targeting of 2% inflation, assuming that it has been below its target in recent years, as break-even inflation is more likely to The sustainability of public finances requires that fiscal be around 1%. policy really should take into account this improvement in the quality of public expenditure in the coming years. This Failure to meet the 2% target should no longer be an excuse criterion should be a guiding element of the reform of the for mechanistic monetary easing. It should also be clear that Stability and Growth Pact (see below). the systematic purchase of bonds should not become a means of enabling governments to finance large stimulus packages without ex-ante conditions, including spending efficiency. How can Member States and the financial sector increase equity support for highly indebted but Wouldn’t such a normalisation of risk lead to viable companies? a bond crash?

A broader concern in all EU economies – and in particular in France and the - is the high level of debt, Such a normalisation can only be gradual and explained to the especially corporate debt, with private sector debt service markets. Moreover, they seem to have understood this before burdens at or above their level during the global financial any explanation. The increase in long-term interest rates crisis despite historically low nominal interest rates. remains very modest to date. Although some firms have used borrowing to build up sizeable cash buffers since the onset of the pandemic, high leverage could moderate new investment. According to the Shouldn’t such standardization be agreed OECD, the debt service ratio of the private non-financial at an international level? sector of adjusted sector gross disposable income is 22% in France, 15% in the US and 10% in Germany.

Two cases will arise: companies whose business model are Of course. This is an essential part of the success of the very seriously threatened and who are unable to assume operation. All monetary policies are interconnected, exchange their debt and, secondly, companies whose fundamentals rates react immediately to changes in interest rates: in order offer hope. to avoid the “beggar thy neighbour policy”, international cooperation is needed, as was the case until the 1990s. For the latter, it will be necessary to provide for the transformation of debt into equity (equity loans and investment funds with a guarantee for investors). For the former, it will be necessary to carry out structural transformation (mergers and acquisitions) or liquidations. * A pan-European system for dealing with these companies in difficulty under current conditions should be established, including for NPLs.

Another essential policy ingredient is a fully functioning Eu-wide banking and capital market. In the EU, these projects like banking and capital markets Union are moving too slowly hampering the emergence of a more dynamic economy able to finance more flexibly and quickly companies and individuals.

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 13 OPENING INTERVIEWS

What is the future for the Stability and Growth of 3% of GDP to be normal, regardless of the quality of the expenditure. This has led Europe to tolerate deficits that Pact (SGP)? Should it be reformed before it can be have essentially financed current expenditures that have implemented again? When should we consider a return no capacity to generate future revenues. It is time to focus on public investment spending that creates future revenues to these rules? and that balances the equation in the medium term. This requires a strong shift from the present situation where public investment is only a tiny part of public expenditures. We can always envisage improvements, but the reality is unfortunately very simple: when the percentage of GDP The quality of public spending should be an important devoted to public expenditure is too high, it must be criterion for assessing fiscal policies. Countries that tend reduced and brought closer to the average of the eurozone to perpetuate very high ratios of public spending to GDP if we want to achieve a degree of homogeneity in budgetary should be discouraged from doing so, and these Member performance, which is essential for the proper functioning of States should be encouraged to maintain investment any monetary union. spending for the future.

It is all the more important to strengthen the common discipline We have to recognize that this shift towards more the system has put on the backburner during the crisis. Those productive public investment will require very substantial rules are the cement to keep together the eurozone [and let us political effort because presently public investment be honest they have never been properly applied]. only accounts for some 4% of GDP while current - non productive expenditure - represent almost all public As long as it is not sufficiently understood, notably in indebted expenditure. So, in order to make room for a significant countries (France, Italy, Spain etc), that excessive debt is a improvement of public investment, we will have to reduce source of under-competitiveness, the economic situation in in parallel the overwhelming share of current expenditures. these countries will continue to deteriorate. Only domestic structural reforms can resolve structural issues and increase In order to achieve the two objectives above, ie primary surplus productivity and growth. It is an illusion to try to solve the and shift towards public investment, a set of EU mechanisms structural problems of our economies by prolonged increases will be required. We need to establish, country by country, the in public or private debt or by using money creation. Yet this is appropriate levels of primary surplus and rigorously monitor what has been too often tried by pursuing lax fiscal, monetary the progress towards a better quality of public expenditure. and political policies that will inevitably pose systemic risks to financial stability and therefore to future growth. c)  Put in place early warning mechanisms to prevent unsustainable public finance trajectories: a country whose share of public expenditure reaches record levels in relation to the European average should be subject to Do the rules of the SGP need to be amended special discipline: it is more serious to have 54% of public (3% deficit, 60% public debt compared to GDP) or expenditure/GDP (before Covid) when the European average is 8 to 10 percentage points lower than to have completed (e.g. with a rule regarding the evolution of public debt above 60%. public expenditure in relation to GDP)? Of course, all of the above could be completely unimplemented, as was the case with the old rules of the Stability and Growth When the facts are proven, some ratios, notably the 60% public Pact. The sanctions originally provided for were never debt/GDP ratio, appear to be problematic. Firstly, they have implemented. If this drift were to continue, we would end up not been respected in the past and secondly the heterogeneity making the virtuous countries pay for the slippage. This is the of Eurozone economies do not fit well with single ratios. The definition of a non-cooperative game where most players try following are some guidelines that could inspire reform: to avoid their obligations by shifting the cost to those who observe them. (a) For countries with debt levels of 100% or more, it is essential to maintain their ratings, which requires that If this were the case, the logical result would be an inevitable, public debt be stabilised. The way to do this is to achieve a major, new crisis of the euro zone. primary surplus (without taking into account the interest on the public debt) as a number of European countries such as Italy understood before the crisis.

This is important because the markets are probably guided more by dynamics than by absolute numbers in determining country spreads. The economic literature has shown that non-resident investors are extremely sensitive to the slope of government debt. However, if we accept that monetary policy will not always be there to buy all the new sovereign issues, it will be imperative to reassure the markets by gradual fiscal normalisation policy. From this point of view, the updated rules should include special monitoring of the primary balance by prohibiting primary deficits.

(b) Insist in these future rules on the importance of the quality of public spending, as Mr. Draghi emphasised in his Rimini speech. We have become accustomed to considering a deficit

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ECONOMIC AND STABILITY CHALLENGES Covid crisis : impacts and responses Economic and Monetary Union Monetary policy impacts International role of the euro Financial stability Indebtedness EU financial sovereignty

FINANCIAL POLICIES CMU 2.0 Asset Management framework Securities trading and post-trading Relaunching securitisation in the EU Banking Union Brexit & Third-country arrangements CEE region funding challenges

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Q&A JOÃO LEÃO Minister of State for Finance, Portugal

We must spare no efforts until we achieve a sustainable and inclusive recovery

What are the priorities of the Portuguese What are the main implications for the financial sector of EU Presidency in the economic and financial area growing public indebtedness in some Member States? for facing up to the economic crisis? When should the Stability and Growth Pact be restored and does it need reviewing once the crisis is over?

More than one year has passed since the COVID-19 outbreak, and the pandemic continues to take a toll on our lives and The financial sector has played a key role in mitigating the economies. Europe’s resilience has truly been put to test. The economic impact of the pandemic crisis. Banks went from widespread uncertainty and extreme vulnerability created being part of the problem in the previous crisis, to being the need for unified action. The EU did not fall short of part of the solution this time around. We intend to keep it its obligations. We have stood strong in our coordinated this way. The broad-based support measures adopted have response to fight against the unbearable social and economic indeed intensified the interlinkages between sovereigns, the losses of this crisis. Our work is, however, not done yet. financial and the corporate sectors. Banks enter this crisis much better prepared than last time around: better capitalized We must spare no efforts until we set the grounds for a and in a better liquidity position. Now, we face the risk of sustainable and inclusive recovery. Now, more than ever, we non-performing loans increasing markedly with the gradual must keep a united front. Coordinating our policies will be of unwinding of support measures. essence. We must keep emergency support measures for as long as necessary. We believe, however, that with coordinated well-thought policies we can maintain a virtuous cycle between sovereigns, Once the health situation allows us to alleviate social banks and firms. Keeping targeted support for as long as restrictions, we should pursue timely targeted temporary necessary will be crucial to avoid insolvencies, and the measures towards the most vulnerable sectors, together with activation of the General Escape Clause has been providing us growth-enhancing policies. A key instrument in this common the needed flexibility to do so. On the other hand, the Next endeavor will be the Recovery and Resilience Facility. Generation EU funds are the cornerstone that will allow us to kick-start our economies without burdening further our public The Portuguese presidency is determined to deliver a timely finances, decoupling sovereign’s public indebtedness from the implementation of the Recovery and Resilience Facility and capacity to promote growth-enhancing policies. the swift and smooth approval of as many Recovery and Resilience Plans as possible. These plans represent a unique These vulnerabilities and interdependencies also make the case opportunity for growth-enhancing investments and reforms for the need to strengthen the EU architecture, including the that will create jobs, while supporting the green and digital need to rethink our fiscal surveillance framework, to become transitions. Now is the time to make our efforts reach the real better prepared for the challenges of tomorrow. We will have to economy. Indeed, the motto of the Portuguese Presidency is: reflect on whether our current framework remains fit for purpose “Time to deliver”. We want to deliver a fair, green and digital in a post-COVID 19 world. We must take into account member recovery. This is our top priority, around which we will state’s high debt levels, after two unimaginably large economic organize all our efforts. recessions, as well as the lasting low interest rate environment.

16 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net Q&A JOÃO LEÃO

We need a transparent Stability and Growth Pact that increases need for a coordinated European approach. To increase EU’s both public awareness and national ownership of the rules. sovereignty, we need sound coordinated policies, like the ones These rules should guarantee sound public finances, while taken at the outset of this crisis. The pandemic pushed us to protecting productive investments and pushing for improved consolidate the European project at an unprecedented speed. quality of expenditure. We should capitalize on our efforts during this last year and continue the work towards a more integrated and resilient EU.

Another key priority to reinforce our strategic autonomy What are the priorities of the Portuguese EU is to strengthen the international role of the euro, which is Presidency in the area of private risk sharing? What closely interlinked with the EU architecture. Indeed, to make progress can be made on the Banking Union and the our currency even more attractive to investors and boost its global usage, we need to deepen further the European Capital Market Union by the end of June? Monetary Union, by making further progress on the Banking Union and the Capital Markets Union. In its turn, a strong euro can add resilience to our financial sector and to the European Monetary Union. The issuance of large amounts The current crisis makes the case for a fully-fledged banking of euro-denominated bonds under the Recovery and union. Its completion should be part of our efforts to ensure Resilience Facility will also represent a key milestone for the a sustainable recovery and to increase the resilience to future EU capital markets. Hopefully, the issuance of green bonds shocks. Although the completion of the banking union is under this instrument will reinforce the euro as a reference anything but straightforward, the Portuguese presidency is currency for sustainable financing, while also strengthening working on advancing discussions on the holistic approach, in the EU’s position as a key global player in the fight against particular, regarding the European Deposit Insurance Scheme climate change. and crisis management.

Simultaneously, advancing the work on a well-functioning and integrated Capital Markets Union is also critical to support the economic recovery and is closely linked to the digitalization of the economy. In this regard, we will strive to advance the discussions on the Digital Finance package which will contribute to boost innovation and competitiveness in the financial sector. We are aiming at making substantial progress on the Commission’s regulatory proposals for crypto assets, hopefully to reach an agreement at the Council.

Is ensuring the financial sovereignty/ independence of the EU a relevant objective in the current macro- economic and political context (e.g. Brexit) and if so what does it imply in terms of public policy?

Strengthening the financial sovereignty of the EU is key, even more so, in the current geopolitical landscape. The pandemic crisis has highlighted both the importance of autonomy and the

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 17 OPENING INTERVIEWS

Q&A MÁRIO CENTENO Governor, Banco de Portugal

Building upon the integration leap we experienced with the crisis

What are the implications of prolonged monetary reserves, whereby a multiplier of required reserves is exempt from the negative deposit facility rate. All in all, it is conceivable policy easing in terms of financial stability? that adverse side effects will tend to become more manageable, no matter for how long monetary accommodation persists.

Given the pandemic’s abrupt, intense, persistent and A generalized backtracking in monetary policy may be ill- asymmetric effects on economic activity it has justified advised. Assessing the precise frictions that are at work, fine the adoption of massive and timely policy support. These tuning the monetary policy instruments in view of those frictions measures redistribute, across agents and over time, the costs or suggesting a relevant role for other policies seems more of the pandemic. This is easier to implement this time because adequate. At the time of evaluating the success of our policies, we have abundant liquidity and no moral hazard concerns. it is perhaps useful to imagine the counterfactual scenario However, risks persist and have even been magnified by without a strong monetary response, both conventional and the crisis; its asymmetric nature. The policy action should unconventional. In this case, the materialization of a disruptive proceed, now more targeted, in order to minimize this impact, scenario would be ever more likely, making the potential trade- allowing for an appropriate adaptation and phasing-out of offs we now face quite limited when compared to the existing measures. losses incurred in such scenario.

It is hard to argue that this prolonged period of monetary easing has had a material and perilous effect on any of the dimensions referred. When and how should the Stability and Growth Pact rules be reactivated and should they be reviewed? First, one should notice that these very low nominal rates (short and long) have not corresponded to very low real rates, at least not in historical terms. This, coupled with the estimated natural real rate that has followed a downward path The crisis impacted severely on public finances. That was over the last decades, means that the stimulus provided is not both inevitable and desirable. Moving forward, the focus for has strong as suggested by the historically low nominal rates. fiscal policy should be on the composition and the quality of Second, there has been a response to those potential public finances, prioritizing the implementation of growth- vulnerabilities from targeted macroprudential and enhancing policies. The responsible use of the EU funds, also microprudential policies, directed at banks and borrowers. targeted at promoting investment in technologies, is crucial in Nonetheless, improvements are welcome: the enhancement this respect. of cross-country coordination mechanisms, or a focus on other parts of the financial system are dimensions deserving Over the cycle, active fiscal policy that goes beyond the impact further development. of automatic stabilisers should be limited to bad economic times. This, however, requires achieving fiscal space and Third, monetary policy has been carefully designed to avoid creating adequate buffers in good times. undue distortions. For instance, to mitigate the effects of the proximity to the so-called reversal rate, the ECB has An institutional framework that reliably creates the proper implemented a two-tier system for remunerating excess conditions for fiscal policy to operate is of utmost importance.

18 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net Q&A MÁRIO CENTENO

Although there is wide consensus on the need to simplify the still in place and their phasing out should be carefully assessed. Stability and Growth Pact, attaining a compromise solution on As we move to a phase in which a more targeted and state- the design of the rules will be challenging, both technically and dependent approach is needed, notably on the fiscal side to politically. Ideally, the debate on European fiscal rules should support viable, if financially stressed, firms, regulators and be concluded at the moment the decision to deactivate the supervisors need to continue monitoring the risks to financial general escape clause is adopted. Until then, the fiscal stance stability closely and take further actions if needed. should continue to be supportive, taking into account the strength of the recovery and phasing out measures in a way Banks profitability also plays an important role. The challenges that mitigates the social and productive impacts of the crisis. that were already noticeable became more evident with the crisis. In addition to the increased competition in financial Some sort of policy support will be needed as long as economies intermediation from new players, often using new technologies, do not go back to full employment, as it is clear from the policy the low interest rate context is challenging for banks. It is of debate in other economic regions, most notably the US. utmost importance that banks continue the restructuring process that started in the aftermath of the previous crisis to become more efficient. Even if, in the short term, this may have a negative impact on profitability, banks need to continue How can Europe correct the growing heterogeneity of investing more on the use of new technologies to decrease economic performances among euro area countries? costs and assess (new) market opportunities.

What impact is expected from the “Next Generation Consolidation of the banking sector should also play a role. It EU” package? delivers cost savings through economies of scale, in particular in less concentrated banking markets, and revenue synergies. However, the risks underlying the emergence of “too big to fail” or “too-complex-to resolve” institutions should not Divergences in productivity and GDP per capita are not be disregarded. Also, it is necessary to distinguish domestic desirable. The converge process shall remain high on our from cross-border consolidation in what concerns potential agenda. Before the pandemic crisis EU countries agreed effectiveness in dealing with the overcapacity of the banking on the first embryo of an Eurozone budgetary instrument. sector in member states and the impact in an incomplete The so-called Budgetary Instrument for Convergence and Banking Union. The completeness of the Banking Union is a Competitiveness (BICC) made already clear that the priority key condition to achieve a more sustainable process of cross- for convergence was adopted, and the crisis made it even border bank consolidation in Europe. more relevant.

The discussions that took place in the on the BICC were crucial for Member-States to better understand and assess What have been the impacts of the Covid crisis the importance of convergence and the best way to support on the EU banking sector and in terms of financial its promotion. They paved the way for the agreement on the Next Generation EU (NGEU), which over the next six years stability? What are the prospects of the Banking will leverage the digital and climate transitions and increase Union in this context? potential GDP growth rates across member countries. The size of the NGEU is not of an embryo anymore. Furthermore, the NGEU also represents an historical agreement on joint debt instruments. It is the response to the challenge outlined in the The COVID-19 crisis has led to an unprecedented, coordinated EG agreement exactly one year ago. This step forward should policy action in Europe. The various action taken were timely, be stressed. It is an integration leap of major importance. coordinated and forceful, including in financial regulation and Going forward, it is crucial that solidarity remains, and that supervision. I do not think that the COVID crisis has further domestic and EU level policies do not hurt the level playing fragmented the Banking Union. It has made more evident the field that characterizes the single market and its ability to need to progress towards a complete Banking Union. promote growth. It is imperative that EU citizens benefit from the positive loop between growth and integration, also with a The EU banking sector is now in a more favourable situation view of keeping public debt ratios on a sustainable path. Going than before the previous crisis, notably in terms of the quantity back to the old days of mistrust and extreme moral hazard and quality of capital held. This represents a significant debates is something that we need to avoid at all costs. improvement in banks’ capacity to absorb the potential losses of this crisis. But, as I have mentioned, the financial stability risks underlying the current crisis have not disappeared yet. The measures adopted were key to mitigate the liquidity shortages Are further measures needed for enhancing the of households and firms and indirectly limited the impact on contribution of the EU banking industry to economic the banking sector. However, the risks of a less pronounced recovery may lead to more acute solvency issues. These need to recovery in Europe? What role do the profitability and be addressed in the non-financial sector, to avoid a significant the competitiveness of the EU banking sector play in increase of losses in the financial sector. this regard and how may they be improved? As financial stability risks underlying the current institutional framework persist, both in the euro area and in Member States, it is key to move forward with the Banking Union. A bulk of measures adopted to mitigate the economic and Procrastination is not a possibility. The Banking Union must financial impacts of the crisis were based on banks financing be completed in the next couple of years. households and non-financial corporations. Measures ranged from prudential and macroprudential to fiscal and monetary. Different in nature but aligned in their objectives. Many are

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 19 OPENING INTERVIEWS

Q&A Executive Vice-President, EU Commissioner for Trade, An Economy that Works for People, European Commssion

Building a better future for Europe: using the recovery to adapt our economies for new challenges

To what extent will the EU’s new €750 billion recovery Reaching agreement on NextGenerationEU demonstrated a high degree of commitment to European solidarity. It has also fund contribute to addressing the economic priorities strengthened trust in the future of monetary union. resulting from the pandemic and the impacts of the Its centrepiece instrument, the Recovery and Resilience Covid-19 crisis on the Monetary Union? Facility, will provide €672.5 billion to support investments and reforms in Member States. National recovery plans must be well prepared and ambitious, meeting the green and digital Socio-economic integration and convergence lie at the heart of mainstreaming targets and be in line with country-specific the European Monetary Union. While the pandemic continues recommendations of . to affect all EU countries, some economies have been hit much harder than others. This will ensure that they facilitate the transition to a greener and more digital European economy, stimulate long-term economic These national differences are largely caused by the severity growth and help to boost the sustainability of public debt. of the pandemic, stringency of containment measures and the relative importance of sectors more affected by the restrictions, such as contact-intensive services. What are the major threats to the effectiveness of this In addition, due to their own structural challenges, some EU EU Recovery package? How may they be overcome? countries are comparatively less resilient to shocks. All this means that the Covid-19 crisis threatens the progress made in reducing economic divergences. Now that the Recovery and Resilience Facility has become law, At the same time, economic and financial spill-overs tend to spread its funding must flow as soon as possible to support a strong quickly through the single market and EMU. So taking a common and lasting recovery. EU approach to tackling the pandemic’s economic impact is in the interests of individual countries and the EU as a whole. However, to access the funds, Member States must first submit high-quality reform and investment plans to the Commission The NextGenerationEU instrument will not only help to for assessment and approval. repair the immediate damage from the pandemic and support the recovery, but also allow EU countries to address their The Commission is in intensive contact with all Member States long-standing structural challenges and prepare better for to give guidance for this, using the country-specific challenges future challenges. in the European Semester as a strategic compass.

Countries which were in a weaker starting position and Growth-enhancing reforms are essential for complementing whose economies were hardest hit by the pandemic receive the major efforts being made to stimulate investment. That a proportionally larger share of EU funding. This will help to includes reforming a country’s business environment, public promote economic and social integration and reduce the risk procurement rules or public administration as a means to of more divergences. reducing obstacles to investment flows.

20 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net Q&A VALDIS DOMBROVSKIS

The Commission will take all this into account when assessing throughout the crisis, there is room to make it more resistant each plan. to future shocks.

The regulation establishing the Recovery and Resilience We particularly need to make good on completing the Capital Facility contains many safeguards to make sure that the money Markets Union and Banking Union. Our revamped CMU is well spent on projects that provide genuine added value and action plan from last autumn will help to make our economic can drive potential growth up for years to come. and financial system more resilient and efficient.

It will also be important to invest in sectors that can generate It will help companies to stay solvent by giving them a more quality jobs. Workers also need to acquire the right skills to stable and diversified funding structure. It will also help navigate the green and digital transitions. We should not allow to finance the twin transitions and contribute to a more the lack of a skilled workforce to hold up growth. inclusive society.

Before the RRF funding can flow, the Commission needs to be legally empowered to borrow on the markets, and this means that all Member States must first ratify the decision on How and when may the Stability and Growth Pact rules own resources. be reactivated? Do they need reforming?

It is only then that the RRF funds, including the 13% pre- financing, can be disbursed to help people and businesses overcome the economic consequences of the pandemic. In March 2020, the EU decided to activate the General Escape Clause (GEC) in the Stability and Growth Pact for the first time. EU governments needed to be able to do what was necessary to deal with the immediate, severe socio-economic When the COVID-19 crisis is over and the recovery starts, of the pandemic. what should be the EU’s economic and financial priorities? Activating the GEC permitted the EU to carry out a timely, forceful and coordinated response to a fast-evolving crisis. It allowed EU countries to depart - temporarily - from the The EU has taken unprecedented measures to protect people’s normal requirements of EU fiscal rules at a time of major jobs and to support companies. This was our short-term economic downturn. response to mitigate the worst effects of the pandemic. And it has been successful. At the same time, the priority throughout this period has been not to endanger medium-term fiscal sustainability. The fiscal measures cushioned the impact on GDP by around 4.5% in 2020. It will clearly take some time for our economy to return to normality. In the meantime, the decision on whether or not to Both this year and next, we will need to continue to provide maintain activation of the general escape clause will depend on support to the economy. the overall state of the EU and euro area economy and will be based on quantitative criteria - in particular, economic output The support measures must remain temporary and targeted. reaching its pre-crisis level. This will allow them to be withdrawn gradually when the time is right, helping a return to more prudent fiscal positions in the Our current economic forecast points to the GEC remaining medium term. active in 2022 and no longer in 2023. A final decision will be taken in spring. Once health risks reduce and we move into a post-crisis phase, Member States will be able to move from short-term Once the recovery takes hold, the debate on the reviewing the emergency support into measures promoting a resilient and economic governance framework will be relaunched. We need sustainable recovery. to build consensus, because a fiscal framework can only be effective if there is strong political commitment to adhere to it. We should make most of this situation to adapt EU economies to face new challenges and create new areas of potential One significant area to examine is how best to make sure that it growth - like green and digital. brings about sustainable fiscal positions in all Member States. We need a credible debt anchor that is adhered to, especially This means investing in people and skills, particularly for during better economic times in the future. working in the green and digital economy, and helping businesses – particularly smaller ones - to stay competitive in Second, the framework has become too complex. One way this new environment. to simplify it would be to move away from indicators that are not directly observable, such as the output gaps and We need to choose our measures well and improve the quality structural balances. of public finances, prioritising investment. This is where the RRF will help a great deal. Regardless of whether we still have the current or new rules by the time the GEC is deactivated, we will continue to take Member States should make good use of the substantial country-specific situations into account. The Stability and economic impulse that will come from the RRF, without Growth Pact provides the necessary flexibility to do this. causing higher deficits and debt.

Lastly, Europe’s financial sector also has a role to play in the recovery phase, including by contributing to the twin green and digital transitions. While it has shown its resilience

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 21 OPENING INTERVIEWS

Q&A MAIREAD MCGUINNESS Commissioner for Financial services, Financial Stability and Capital Markets Union, European Commission

Strengthening the European financial system after Brexit and the Covid crisis

What are the priority measures for the EU financial • Accelerates its support for the transition towards a low- carbon, circular and sustainable economy, while preserving industry that would enable a strong and rapid its stability. economic recovery in Europe? • Embraces the digital revolution to guarantee the sustainability of business models in a post-pandemic world where customer behaviour has changed.

The EU financial sector has shown its resilience during the pandemic. Banks and other institutions started the crisis with strong capital positions and liquidity. Markets and Has the Covid crisis further fragmented the Banking infrastructures proved robust and efficient. It’s thanks to the Union? Which measures are needed to address great efforts by industry, regulators and supervisors over the past decade, learning the lessons of the global financial crisis. banking overcapacity challenges and reduce the This strength has been vital. Lending and other forms of fragmentation within the Banking Union? finance grew considerably throughout the crisis, helping the economy to bridge liquidity needs.

The Commission has supported these efforts, maximising Activating flexibility in fiscal and state aid rules allowed banks’ capacity to lend and absorb losses with its Banking Member States to provide a decisive, coordinated response to Package and making it easier for capital markets to help the COVID crisis. Fiscal support in 2020 is estimated at 8% of businesses recover with the Capital Markets Recovery Package. GDP in the euro area, in addition to liquidity schemes of about We want to maintain the strength of our financial system so 19% of GDP. And the flexibility provided by supervisors and that it can finance the recovery. regulators to banks has helped them channel funds to affected households and businesses. However, the heterogeneity of Against this background, we must make sure that our national support measures may have unevenly shielded the financial industry: banking sector from eventual losses.

• Remains stable. While navigating the gradual reduction in This situation, combined with varying exposure to sectors public support, banks should continue to measure risks in most affected by the crisis, might lead to increased market an accurate, transparent manner. Banks must also be able fragmentation if left unaddressed. The quick implementation to address the likely rise in non-performing loans and keep of the NextGeneration EU recovery plan will be important to space on their balance sheets to finance new projects. We reinforce cohesion. will swiftly implement December’s Action Plan on non- performing loans. This year will be important as we move towards completing • Develops market-based channels to complement bank the Banking Union. In December 2020, the Euro Summit finance. Capital markets will be key for the re-equitisation invited the Eurogroup to prepare a stepwise and time-bound of companies, so we will need to implement our Capital work plan on all outstanding elements needed to complete the Markets Union (CMU) Action Plan of September Banking Union, which includes market integration. In parallel, 2020 effectively. the ongoing work on revising the crisis management and

22 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net Q&A MAIREAD MCGUINNESS deposit insurance (CMDI) framework and creating a stronger Do the post-Covid situation and Brexit developments financial safety net (European common deposit insurance) will result in a first package of measures later this year. create any new challenges in this respect?

Our framework could be improved to cater for the failure of smaller and medium-sized banks. In practice we’ve seen that The COVID crisis has shown that deep and efficient capital mar- these banks may be more prone to failure than large, diversified kets are more necessary than ever. Given possible difficulties banks banks. The review of the CMDI framework will aim to ensure may face in providing credit and rising corporate debt levels, firms that the failure of any bank (irrespective of size or business need to tap into equity and other capital market instruments. model) can be managed without recourse to taxpayer money and while fostering financial stability, a level playing field and Post-Brexit, we will continue to strengthen the efficiency depositor confidence. and robustness of the EU’s financial system by advancing the Banking Union and the CMU, deepening the integration of the This review, and progress in setting up a European Deposit Economic and Monetary Union. Insurance Scheme, should be a precursor to completing the Banking Union in the longer term and unlock further reforms, At the same time, we’re continuing to monitor the significant including on reducing market fragmentation. Importantly, level of interconnectedness between the EU and the UK to measures touching on the home-host balance need to be ensure we avoid any level of dependency that would undermine accompanied by credible, enforceable safeguards for host the stability of the EU’s financial system. Member States to ensure the right balance between integration and financial stability. Is ensuring the financial autonomy of the EU a relevant What is the state of progress of the CMU initiative and objective in the current macro-economic and political what results have been achieved so far? What are the context (e.g. Brexit) and if so what does it imply in key next steps and priorities? terms of public policy?

Since its inception in 2015, the CMU has delivered results on Recent global trends point to an increasingly multipolar several fronts. For example, it has simplified access to capital geopolitical context and a departure from multilateralism. market finance for companies with measures such as the new Prospectus rules and targeted legislation to facilitate SME The withdrawal of the UK from the EU was a fragmenting event access to public markets with the SME Listing Act. We also that has highlighted some of the vulnerabilities of EU capital strengthened the supervisory framework, including with the markets, such as dependence on UK market infrastructures. European Supervisory Authorities review. Against this backdrop, the EU remains open to the rest of the Our new CMU Action Plan from September 2020 builds on world and continues to advocate for multilateralism and rules- earlier work and aims to make progress in all areas where based global economic governance. The EU financial system is barriers to the free movement of capital still exist. It raises globally interconnected via credit and financial markets, as well the ambition in areas like long-term investments, the quality as payment systems. We want to continue enjoying the benefits of investment advice and rules for listing on public markets. It of openness. But we cannot be naïve. We are determined to also expands into new fields such as company data, company develop a stronger, more resilient EU economic and financial law and financial literacy. system commensurate with the size of the European economy.

In the short-term, we will table a legislative proposal for a This is in essence the concept of ‘open strategic autonomy’ that European Single Access Point this year to provide investors the Commission presented in its January communication, “The with seamless access to company data. We will review the European economic and financial system: fostering openness, framework of European long-term investment funds to strength and resilience”. encourage more sustainability-related and digital investments, as well as investment in infrastructure. We will revise the First, we will work towards strengthening the Economic and prudential treatment of insurers to foster the re-equitisation Monetary Union, building on the Banking Union and the CMU. of businesses. And in the context of our Markets in Financial This will increase the resilience of our financial system by diversi- Instruments Regulation (MiFIR) review, we will deliver on trade fying funding sources for EU businesses, including for innovative transparency and consolidation of data to further integrate our and sustainable investment projects. This will also help bolster capital markets. confidence in the euro and contribute to reducing stability risk at international level, thanks to greater currency diversification. Also this year we will report on supervisory convergence within the EU and the functioning of our Single rulebook for Capital Second, we need to make EU financial market infrastructures Markets. And we will continue to work on financial education. more resilient to ensure uninterrupted provisions of critical Structural measures, such as non-bank insolvency procedures financial services in the EU. For instance, in the area of and cross-border taxation procedures, require more derivatives clearing, we will identify impediments and preparation but we remain determined to act on them. incentives to scale back EU market participants’ exposures to UK central counterparties (CCPs). To succeed, the CMU requires strong cooperation from all stakeholders including EU institutions and market Lastly, we will protect EU operators by acting against the participants. We need to tackle structural barriers to the free unlawful extra-territorial application of sanctions by third movement of capital embedded in national legal systems or countries, while also ensuring more effective implementation behaviour patterns across Member States. of the EU’s sanctions regime.

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 23 OPENING INTERVIEWS

Q&A Commissioner for Cohesion and Reforms, European Commission

Reforms and investment needs for the European recovery

Why has the Eurozone been impacted more in terms of Moreover, one should not overlook the role of national automatic stabilisers (enabled by the triggering of the SGP lost economic growth by the pandemic in 2020 (-7.2%) escape clause) and other important measures taken at European than the United States (-3.4%), Japan (-5.1%) or China level to support employment and cushion the social impact of the crisis, such as the emergency aid by the Structural Funds, (+2.3%) and why are the future growth prospects for the SURE initiative, the temporary framework for state aid 2021 lower as well? rules and the Pandemic Emergency Purchase Programme of the ECB.

Several factors help explain these differences. Due to its nature, the Covid-19 crisis has disproportionately hit economies What are the main structural impediments which reliant on physical contact such as industry, , culture hinder productive investment in Europe? What and hospitality. Some countries also had the misfortune of being exposed to the virus earlier and more severely than are the most urgent reforms to be carried out in others, which resulted in stricter containment measures and the EU for fostering productive investment and further economic disruptions (e.g. Spain and Italy had an above-average GDP contraction of 11 and 8.8% respectively in sustainable growth? 20201). So there are significant differences between regions and countries to consider. The EU’s ambition is to accelerate the recovery through Three additional elements may explain the lower economic growth-enhancing reforms together with future oriented performance of the euro area as a whole compared with the and environmentally sustainable investments. The joint United States (US). First, the greater openness of the European and coordinated impact of the multiannual budget (2021- economy2 acted as a drag when cross-border trade and 27) with the NextGenerationEU, notably the RRF is a global supply chains were disrupted. Second, given its older unique opportunity to trigger it. The new Technical Support population structure3 and higher population density4, Europe Instrument (TSI) will complement the RRF, offering Member was more vulnerable. Finally, Member States immediate States expertise to design and implement reforms. stimulus responses were different in magnitude and speed. Reform needs are specific to each Member State and are By putting in place an unprecedented recovery package called detailed in the country-specific recommendations emanating NextGenerationEU (NGEU), the European Union (EU) responded from the European Semester. Three horizontal reforms are decisively. In particular, the new Recovery and Resilience Facility very dear to me: innovation; public administration, including (RRF) will take into account the different economic impact of digitalisation; and economic, social and territorial convergence. the pandemic in Member States and contribute that we emerge Building an economy fit for the next generation requires change, stronger and more resilient from the crisis. capacity to look ahead and adapt. The EU needs to invest in people to boost innovation and creation of value. Investments The EU recovery plan may be rolled out less rapidly than the and reforms must encourage research and innovation. In US stimulus checks, but is calibrated to support long-term order to benefit from cutting-edge technologies, we need to growth and address the challenges posed by the green and stimulate interactions between the business and research digital transitions. worlds fostering knowledge transfer. European capital markets

24 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net Q&A ELISA FERREIRA are needed to make sure that the most innovative companies A key success factor will be countries’ broad ownership of have access to capital to grow and compete on a global scale. these plans. Despite the urgency, Member States must engage with national stakeholders to bring out the best reform ideas Efficient public administration is a key enabler for innovation, and investment projects. This dialogue will also improve the quality investment and growth enhancing reforms. Public quality of the implementation process. administration may become a hindrance to growth if it doesn’t keep up with organisational developments. Efficiency of public administration, namely through digitalisation and simplification of procedures is thus vital for competitiveness. Some countries of the EU have been unable to spend Finally, the economic recovery must reduce imbalances within efficiently European structural funds over the period the EU and within Member States. The RRF will have an important role to play in combination with the new cohesion 2014-2020. Will the national plans presented in the policy. Reforms and investment must take into account regional context of the NGEU recovery instrument make better and local specificities to facilitate convergence, without which, economic, social and political fractures will be inevitable. use of European funds this time round? Do all Member States have sufficiently effective administrative capabilities to manage the mass of projects needed to How will the EU’s new €750 bn recovery fund absorb these funds? contribute to addressing the post-Covid economic recovery of the EU and Eurozone? The unprecedented amounts of funds available under the NGEU and the new 2021-27 EU budget will be challenging also National allocations under NGEU’s largest instrument, the in terms of absorption capacity. The Commission is well aware RRF, should contribute to make European economies and of persisting issues in implementation and continues its efforts societies more resilient and better prepared for the challenges to address them. A significant effort of simplification was made of the green and digital transitions. In addition, the Recovery in the legislation for the new EU cohesion policy for the 2021- Assistance for Cohesion and the Territories of Europe (REACT- 2027. However, similar efforts are necessary from the Member EU) extends the crisis repair measures delivered through the States themselves as national “gold plating” is frequent. Coronavirus Response Investment Initiatives (CRII and CRII+) until 2023. As referred above, the quality of public administration is a critical factor not only for the absorption of funds but, more Thanks to its redistributive effects, these funds will contribute generally, for the success of all public policies. The TSI through to a less divergent recovery of the euro area economies, and which Member States can request technical support from the act (temporarily) as an anti-cyclical instrument, badly needed Commission to devise and implement policies, including to when, in a Monetary Union, national automatic stabilisers upgrade their public administration can play an important are structurally constrained. Long term bonds issued by the role. Having the possibility to finance the reform of public Commission to finance the NGEU will create a truly pan- administration is, in itself, a major occasion to improve general European safe asset, contribute to financial stability and efficiency including better management of the funds. increase the recognition of the euro as an international currency. Importantly, the EU will become the world’s biggest Above all, the need for a sustained and fast recovery will be the issuer of Environmental, Social and Governance (ESG) bonds best stimulus to a good use of this unique historical opportunity. and the benchmark for such instruments globally.

What are the major threats to the effectiveness of the Next Generation EU (NGEU) package? How to overcome potential “blockages” and ensure that the funds are well spent and go hand in hand with effective reforms?

There are two critical steps for the implementation of the NGEU package, the first of which is the ratification by all Member States of the Own Resources Decision, which will allow the Commission to borrow funds on the capital markets. Then, to be able to access the RRF, Member States need to prepare Recovery and Resilience Plans (RRPs) that have to be approved by Commission and Council.

Disbursements from the RRF will be based on the achievement of pre-defined and agreed milestones or targets. The capacity by 1. Commission’s Winter 2021 forecast Member States in identifying the right reforms and investments, 2. Trade openness of 26% of GDP in the U.S. vs. 88% for the euro area according to World but also the operative means for their implementation, both Bank data. 3. 21% of inhabitants over 65 in the euro area vs. only 16% in the U.S. according to the public and private, is therefore paramount for ensuring the Commission’s AMECO database. good use of the funds. Reforms, in particular, must address 4. 36 people per sq. km of land area in the U.S. vs. 127 in the euro area according to World structural bottlenecks to development. Bank data.

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 25 OPENING INTERVIEWS

Q&A ASHLEY ALDER Chair, Board of the International Organization of Securities Commissions (IOSCO) & Chief Executive Officer, Securities and Futures Commission, Hong Kong

Key issues for global regulators post-Covid

Are there increasing signs of financial fragmentation at Brexit has been another extraneous event which has important implications for the European Union’s (EU) financial system the global level? Which activities are most affected and as well as for global capital markets. For example, the UK’s what is the appropriate way forward for addressing departure from the EU has led to fragmentation concerns in both trading and clearing activity. Changes to the rules for this situation? passporting rights for UK-based activities as well as delegation rules could also affect funds managed from Asia.

In recent years, a key focus for international policymakers and IOSCO has carried out a significant amount of work on cross- standard setters was on harmful market fragmentation as an border regulation, including its 2015 Report on Cross-Border unintended consequence of regulatory changes following Regulation and 2019 Report on Market Fragmentation and the global financial crisis, potentially undermining the Cross-Border Regulation. Last year, IOSCO published another effectiveness of the reforms. IOSCO and the Financial report which identified good practices for establishing and Stability Board (FSB) promoted greater global consistency in operating deference, recognition or equivalence processes the implementation of reforms, for example by establishing which are outcomes-based, risk-sensitive, transparent, international standards for prudential requirements and sufficiently flexible and backed by strong cooperation. setting out governance arrangements and technical guidance Fragmentation in the securities and derivatives markets remains for over-the-counter derivatives clearing and trade reporting. one of IOSCO’s top priorities, with its current two-year work However, local variations became all too apparent, and plan focusing on ways to strengthen regulatory cooperation fragmentation also affected cross-border resolution regimes. to support deference mechanisms and assist regulators in addressing areas where harmful market fragmentation may be COVID-19 was an example of how a market crisis could taking place. be triggered by unanticipated events outside the financial sector, but where close communication and coordination at the international level helped to support synchronised policy responses. The initial outbreak put global markets under In the increasing incorporation of ESG criteria in considerable strain, leading to a flight to safety followed financial decisions calling for more standardization in by a severe liquidity crunch in core funding markets. The pandemic’s spread and the containment measures to combat it this area at the global level? What are the priority areas created the conditions for increased fragmentation risk in the concerning reporting in particular? Eurozone and elsewhere.

However, central banks and other financial policymakers took very swift, coordinated and effective action to provide liquidity Governments worldwide have committed to achieving net- and other support across markets and to the real economy. zero emissions targets and recent surveys show that more Securities regulators were quick to acknowledge the risks investors are incorporating ESG issues into their investment and allowed a measure of regulatory flexibility to ensure that and capital allocation decisions. Companies with strong ESG markets continued to function in an open and orderly manner. practices have outperformed during the pandemic, prompting The overall level of cooperation was in fact of a high order, a growing number of businesses to recognise the value of ESG although there were inevitable differences; short-selling bans and sustainability disclosures for investors as well as for a wider and dividend restrictions are cases in point. community of stakeholders.

26 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net Q&A ASHLEY ALDER

A top priority for global regulators is to agree on a set The unprecedented demand for liquidity in March and April of standardised sustainability reporting standards. The 2020 amidst the “dash for cash” created considerable strains recommendations made by the FSB’s Task Force on Climate- across core funding markets, and especially in short-term related Financial Disclosures (TCFD) are a good start, but it is markets, which placed investment funds in the spotlight. crucial that they are adopted and further developed globally. There was a major deterioration in funds’ liquidity profiles and This will help firms embed a broadly accepted framework increases in redemption pressures, particularly those open- for reporting on climate-related financial risks into their ended funds invested in riskier and less liquid corporate credit. governance and risk management processes as well as their Mismatches between the liquidity of funds’ underlying assets communications with stakeholders. The UK, , and redemption requests can expose funds to vulnerabilities. New Zealand and Hong Kong have all pledged to align their A particular area of stress was experienced in money market disclosure requirements with the TCFD recommendations. funds exposed to short-term commercial paper. In addition, leverage in some investment funds, especially hedge funds, In Europe, major steps have already been taken to accelerate may make them more sensitive to sharp swings in asset prices. the implementation of non-financial reporting frameworks, Funds may be forced to sell assets to obtain liquidity and such as requiring large firms to publish regular reports on deleverage during periods of market stress. the social and environmental impact of their activities. Whilst we are moving towards more consistent, comparable The funds sector and the broader financial system nevertheless and reliable sustainability reporting, difficult issues such as proved to be resilient. However, issues in NBFI have now differing standards and the availability of reliable data and been brought to the fore amidst questions as to whether agreed industry-specific metrics will remain, as will the risk of unprecedented central bank interventions were as much about greenwashing and inconsistent ESG ratings. IOSCO working vulnerabilities in underlying core funding markets as they groups are very actively tackling all of these areas. were about structural vulnerabilities in NBFI. One question is how the higher capital requirements introduced as part of The important proposal by the International Financial the reforms following the global financial crisis may have led Reporting Standards Foundation (IFRS) to establish a new to structural changes in the financial system and contributed global sustainability standard-setting board (ISSB)—similar to the rapid growth of NBFIs and associated vulnerabilities to the International Accounting Standards Board (IASB)— amidst compressed risk premiums after years of low interest is a very positive step. IOSCO strongly supports the IFRS rates, quantitative easing and “reach for yield” behaviour. proposal to create a comprehensive and harmonised reporting framework, starting with climate. IOSCO played a pivotal role Authorities should proceed with caution when considering in the establishment of the IASB around 20 years ago and will policy options to address lessons learned from the stresses of play a similar role in relation to sustainability reporting under last year. One key consideration is how to ensure that NBFI a new ISSB. IOSCO will be closely involved in the design and activities are sufficiently resilient, but to do so in a way which ongoing supervision of a suitable governance framework does not stifle investment flows and hence their contributions and, ultimately, will create a mechanism to endorse ISSB to the real economy, especially during times of stress. sustainability standards for use globally, as it did with the IASB. This will require building more specific disclosure standards Financial stability risks arising from NBFIs is one of IOSCO’s around the core TCFD elements, which are mainly to do with key priorities in its current work plan. We are working with governance, risk management and strategic decision-making. the FSB on a number of policy areas, including the resilience An alliance of private sector standard setters has published of money market funds, liquidity risk management for open- a joint “prototype” standard for climate reporting which, ended funds, leverage in investment funds and the provision of together with the TCFD recommendations, should give the liquidity in corporate bond markets. ISSB proposal a running start.

In the meantime, the EU and China are working on a Common Ground Taxonomy which can provide a common cross-border standard for identifying environmentally sustainable activities. Taxonomies are vital to the sustainable finance effort as they enable capital to be allocated to the right places to support the transition to a greener economy. In the long run, this could provide more transparency for investors and firms, reduce transaction costs and, ultimately, facilitate greater green capital flows across border.

What are the main vulnerabilities exposed by the COVID crisis in the fund sector and more broadly in NBFI (Non Bank Financial Intermediation) activities? What are the underlying issues and are further measures needed to mitigate such risks?

The COVID-19 crisis demonstrated the deep and complex interconnectedness between the capital markets and the wider financial system as well as potential structural and regulatory vulnerabilities in the activities of non-bank financial institutions (NBFIs).

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 27 1

POST-COVID CHALLENGES AND PRIORITIES

ISSUES AT STAKE

One year into the Covid-19 pandemic, high uncertainty surrounds the global economic outlook. The decline in activity due to the COVID crisis is much greater in Europe than in other regions (US, Asia). The COVID crisis is also amplifying the heterogeneity of economic performance across Member States.

In July 2021, the European Council reached an historic fiscal agreement on the €750 billion Next Generation EU (NGEU) package. Once legislated, this temporary instrument will provide grants and loans to EU members over the next few years to help accelerate the recovery, modernize EU economies, make them cleaner and greener, more digital and more inclusive.

Many issues however hinder productive investment in Europe: fragmented financial markets, savers’ preference for risk-free investments, very high levels of public or corporate debt, lasting zero interest rates, regulatory environment…Structural reforms are needed for tackling these issues and also mitigating the risk of further economic divergence across Member States. POST-COVID ECONOMIC AND FINANCIAL PRIORITIES...... 30

Klaus Regling - European Stability Mechanism / Andrej Sircelj - Ministry of Finance, / Werner Hoyer - / Pablo Hernández de Cos - Banco de España

EU RECOVERY PACKAGE IMPLEMENTATION...... 34

Harald Waiglein - Federal Ministry of Finance, / Emmanuel Moulin - Ministry of the Economy, Finance and the Recovery Plan, France / Jörg Kukies - Federal Ministry of Finance, Germany / Gert-Jan Koopman - European Commission / Irene Tinagli - European Parliament / Ricardo Mourinho Felix - European Investment Bank / Vittorio Grilli - J.P. Morgan

FOSTERING MORE INVESTMENT IN THE EU...... 42

Markus Ferber - European Parliament / Declan Costello - European Commission / Boris Vujčić - Croatian National Bank / Mārtiņš Kazāks - Bank of / Pierre Heilbronn - European Bank for Reconstruction and Development / Laurent Zylberberg - Caisse des Dépôts / Sylvain Broyer - S&P Global Ratings Europe Ltd. / Cyril Roux - Groupama POST-COVID CHALLENGES AND PRIORITIES

POST-COVID ECONOMIC AND FINANCIAL PRIORITIES

KLAUS REGLING Managing Director, European Stability Mechanism (ESM)

Post-pandemic fiscal priorities for the euro area

The Coronavirus pandemic came as an unprecedented common supporting the greening and digitalisation of the economy to external shock, it has been the most severe and widespread create a stronger, more innovative and sustainable EU. economic contraction of our lifetime. Countries have spent huge amounts on healthcare, and on containing the economic Furthermore, EU fiscal rules are rightly suspended until next consequences of the pandemic. year to accommodate the large increase in government spending and the decrease in revenues. Let me stress that the Stability and To support countries’ efforts and avoid growing divergences Growth Pact has worked better than widely believed. Just before between Member States, the EU rolled out a huge package the pandemic, the euro area was doing significantly better in fiscal to support workers, businesses and countries. As part of this, terms than the rest of the world, providing more budgetary leeway the ESM offers all euro area countries a precautionary credit when the crisis broke. However, the pact needs to be reformed to line to cover direct and indirect healthcare costs related to the make it less complex and to improve its implementation. pandemic. Additionally, the extraordinary €750 billion ‘Next Generation EU’ recovery fund was designed to mitigate the impact of the pandemic on economic growth and to provide further financial assistance to the most affected countries. …the agenda for deepening Without these public sector measures, the recession would surely have been deeper and there would be a greater risk of the Economic and Monetary Union divergences between countries within the euro area. When the remains even more valid than EU makes this comprehensive public funding available, we need before the crisis… to ensure its efficient use. All the more so, as the fiscal situation will remain challenging for many countries in the medium term amid uncertain future economic developments.

I see four additional risks for future growth: Nowadays, the capacity of governments to service debt is higher than the levels envisaged in the EU Treaty, although by how First, the potential growth rate is likely to be lower than before much is a matter for debate. Like many others, I would argue the crisis unless the recovery fund is highly successful. that we have to rely more on observable variables. It would be useful to have an expansion path for expenditures, for Second, companies may survive in the short term by taking out example, to prevent public expenditures from growing faster loans, but high debt loads may impair their future ability to than trend growth. I would also argue that the overall 60% debt invest. An increase in insolvencies seems unavoidable. limit could be reconsidered while the annual 3% deficit limit remains relevant. Third, banks, although safer than in the past financial crisis, are still struggling with persistent low profitability and may see The discussion has been overshadowed by the ongoing pandemic an increase in non-performing loans due to the pandemic. So, crisis, but we must take the opportunity to think ahead, about although encouraged to continue to support the economy, they how our fiscal rules can help governments, parliaments and may not have the capacity to continue providing sufficient credit markets understand how fiscal policies will evolve in future. for investment going forward. As a final point, the agenda for deepening the Economic And finally, higher public deficits and debt are a necessary and Monetary Union (EMU) remains even more valid than response to the crisis, but it will not be easy to reduce fiscal before the crisis: completing banking union, creating a capital deficits over the next few years to sustainable levels. Given these markets union, setting up a fiscal capacity for macroeconomic challenges, government measures need to be targeted, cost- stabilisation and implementing the ESM reform. All this serves effective and focus on longer-term growth. Next Generation the longer-term objectives of creating a safer, more robust euro EU rightly fosters competitiveness and investments while area and of promoting the international role of the euro.

30 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net POST-COVID ECONOMIC AND FINANCIAL PRIORITIES

ANDREJ SIRCELJ Minister of Finance, Slovenia

Post Covid-19 Recovery Plan for Europe

The EU should continue with the coordinated political importance of an adequate risk management, systemic reaction, enhancing the EU added value. stability, and resilience while ensuring better protection for customers and investors. In the current times, we are rethinking our health systems and business and economic practices. Achieving a successful Hence, one of the priorities is the revision of the Basel III recovery will require harnessing all the potential of the green standards in the EU banking legislation, which will provide and digital transitions. improved rules to further reduce banks’ exposure to risks: credit, operational, market, and other risks. It is important The COVID-19 pandemic has led to a need for emergency that banks maintain their capital adequacy for the real liquidity in large parts of the economy to cope with the economy, especially for SMEs. Securitization of loans would economic consequences. Many insolvencies, bankruptcies, allow the banking sector to free up bank capital for further and redundancy of workers were prevented by the support lending, allowing a wider range of investors to finance the measures. But eventually, we will have to switch to the economic recovery. recovery measures. This means that some companies might also exit the market. However, we need to create conditions for new entries and provide viable companies with an access to R&D stimulations, upgrading employee skills, and flexible working schemes. The EU should continue The historic agreement on the EU fiscal stimulus is a starting with the coordinated political point for the recovery. Hence, efficient implementing of the reaction, enhancing the EU investments and reforms envisaged in the recovery plans is added value. the top priority. A successful recovery will provide the best basis for discussions on the fiscal stance. Designing the appropriate path to the recovery and sustainability is parallel to the top priority. An agreement on dynamics is required. With smart investments, we need to design a path to a The revision of Solvency II framework is among the most sustainable recovery, look beyond 2022, and not repeat the important steps toward the completion of the Capital Markets mistakes from the previous crisis. But the recovery cannot Union. Improvements to prudential rules are necessary to happen overnight. After 2022, we should focus on simple but provide further implementation of a risk-based prudential politically sensible solutions. regime. Therefore, we need to complete the Banking Union and the Capital Markets Union. Compromises will be As restoring debt to pre-crisis levels is essential in the short necessary to achieve these goals, but if we take a constructive term, it requires a better market ecosystem for issuing new approach, we will be able to fulfil the vision and move on equity. Government support packages and monetary policy to even more ambitious goals to achieve higher levels of and regulatory flexibility have in many ways ensured that prosperity, innovation, and environmental sustainability. short-term finance is available to businesses, but further steps are needed. Guaranteed loans have covered emergency We are entering a new reality of rising inflation, low interest liquidity needs for companies, but solutions to restore rates, high debt, and different forms of economies facing large solvency must also be provided. Yet, in such a demanding investment needs to further improve our health systems and COVID-19 environment of elevated public debt, it is to pursue our goal to prepare Europe for the green and digital paramount for sovereigns to improve the risk metrics and the transitions. Thus, the EU should continue to work together debt structures. In this context, in the environment of strong – a prosperous future lies in the strength of unity, and this is demand for duration and given elevated funding needs, the an opportunity that we must not miss. long-term funding is the logical choice.

To make our economies more efficient, competitive, and sustainable, the access to funding, especially non-banking, must become easier. Our aim should be to improve Europe’s capital market effectiveness and increase its resilience while keeping it competitive and attractive to market participants. The importance of a rapid recovery should not neglect the

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 31 POST-COVID CHALLENGES AND PRIORITIES

WERNER HOYER President, European Investment Bank (EIB)

Recovery and cohesion through green and digital transformation

Europe needs to wake up to the potential for digital Skills and management capabilities are proving key barriers technologies to achieve sustainable growth. The digital to digital adoption. Digital innovation hubs, such as those revolution has already transformed industries, production supported by the Innovation Finance Advisory service of processes and ways of living and working, but many of the EIB’s European Investment Advisory Hub, can be game- these shifts are only just beginning. Most European firms changers in overcoming these barriers. At the same time, surveyed by the European Investment Bank (EIB) think that access to very high capacity digital infrastructure (i.e. 100 the COVID-19 pandemic will accelerate the use of digital Megabits/second or above) is critical, not only in urban technologies even further. but also in remote areas. 16% of European firms say that lack of digital infrastructure is still a major impediment to On digital adoption, however, Europe lags behind other digitalisation, compared to only 5% in the US. Data show that regions, notably North America and Asia-Pacific. With the digital adoption rates are higher where local municipalities “winner takes all” tendency of digital technologies and digital claim good digital capacities and infrastructure. platforms, Europe risks being left behind for good. After the pandemic, Europe will need a digital transformation to underpin its green transition.

The adoption of digital technologies by EU firms is growing, After the pandemic, but it has not yet closed the gap with the United States. In 2020, 37% of European firms had still not adopted any new Europe will need a digital digital technologies, compared with 27% in the United States. transformation to underpin There is a risk of polarisation within Europe, too, because its green transition. its small businesses are creating the lag. And while some countries and regions are at the global forefront, others risk being left behind. The downside risks to jobs and growth from both automation and the climate transition are not evenly spread. In fact, some of Europe’s least developed regions are The constraints facing municipalities are financial and most at risk, often aggravating structural weaknesses. technical, requiring the combination of advisory services with adequate financial instruments. The EIB has financed But digitalisation is mainly an opportunity, not a threat. telecom infrastructure projects with €10 billion over the last Our data shows that digitalised firms are more productive four years. The Bank estimates that the total investment and foresee higher wages and more employment growth. By needed to achieve the European Commission’s goal of Gigabit taking action to help firms, notably SMEs, to adopt the new Society is about €380 billion, but the market can deliver only technologies they need to thrive, we can spur sustainable about one third of this. An investment gap of €50 billion per growth and help close the divides that exist within Europe year remains. This may be exacerbated by COVID-19. and strengthen cohesion. Digital innovation by firms, meanwhile, requires risk- Innovation will also be vital. Unfortunately, the United States absorbing finance that is still hard to obtain from private still dominates in the sphere of digital innovation, with China investors in much of Europe. Here again, the EIB Group is – not Europe – catching up. But Europe has a chance, thanks part of the solution. We spur innovation through our RDI to the green transition. Digital technologies will play a critical lending, and the catalyses the enabling role in the green transition, and Europe is a global leader Europe-wide market in equity finance and venture debt. This in green innovation. We lead specifically at the intersection of is just what the continent’s most innovative and growth- green and digital, latest data showing that we registered 76% enhancing firms need. more patents combining green and digital technologies than the United States. This lead is fragile. Building on it will be critical for future sustainability and competitiveness.

To accelerate the pace of digital innovation and adoption, we need above all three things: an enabling ecosystem, the right kind of financial support and a European vision to counter the imbalances across our Union. The EIB Group plays an important role in all three regards.

32 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net POST-COVID ECONOMIC AND FINANCIAL PRIORITIES

PABLO HERNÁNDEZ DE COS Governor, Banco de España and Chair, Basel Committee on Banking Supervision (BCBS)

Securing a robust recovery: how can banks be part of the solution?

Much has been said about how the banking system has flaws and frailties in the banking system would remain remained broadly resilient thus far during the pandemic, unaddressed if jurisdictions do not implement Basel III in full and how banks have not been part of the “problem” to date and consistently. in exacerbating the economic crisis. This is in no small part due to banks entering the pandemic on a much more resilient The Basel III reforms have benefited from an extensive footing than was the case during the Great Financial Crisis consultation process with a wide range of stakeholders. They (GFC), thanks to the initial set of Basel III standards and are by design a compromise that reflect the different views of ongoing cooperation among Basel Committee members. In our members. They have been calibrated based on rigorous addition, the unprecedented range of fiscal and monetary quantitative analyses and meet the Committee’s objective policy measures to support the real economy have largely of not significantly increasing overall capital requirements shielded banks to date from losses and the crystallisation at the global level; capital requirements would increase by of risks. less than 2% in aggregate. Of course, some “outlier” banks may face higher requirements as a result of aggressive While the trajectory of the pandemic continues to be highly modelling practices, for example. Even in those instances, uncertain, it is clear that risks to the global banking system the implementation timeline includes sufficiently long may heighten over the coming period. Bank losses could transitional arrangements: the final element of these reforms begin to materialise as a result of the unwinding of support will be implemented by 2028, fully 20 years since the GFC. measures and broader macroeconomic dynamics. The potential permanent economic “scarring” from the crisis, alongside rising debt levels, could increase the longer-term structural fragilities of banks’ balance sheets. It is therefore critical that banks and supervisors remain vigilant to Frailties in the banking these risks. system would remain Looking ahead, how can banks and authorities best ensure a unaddressed if Basel III robust and sustainable recovery? is not fully implemented. A crucial factor to achieving this outcome is the full, timely and consistent implementation of the outstanding Basel III reforms. These reforms tackle some of the glaring shortcomings in the banking system exposed by the GFC, And it is increasingly clear that the Basel III reforms will including the excessive degree of variability in banks’ have a positive net impact on the economy, as highlighted modelled capital requirements, the lack of robustness in by a growing set of robust empirical studies. Safeguarding mitigating banks’ operational risks, and, ultimately, the the resilience of the banking system through prudent and credibility of banks’ reported capital ratios. credible global standards will help reduce the likelihood and impact of future banking crises. Moreover, as the current Recall how, at the peak of the GFC, investors lost faith in crisis reminds us, it is healthy and well-capitalised banks banks’ published ratios and placed more weight on other that are best able to support the recovery by lending to indicators of bank solvency; when asked to model capital creditworthy households and businesses. requirements for the same hypothetical portfolio, banks’ capital ratios varied by 400 basis points. In a similar vein, Combatting infectious diseases and safeguarding financial banks’ operational risk models lacked robustness, with stability are both global public goods which know no borders losses incurred by some banks far exceeding their estimated and require collaboration among countries. It is in all of our capital needs. collective interests to lock-in the benefits from the Basel III framework by implementing the outstanding standards in a Covid-19 has only further reinforced the importance of full, timely and consistent manner. addressing these fault-lines. It has underscored how a functioning banking system is one that is resilient and capable of absorbing shocks instead of amplifying them. A banking system underpinned by prudent global regulatory standards is also better placed to maintain the provision of critical services to households and businesses. Yet structural

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 33 POST-COVID CHALLENGES AND PRIORITIES

EU RECOVERY PACKAGE IMPLEMENTATION

via structural reforms, and pointing of Member States and the EC. Given to areas in which further work needs the many requirements for RRPs, not to be done to make the Plans eligible all national Plans may be ready for for financing. We are thus confident submission by end April. The pay-out that the RRF addresses the short-term of funds may thus be delayed. However, economic priorities resulting from the liquidity is not a major constraint to pandemic, and medium- to long-term any Member State right now, and a structural challenges identified during somewhat delayed approval of RRPs the past two years, including the green shall not be a concern if this comes in and digital transition. exchange for high-quality plans.

Three factors support our view that Yet a fundamental problem of the the conditions are in place for effective euro area remains unresolved. That use of RRF funds: First, the EP has is extremely high levels of public and taken an important role in improving private debt in a number of Member the governance framework, addressing States. The measures to address the some of the weaknesses of the original fallout from the pandemic crisis are proposal in the areas of monitoring adding to debt stocks, while NGEU and the overall impact of the Facility on the ECB’s monetary policy are changing common EU targets. The Recovery some of the parameters determining HARALD and Resilience Scoreboard that is debt sustainability. Public support is being developed by the EC until the imperative in the current situation, WAIGLEIN end of the year will reflect to which but we need to be mindful that the Director General for Economic Policy, extent RRF funds are living up to problem of high debt is being shifted Financial Markets and Customs Duties, their expectations. Second, the EC into the future and partially onto the Federal Ministry of Finance, Austria seems to have learned from experience EU level. It will hit back at some point with the SURE Instrument, which at the younger generations, who are at unconditionally supports Member the same time taking the largest hit on States’ measures to protect incomes of their personal economic trajectories workers and the self-employed during due to COVID. the COVID crisis. RRF will address Once the recovery is on track, we have to focus attention on debt stocks, structural reform public and private. Efficient insolvency mechanisms are key to avoid that capital needs, but key Once the recovery remains trapped in unviable firms. We is on track, we have need to be aware that not all of the problems remain support that is being granted now, with to focus attention or without EU support, will be used unresolved on debt stocks, efficiently, as some firms may have been public and private. unviable even without COVID. The urgency of support during the The European Recovery Instrument, current crisis has not always allowed with the Recovery and Resilience proper assessments of every firm, Facility (RRF) at its heart, provides an Without doubt, many of the measures so there will be sunk costs that put unprecedented opportunity to foster that are being financed via SURE pressure on public balance sheets. structural reforms in Member States, would not comply with the criteria for During the past decade, we have while addressing investment needs RRF funding with regard to relevance, accumulated sufficient experience of the green and digital transition. A effectiveness and efficiency. The high with unsustainable debt to image the lot depends on the EC’s guidance to level of detail in the RRF Regulation, potential consequences for individual Member States during the preparatory together with the assessment criteria euro area Member States. The fact that phase, in particular the extent to which and minimum ratings, provide today’s increases in debt stocks are the EC insists on ambitious reform assurance that only the best projects policy-driven does not reduce the risk agendas, on the one-off nature of can benefit from RRF funding. Third related to it. And markets will not be expenditures included in Recovery and and perhaps most importantly, we all calm forever. Resilience Plans (RRPs), their relevance, know that if the RRF goes wrong, the effectiveness and efficiency, and the idea of a common budget is dead. way the DNSH principle is applied. The governance framework is Our impression so far is that the EC ambitious and promising, but also takes its job very seriously, steering work-intensive. The preparation of national authorities towards making the high-quality national plans requires best of the use of the funds, including huge administrative efforts on the part

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amounts of money to fund the recovery of national policies. Respecting these in the short term while only incurring principles is key to success. the costs down the road when growth has returned and is solidly entrenched. The implementation of the RRF will help maintain a supportive fiscal stance The other defining feature of NGEU is in the coming years and achieve a that 390bn€ out of the 750bn€ raised more balanced policy-mix after the will be passed on to Member States crisis. Indeed, in the wake of the 2010 in the form of grants via EU budget sovereign debt crisis, the EU embraced programs, and in particular via the new fiscal consolidation too soon, hence Resilience and Recovery Facility. hampering the return of growth.

The allocation criteria ensure that This time, backed by the activation of the size of the shares each Member the General Escape Clause in 2021 and State will receive will depend, to some its likely extension in 2022, Member extent, on the severity of the crisis. As States ought to keep in place support such shares may end up differing from measures as long as necessary and the countries’ eventual contributions coordinate fiscal policies to maintain to the reimbursement of these sums, an expansionary aggregate fiscal this mechanism will lead to money stance. The Commission should also EMMANUEL transfers to the benefit of Member address differentiated fiscal guidance States most hit by the crisis. to Member States namely to encourage MOULIN those with fiscal space to invest in Director General of the Treasury, However, several safeguards were support of domestic demand. Ministry of the Economy, attached to this mechanism to insure Finance and the Recovery Plan, its legal soundness and political Finally, we must foster strong and France acceptability. First, the instrument well-supervised European financial is meant to be temporary, one-off actors and deeper capital to help and designed exclusively to deal with fund the recovery and also promote the effects of the Covid19 crisis. The the international role of the euro. introduction of new own resources to Therefore, we must strengthen the refund NGEU bonds will also be critical Capital Markets Union by simplifying Delivering on the EU in avoiding an undesirable increase in and bringing closer our 27 legal Member States’ contributions to the frameworks and make our Banking recovery fund EU budget between 2028 and 2058. Union more credible by simultaneously Second, the money will finance, to a advancing crisis management, EDIS large extent, investments in the green and cross-border integration. and digital transitions and reforms to Right after the emergency response to boost resilience and competitiveness. The issuance of NGEU bonds is also the crisis, France, jointly with Germany, an opportunity to create a euro- strongly advocated for an ambitious denominated safe asset which will help recovery fund to make Europe bounce in propping up the international role of back stronger than before the crisis. the euro. The Commission’s proposals followed The EU agreed suit and their formal approval at the July 2020 European Council was a on a borrowing-for- historical breakthrough and a step spending mechanism towards deeper economic integration to tackle the Covid of the EU in many regards. crisis. We must now Indeed, the Commission had already strive to implement borrowed on financial markets in the it thoroughly past to on-lend the funds to Member States requesting financial assistance. and swiftly. The latter remained however entirely and ultimately liable for these back- to-back loans. With NGEU, the Commission will still issue bonds – In this respect, we now need a swift though at a much larger scale - which implementation of the RRF to ensure it means Member States will again benefit effectively contributes to the recovery. from the Commission’s good credit This is the main challenge ahead rating. and the clear priority. Third, the governance of the RRF was extensively Yet, this time, common indebtedness discussed as part of the political (through a temporary and exceptional agreement. The solution that has been increase of the own resources ceiling crafted ensures that the Commission for tackling the Covid19 crisis) - and the Member States have a say on combined with a long grace period the implementation of those measures, before redemption of principal kicks while ensuring national ownership in in - allows for swiftly raising significant the design and the implementation

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 35 POST-COVID CHALLENGES AND PRIORITIES

regulation. Those include in particular ensuring effective control and audit a climate target of 37% and a digital procedures is also not an easy task. target of 20% of RRF funds. This means, in total around 250 bn Euro of the RRF Against this background, it is important will be spent on the green transition in to minimize impediments for the the next years, and over 130 bn Euro on proper functioning of the instrument the digital transition. A big step towards wherever possible. This means inter making our economies more resilient alia, that milestones and targets and fit for the future. Furthermore, the should be defined in a way that avoid RRF aims at strengthening economic frequent amendments of the plans. and social cohesion while enhancing Attention should also be paid to the the growth potential in the aftermath administrative burden for Member of the crisis. States when drafting their plans and implementing their projects. At the That requires a country-specific same time, this is precisely the moment approach. Therefore, Member States for Member States to not only invest will have to address their national but also address reform bottlenecks. challenges and priorities identified in the European Semester. Comprehensive Member States can make requests for national reforms in combination with payments twice a year, leading to up to JÖRG investments in key policy areas create a over fifty requests per year. Given that, it unique chance to emerge substantially will be important, that the Commission KUKIES strengthened from the crisis. and the Economic and Financial State Secretary, Committee (EFC), representing the Federal Ministry of Finance, Member States, handle the assessment Germany of the requests in a pragmatic way. The fact that the process builds on well- The RRF is the established structures of the European right instrument Semester should help in this regard. at the right time. The EU recovery package is the right NGEU and RRF – Joint efforts are instrument at the right time. Making needed to make it the best out of it requires joint efforts from all sides. Implementation work properly. will be key

Challenges for Member States arise In a historic step, EU leaders decided inter alia from the time constraints in July 2020 to establish the temporary under which adequate reforms and European Recovery Fund Next investments need to be identified Generation EU (NGEU) worth 750 now. However, Member States that bn Euro – more than 5% of EU GDP already took decisive steps towards in 2019. In its autumn forecast 2020, their recovery before the creation of the EU Commission showed that the NGEU (i.e. since February 2020) are the EU package could contribute allowed to include those in their plans. to a significantly quicker and more This will help to make funds flow as sustainable recovery, resulting in an soon as possible. up to 2% higher GDP in the coming years. The Recovery and Resilience Meeting predefined milestones and Facility (RRF) is going to be the main targets is a prerequisite for the payout distributing instrument of NGEU of the funds. Given the highly uncertain with a volume of up to 672.5 bn Euro, economic outlook as well as internal representing 90% of total NGEU. imponderables, including possible bottlenecks and absorption problems, The disbursement of funds is there is a risk that some of them might conditional on the implementation of be missed, especially further down the reform and investment packages by timeline. Member States, set out in individual national Recovery and Resilience Plans However, timing is key to support the (RRP). Member States are currently recovery effectively. That is why all drafting their RRP that should be funds have to be allocated by the end of submitted to the EU Commission by 2023 and disbursed by the end of 2026. end of April. Member States will have the possibility to update their national plans in We are, hence, at a crucial moment of 2022, when 30% of the RRF funds are the RRF process. Member States should newly distributed based on the latest now set up ambitious plans in line with economic data. While necessary, the conditions laid down in the RRF calculating plausible cost estimates and

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billion instrument to help protect The big picture jobs. As of mid-March 2021, we had raised 2/3rds of EU SURE funds in NextGenerationEU gives an ambitious 5 very successful issuances. All EU answer to an unprecedented crisis. SURE bonds benefit from the social It demonstrates solidarity at difficult bond label. times. It has shown that the EU can and will stand together to face challenges. It NextGenerationEU is a game-changer. will help transform our economies and With volumes of €150-200 billion per societies for the better. year, it will make the Commission one of the biggest issuers in euro, at par There is more. NextGenerationEU – with the largest sovereigns. building on the success of SURE – will turn the EU into a major player on the Facing the growth challenges global capital markets. The EU bonds represent safe financial instruments This has called for a fundamental in euro, which are appealing for change in our approach. Given the international investors as we see in volumes, frequency and complexity of the huge oversubscription rates of our the borrowing, the Commission will recent issuances. Financial market have to act like a sovereign borrower. participants tell us that they will look GERT-JAN at the EU-B yield curve as they price We will, therefore, implement a other paper. Should this materialise at KOOPMAN diversified funding strategy. This will scale, then the issuances will further Director-General, allow more flexibility in the timing of the EU capital market integration. DG Budget, European Commission funding transactions and the choice of Finally, the bonds are making euro funding instruments and maturities. As denominated paper a much more part of this, we will also be using short- attractive investment destination term debt instruments – EU-Bills. and, in the process, strengthening the Recourse will also be given to auctions international role of the euro. Making the as an issuance channel, in addition to syndication. The Commission intends The EU SURE social bonds and the recovery work: to raise 30% of the funds as green bonds. future NextGenerationEU green bonds are making the EU one of the NextGenerationEU as Our ambition is to have a regular biggest Environmental, Social, and presence on all parts of the yield curve Corporate Governance (ESG) issuers a game changer on with large, liquid and safe EU-Bonds. – which is inspiring others to choose this approach. the capital markets In this way, we will be able to reconcile the demands and constraints of the The big challenge now is to make all NextGenerationEU funding, and of this start on time. The Commission deliver all funds as required on the is working hard to that end – and 2020 was an extraordinary year in most advantageous terms for the EU. we count on the support of all EU policy making. The EU was hit by interested stakeholders. Together, we an unprecedented crisis. Politicians Next steps stand stronger. and policy-makers had to act quickly and comprehensively to find and The Commission intends to start offer solutions. issuing funds under NextGenerationEU in the summer of 2021. NextGenerationEU – a game changer For this to happen, two key conditions The EU provided a very concrete have to be met. First, Member States response. At the heart of this was an need to complete the ratification of unpreceded €1.8 trillion package – the Own Resources Decision, the backed by the EU budget - to support piece of legislation that will enable the the economic recovery and build Commission to borrow. Good progress a greener, more digital and more is being made and we expect the resilient future. To finance a part of it process to be completed in due course. - the €750 billion NextGenerationEU Second, for Member States to received instrument - the EU will borrow on the funding under the €672.5 billion capital markets. Recovery and Resilience Facility (RRF), their Recovery and Resilience Plans The European Commission, on behalf need to be submitted and approved, of the EU, has been present on the with all relevant details settled. The capital markets for years. We have RRF accounts for 90% of the funds been running lending programmes to under NextGenerationEU, the rest will support EU Member States and third go to several EU programmes that will countries. all be up and running in the summer. Once the plans have been approved, In 2020, the Commission also started the Commission will be able to start borrowing for SURE – the up to €100 disbursing the first funds.

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two objectives, and the related tools, The third risk relates to the long-run are and must be interconnected, but sustainability of the recovery. Too often they also require diversified approaches we talk about recovery by focusing and tools, and each will have to be entirely on aggregate variables. evaluated with appropriate criteria. However, this approach is insufficient and dangerous. If GDP returns to pre- I see three risks here. The first relates to crisis levels but inequality in income the recovery. This recession is peculiar and wealth distribution is even because it simultaneously affects greater than before the crisis, this risk the demand and supply side. But the jeopardizing the economic and social implications for the recovery of this sustainability of the recovery itself, aspect - and of other no less relevant undermining the European long-term ones - are usually not adequately growth. Therefore, when preparing discussed. Attention seems to be national plans, we should also take this focused almost exclusively on what dimension into account. are considered the structural problems pre-existing to the pandemic. This is As European Parliament, over the next not wrong, but it may not be enough years, we will be vigilant to ensure that if the specific structural effects of the the Commission carries out the tasks recession on production methods, assigned in appropriate ways so that the IRENE TINAGLI on the composition of aggregate facility reaches its objectives, especially Chair, Committee on Economic demand or on expectations for the in terms of digital and environmental and Monetary Affairs, future are also hampering recovery. transformation, social impact and the European Parliament These new structural effects must also Next Generation policies that we have be considered. envisaged for the Union.

The second risk relates to the link between recovery and resilience. Structural problems to be removed Three challenges for are rightly the core of the current discussion, but few seem to care about the implementation of the intensity and speed of the effects such projects may have on economic Next Generation EU recovery and their ability to remove the additional structural obstacles created by the recession itself. Delaying and weakening recovery can have Next Generation EU (NGEU) has devastating effects in the long run, rightly been hailed as a paradigm especially for those young people to shift in EU governance, or at least whom we all pay great attention. the first step that hopefully will not fade with the pandemic. NGEU is not just the money made available to Member States. It represents also a paradigm shift in terms of defining Recovery and the cornerstones of future economic development and the role of public resilience are policies in the next decade. and must be interconnected, but There are three keywords to frame the NGEU method: programming, direct they also require intervention, resource allocation. The diversified approaches accompanying documents of NGEU and tools. define a lot of detail required in the control and in the governance of the processes, and this represents an ambitious challenge for all Member States. National governments have to As numerous studies show, delayed present national plans aimed at two entry into the labour market or an objectives: recovery and resilience. entry in a depressed state of the economy has negative effects on the The first is a shorter-term objective that entire (working) life of young people. requires well-designed fiscal measures This does not seem to be a secondary aimed to reduce as much as possible effect and it would be good to take the economic and social damages it into account in a conscious and created by the pandemic, and to restart responsible decision-making process. economic activity. The second is a Here our challenge is how to combine longer-term objective concerning the reform and recovery in national plans, ability to favour structural changes in and what is the best sequence of reform the economic system. Obviously, the and recovery interventions.

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economy by EU governments, in the reforms will determine the overall context of temporary waivers of the economic impact of the RRF. Secondly, State Aid rules, and by central banks. the successful combination of the These support schemes have taken conventional EU programmes, as the form of public guarantee schemes, Cohesion policy, and the RRF and debt moratoria and direct support the institutional and administrative to some firms via outright state aid. capacity of the Member States to put Central banks expanded their balance in place high impact projects quickly. sheets further through asset purchase Thirdly, additionality. The RRF programmes ensuring the maintenance funds must enable the deployment of of liquidity, and micro- and macro- investment projects that would not prudential supervisory rules for banks be possible to deploy otherwise. If were temporarily loosened. RRF grants are simply used to finance investment that already has other While this support has been crucial funding sources or to crowd out private to keep the economy afloat, it has investment, then the RRF will simply be invigorated a debate on whether such a missed opportunity. policies are appropriately targeted at economically viable firms hardly hit The RRF Regulation provides the by the crisis, or if their broad base may opportunity to deploy and use resources RICARDO induce the risk of some “zombification” through financial instruments. of the European economy. Financial instruments increase the MOURINHO overall impact of the resources, thus Resources are scarce, so any support fully unleashing the growth potential of FELIX to the economy should be targeted the EU economy above pre-crisis levels. Vice-President and Member at viable companies. Lending and of the Management Committee, supporting non-viable companies on The extensive experience of the European Investment Bank (EIB) the back of public guarantees erodes EIB Group in delivering financial the public purse, artificially preserves instruments and our technical firms with no future and retains their assistance platforms can act as workers, instead of putting their important levers for Member States productive capacity at the service of to evaluate investment needs, assess viable value-added projects. Support to barriers and setup the most adequate Challenges and companies should never be a substitute financial instruments. The advisory for insurance schemes, capacity of the EIB can support the opportunities of the which were long ago designed to ensure design and the development of funds a better job matching. Schumpeterian and financial instruments under RRF, new Recovery and creative destruction is a critical part of a including national recovery funds sound and competitive internal market or the implementation of financial Resilience Facility and key for a green and smart recovery instruments through the national that boosts productivity, growth and compartment of the Invest EU. generates well-being for our citizens. The EIB stands ready to provide its The European Union’s (EU) package for support, its expertise and its capacity supporting the recovery of a European to governments and companies that economy devastated by the coronavirus want to fully seize the opportunities of crisis is a very bold step. It is totally The RRF paves the new RRF. As the EU bank, we stand unprecedented. the way for future together with the other EU institutions to deliver on the Union policy priorities The Recovery and Resilience Facility growth by supporting to grant citizens a future of Freedom, (RRF) will contribute to the EU’s innovation, promoting Solidarity and Prosperity. economic recovery, supporting viable companies and, productive public investment and the implementation of structural reforms. thereby, contributing Despite being a temporary policy, the to a green and RRF impact should be a permanent smart recovery. oneand will contributeto an increase in productivity and to sustainable growth prospects. Governments and companies have the duty to seize this opportunity to change gears and The RRF opens up new opportunities foster a greener, smarter and more to leverage the scarce public resources. resilient economy for the EU citizens. Achieving an effective and efficient A more inclusive economy with allocation of resources is of the lower inequality and ready for the essence, and it is intrinsically linked to forthcoming challenges, leaving no one several factors. behind. This is an imperative! Firstly, the rigorous selection of the most The COVID-19 crisis led to an productive public investment projects extraordinary financial support to the and an effective implementation of

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 39 POST-COVID CHALLENGES AND PRIORITIES

have experienced negative average As the Recovery Fund goes live and with investment growth, and even France a view to a common debt instrument, and the Netherlands saw a decline in we are confident the EU will continue investment growth of nearly half. The to work with best-in-class arrangers package could help hard-hit Member to be well-positioned for successful States improve levels of investment issuance in different market conditions. which could bring GDP growth in- This will allow access to a diverse and line with the rest of the EU and thus increasingly global investor base, in strengthen the entire compact. terms of type and geography, and the broadest possible market intelligence If the EU were inclined towards the for future transactions. It would be creation of a “safe asset”, common debt reinforcing to see more EU countries issuance could contribute to this goal, making use of these programmes. possibly facilitating ECB monetary policy. There is likely appetite for a safe asset since debt issued by highly- rated EU countries represented only c.29% of outstanding sovereign EU debt as of end-2020; with €750bn, that would increase to c.35% of 2020 debt. VITTORIO Continued, regular issuances and a liquid curve will also be necessary for GRILLI the full development of a safe asset. Chairman of EMEA Corporate and Investment Bank, Though implementation of investment J.P. Morgan and reform will remain critical, a safe asset coupled with a more dynamic, balanced and cohesive EU economy could lessen concerns of tail risks and thus support the international role of the euro. Strengthening the internationalisation of the euro and Common debt the EU’s future issuance is a potential game-changer for competitiveness Europe’s economic through common growth dynamics through the debt issuance Recovery Fund.

The unprecedented EU recovery package was a milestone for deeper SURE has proved a successful instru- fiscal integration, with extraordinary ment for debt issuance due to the clear measures enacted to support Member communication to the market on deal States grappling with the fallout of sizes, tenors, timetable and “what” in- COVID-19. Common debt issuance is vestors would be buying, as well as co- a potential game-changer for Europe’s ordination with other supranationals. economic growth dynamics through The use of a Social Bond Framework the Recovery Fund, with the potential proved fruitful given the thematic dom- to strengthen the internationalisation inance of ESG amongst global investors, of the euro and the EU’s future whilst the general market backdrop was competitiveness. favourable and led to record order books for SSA issuers in recent months. The recovery package’s focus on investment could lift Europe out of J.P. Morgan was delighted to be secular stagnation. Average annual appointed as joint-lead on a SURE (inflation-adjusted) growth in EU transaction and we endeavour to investment declined from c.3.4% (1999- continue supporting SURE and the 2007) to c.2.6% (2011-2019), whilst deployment of the Recovery Fund. We the euro-destabilising variance in have operated in the region for close investment across Member States has to 200 years and our commitment to been even more dramatic across the companies and our clients remains same period. Italy, , and Portugal unwavering.

40 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net We thank the partner institutions for their support to the organisation of the Eurofi April 2021 Seminar POST-COVID CHALLENGES AND PRIORITIES

FOSTERING MORE INVESTMENT IN THE EU

Even the European Commission has This year, we do have a few chances to concluded in its “Sustainable Europe get the incentives right: We have three Investment Plan” communication that big files that will allow us to set the reaching the “old”2030 climate target tracks into the right direction. Firstly, of a 40% reduction in greenhouse gases we have the implementation of the would require an additional 260bn Basel III finalisation package, which EUR in investments. That was arguably will determine in a major way how before the European Union decided to and under what conditions European substantially increase its 2030 level of companies will be able to finance ambition and before the impact of the themselves through banks. At a time, Covid-19 crisis. when we want European companies to make productive investments, we The pandemic has hit public finances should be very careful to calibrate the hard and has directed both, public funds new Basel framework in a way that is and attention away from climate issues conducive to that goal. and towards immediate crisis relief. The economic fallout of the pandemic Secondly, we have the review of MiFID will therefore have only increased II, which sets the ground rules of how the investment gap. Part of that delta financial markets in Europe work and might be compensated for by the EU’s how European companies can tap into MARKUS Recovery and Resilience Facility that those markets. We should work on this comes with specific spending targets recast with a view to strengthening FERBER for digital and climate expenditure. EU financial markets, cutting red tape MEP, Committee on Economic and facilitating market access for both and Monetary Affairs, companies and investors. A smart European Parliament review of MiFID II will go a long way in bolstering up companies’ equity If we want to plug base and will allow them to invest in the investment gap, profitable business ventures. we cannot rely on Thirdly, we have the review of Solvency Setting the right public money alone. II, which governs how insurance companies can operate across the single incentives for private market. Insurers are the perfect long- term investors. They have a long-term investments time horizon and predictable cash- Nonetheless, in light of a higher level flow needs, yet they currently invest of ambition and additional pressure too little in long-term projects, which on public finances, the investment is due to regulatory reasons. With the The world as we know it as well as our gap has probably increased rather Solvency II review, we have a shot at economies are changing rapidly. To than narrowed. That leaves one major fixing that issue. deal with this change, the European conclusion: If we want to plug the Union has given itself an ambitious investment gap, we cannot rely on If we want to bridge the investment agenda and identified two major public money alone. Even in times of gap, we need to get the legislative challenges to prepare for: the twin an exceptionally favourable interest framework right to incentivise transitions towards a more digitised rate environment, public finances are private investments. economy and towards are less stretched. The debt-to-GDP ratio in carbon-intensive economy. the Eurozone will likely surpass 100% this year and getting back towards Particularly the latter one will require somewhat sustainable debt levels, massive amounts of investments as it will leave little fiscal space for grand implies a fundamental remodelling of expenditure programmes. our energy infrastructure from energy generation to energy transmission. Ruling out the public sector as a big driver of overall investment, Unfortunately, those investments are leaves private investment as the key not easy to finance. Even before the contributor. Private companies will not Covid-19 pandemic struck, we had a finance the EU’s policy priorities out consistent and substantial investment of the kindness of their heart though, gap in the European Union, which but because they expect a reasonable the European Union attempted to return. The underlying pre-condition address with the European Fund for for that is a favourable and predictable Strategic Investment (EFSI) and later regulatory regime, which we have a the InvestEU programme. hand in influencing.

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among many factors contributing to The common and coordinated such an outcome. European approach to tackling the pandemic’s economic consequences is The longer the crisis lasts, the greater an expression of European solidarity, the risk of major cross-country but it also makes good economic sense. divergences becoming entrenched, Economic and financial spillovers leading to a fragmentation that would spread fast through the Single Market disrupt the functioning of the internal and Monetary Union, supporting market. A protracted crisis also risks growth in all Member States. inflicting deep scars on the fabric of Moreover, high-quality investment the European economy and society, and reforms address the challenges predominately through bankruptcies ahead – combatting climate change and higher unemployment. and supporting digitalisation. Our efforts are now fully geared towards the Given the disproportionate impact implementation of the RRF. Member of the crisis on economically more States have been developing – in close vulnerable people, including youth and cooperation with the Commission women, a deepening of pre-existing – Recovery and Resilience Plans inequalities is also a real risk. that outline national reform and investment measures. DECLAN The Member States and the EU have reacted swiftly to the enormous A lot of work lies ahead. However, COSTELLO economic impact of the Covid-19 crisis. there are good grounds to believe Deputy Director General, DG for Swift and determined policy action that Recovery and Resilience Plans Economic and Financial Affairs, at all levels has helped to shield firms can be finalised in months, allowing European Commission and workers from losing earnings and disbursements to commence around jobs in the acute phase of the crisis. summer. Next Generation EU and the The European Commission’s €750bn- RRF should be seen as Europe’s attempt Recovery Instrument, ‘Next Generation to ‘build back better’, an endeavour that EU’ (NGEU), complements the various will require ambition to combine the emergency measures by supporting investments in the right areas with the Next Generation EU: a swift recovery and building a more adoption of essential reforms. resilient European economy in the a pillar of the recovery wake of the crisis.

More than a year after the outbreak of the Covid-19 pandemic in Europe Next Generation the economic recovery is yet to gain ground. The breakthrough in vaccine EU and the RRF are development in the autumn and the Europe’s attempt to start of mass vaccination campaigns ‘build back better’, are a game-changer that significantly brightens the economic outlook. But combining future- in the meantime, renewed waves of the facing investments pandemic have forced many Member with essential reforms. States to reintroduce or tighten containment measures.

As a consequence, economic activity has remained subdued in the first months of Its centrepiece, the Recovery and the year. In its winter interim forecast, Resilience Facility (RRF), will deliver the European Commission projects financial support for investments and only a mild uptick in economic activity reforms in a fair manner. The allocation before summer. Once the assumed, of financial support takes account of gradual relaxation of containment economic needs arising from the crisis measures truly picks up pace in the while supporting the green and digital second half of the year, the economy is transitions of the European economy. expected to start recovering. If implemented swiftly, with a strong Yet, just as the pandemic’s initial hit focus on high-quality public investment was very uneven across Europe, so will and additionality, the level of real GDP Member States’ recovery paths be. More in the EU could be roughly 1.5 to 2 1. European Commission (DG ECFIN) (2020), European than half of Member States are forecast per cent higher than without NGEU, Economic Forecast Autumn 2020, European Economy Institutional Paper 136, p.65-70. to close the distance to their pre- according to stylised simulations with 2.  QUEST is a structural macro-model in the New- crisis output levels by the end of 2021. DG ECFIN’s QUEST model.1,2 This Keynesian tradition with rigorous microeconomic Others are expected to take longer. The would help not only the sustainability foundations and frictions in goods, labour and financial markets. See Burgert et al. (2020), ‘A Global Economy economic structure — and the share of of our economic model, but also that of Version of QUEST: Simulation Properties’, European the tourism sector in particular — are public debt. Economy Discussion Paper 126.

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 43 POST-COVID CHALLENGES AND PRIORITIES

Still, their first buffer for shocks, insolvencies has so far been avoided – profitability, was subdued even before to the contrary, exactly the opposite the crisis. This was slowly chipping has happened as insolvency rates away at the ability of banks to provide have fallen below even the levels funding to the economy and act observed in good years. However, as a transmission mechanism for insolvencies will gradually catch-up monetary policy. as broad-based support measures are gradually unwound, even if potentially The reasons for low bank profitability destructive cliff-effects of a too-early are multiple. European regulators withdrawal are avoided. have not always been vigorous to push inefficient banks with broken Banks will have to make complex business models out of the market. decisions to restructure debts of viable Such decisions are not always easy – companies and pull the plugs on non- as we in the Croatian National Bank viable businesses. The role of a neural know very well. Over the past two and vortex entails cleaning the economy of a half decades, since I got my first job “zombie” firms, which have survived due at the Bank, the number of commercial to ample support, but lack the flexibility banks operating in has shrunk to adapt to changing circumstances. BORIS by about two-thirds, coming from 60 This should not be taken lightly. down to 20. This has always been a sensitive job, full of legal and political An old Indian saying that a healthy VUJČIĆ landmines, but the alternative of person has a thousand wishes, a sick Governor, overbanking is, as we can attest, person only one, can be adeptly applied Croatian National Bank even worse. to policymaking. As our societies overcome the disease, we will again have to deal with our thousand regular issues in the financial sector, many of them exacerbated by the crisis. Our Thousand financial As our societies banks are even more intertwined with national governments than before problems of a overcome the the crisis, dynamism in the corporate disease, we will sector has further dropped and banks healthy society again have to deal may again have to deal with a pile of bad debts. with our thousand regular issues in the And the banking union still stands While the magnitude of the initial shock financial sector. uncompleted. So, as we cheer the brought by the COVID-19 pandemic departure of the disease, we’ll be moving may have run out of scale, European to many old unresolved issues again. policymakers reacted with speed and decisiveness, in a way that may provide a temptation to congratulate Further on, banks have been slow themselves. With lockdown policies to reinvent themselves in the face struggling to contain the virus and of advances in information and in scarce vaccine supplies, the lifeline particular mobile technologies. After provided by the unprecedented fiscal, several decades of warnings that monetary and regulatory stimulus has repeatedly turned out to be false kept our economies afloat. alarms, the speed of technology diffusion in finance has been Not only employment and incomes accelerating. In essence, banks need remained resilient, but also our to become technology hubs in order to financial sector, strengthened by the maintain their most cherished lines of decade of continuous reforms, provided business. Technological transformation a lifeline to companies. However, if we may be painful for banks, and for look beyond the obvious, we may find bankers in particular, but it is the only the same old problems that warrant way forward. caution and vigilance. Finally, the long period of extremely The banking sector is indeed operating accommodative monetary policy has on a lower leverage, taking fewer risks, driven interest margins down and maintaining substantial liquidity compressed income from banks’ core reserves, and overall becoming much business. According to most market more robust and resilient than it was observers, this headwind is not likely to a decade ago. In contrast to the global disappear any time soon. financial crisis, when the financial system triggered the initial shock On top of reinventing their operations, and continued to amplify it, this time dealing with the aftermath of the crisis round banks stood ready to cushion will be particularly challenging for the blow and stabilize the economy. banks. A sharp increase in corporate

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value into profitable endeavors. Of Third, frontloaded and investment- course, some of the recent investment geared fiscal support is needed both at weakness is cyclical, but it is not the the national and the EU level. The euro whole story. Structural factors must area non-financial investment has not play a role there, too. Let me point to yet fully recovered from the austerity of three such factors. 2012-15. In view of worsening corporate balance sheets, low cost of sovereign First, the EU common market is still financing makes it possible for the in many ways fragmented, particularly public sector to fill in the most critical in services. Take the digital domain. private sector investment shortfalls. Different national requirements still act as virtual borders. Building scale quickly True, national fiscal policies have been to harness network effects is crucial and expansionary during the Covid-19 the national markets of even the largest crisis, but little of it has supported EU countries are too small for that. It investment. While the USD 1.9 trillion is somewhat ironic that cross border Biden package could risk being too retail transactions in the EU are mostly concentrated in time and overheat enabled by payment solutions developed segments of the US economy, it is outside the EU. We need to complete the projected to close the output gap single digital market and create a retail already at the turn of the year. MĀRTIŅŠ payment solution based in the EU. The latter should ideally be a private sector The EUR 672.5 billion EU Resilience KAZĀKS solution. A digital euro could support it. and Recovery Fund is a very welcome Governor, step in the right direction but is Bank of Latvia Second, financial markets in the EU are stretched over five years, only to visibly dominated by banks. Underdeveloped kick in towards the end of the year and capital markets, especially in smaller will not close the negative output gap jurisdictions, mean fewer sources neither this year nor next. With single of financing for investment and monetary policy, a larger common We have brought innovation, less diverse risk taking fiscal capacity would yield a more and a limited set of business strategies, effective policy mix. If we let long-term water to the horse, especially if the market is dominated investment dwindle, productivity and by just a few big lenders. Moreover, income growth will be anemic. but we cannot make the profitability of the European banks has been weak and that is only partly a To summarize, in addition to monetary the horse drink cyclical issue. policy, we need two more games in town - structural reforms and bolder fiscal policy. Paraphrasing an old saying, central banks can make sure that there Since the global financial crisis and, is plenty of water in the river, we can in particular, during the Covid-19 In addition to even bring water to the horse, but we pandemic major central banks have cannot make the horse drink. provided ample monetary policy monetary policy, we accommodation. By several measures, need two more games the ECB has provided more support in town - structural than the Fed. Since 2017 the balance sheet of the ECB in percent of GDP reforms and bolder has substantially outgrown that of fiscal policy. the Fed. The Fed never resorted to negative rates.

Euro area nominal and real interest rates are near their historical lows. Despite the efforts to strengthen the Targeted long-term refinancingEuropean banking union, banks largely operations provide very favorable remain domestically oriented, with financing conditions to banks that pass a strong bank-sovereign nexus. As a this funding to their lending portfolio. result, they are not able to reap the full Tiering shields bank profitability by benefits of . Extra reducing the cost of holding excess efforts are needed to move towards reserves when banks cannot pass this a genuine . cost to their clients. At the same time, banks cannot and should not intermediate all risks. Unless policy rates go beyond their reversal rate levels, which they have A more diverse financial market not, zero or negative interest rates ecosystem is a must. Deep and well- are supportive to investment. Ultra- functioning capital markets are not low interest rates should encourage a luxury. Without a dynamic capital investment as they expand the universe market, Europe risks more under- of profitable projects, turning some of investment, a less vibrant economy and those that had negative net present lost opportunities for its citizens.

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nises that these types of solutions are money to a sustainable future. Positives likely during crisis, but we will be there are already occurring in and the to advise when such emergency meas- , with both countries ures need to be reversed to promote a attempting to move to a future less private sector-led recovery that is both dependent on coal.3 inclusive and sustainable. Separately, in , the Central When we interpret “sustainability” in Bank is working with the EBRD to its broader sense, meaning the ability develop a sustainable capital markets to continue over a prolonged period development strategy, which will of time, we need to look at the diverse complement its ongoing initiatives tools at our disposal. At the EBRD, we aiming to green the financial system are committing all of our activity in and to mitigate the risks of climate 2020-2021, worth €21 billion, to help change. A similar project is ongoing our regions counter the economic in . impact of the pandemic.1 Separately, all eleven CEE EU members will be The genesis of many of these initiatives net recipients of grants and will have pre-date the Covid crisis, but are even access to new, cheap loans under the more relevant now. And there are other PIERRE EU’s EUR750 billion pandemic recovery reasons to be optimistic for the CEE plan. It is encouraging that the Rating region: the International Renewable Agency, Fitch, forecasts higher growth Energy Agency has confirmed that HEILBRONN for all bar one of these countries in there is huge potential for clean energy Vice President, Policy & Partnerships, 2022 than 2021, making the CEE region there. According to a recent study, European Bank for Reconstruction stand out.2 the economies of Central and South- and Development (EBRD) Eastern Europe could cover 34 per However, no single source of finance cent (from 16% in 2015) of their rising will come to the rescue – they need to energy demand cost-effectively with be manifold and diverse. That is why renewables by 2030.4 the EBRD has focused on introducing new products in the region, such as At the EBRD, we stand ready to support Recovering the Commercial Paper (CP) programs them in their transition. to mobilise emergency assistance for sustainably from working capital as well as Banking sector capital Instruments to strengthen the the Covid-19 crisis – capital base and promote new lending. focus on CEE

We must tackle The word “sustainability” is in vogue this recovery in a now – it is used so often and in many different contexts that its original manner that endures meaning can sometimes get lost. But beyond emergency when it comes to recovering sustainably interventions, so that from the economic crisis precipitated by the Covid-19 pandemic, we need we give true meaning to go back to first principles. It is to our promise to important that we tackle this recovery Build Back Better. in a manner that will endure beyond emergency interventions, so that we give true meaning to our promise to “Build Back Better.” Interpreting “sustainability” in the more Understandably, the emergency re- narrow sense, in terms of its impact sponse of governments worldwide, on environmental matters, the EBRD including in the Central and Europe- recognises how important it is that an (CEE) region, has been focused on there is a post-Covid . individual’s incomes and corporate The emergency response in the CEE liquidity. Because of the severity of has so far not focused on green stimulus the crisis, there is always the risk that measures. However, if they are properly well-intentioned kneejerk reactions targeted, public policy interventions could lead to less sustainable outcomes. could spur economic growth in a more For example, increase in state owner- climate-friendly way. Policymakers 1. https://www.ebrd.com/what-we-do/coronavirus 2. https://www.fitchratings.com/research/sovereigns/next- ship of companies to protect corporate should harness this unprecedented generation-eu-fund-to-boost-cee-sovereigns-growth- balance sheets is likely viewed as sys- opportunity and use it as a springboard in-2022-13-01-2021 temically important. As a multilateral to a greener path. And a new vibrant 3. https://think.ing.com/uploads/reports/CEE_Green_ Opportunity_Master_3_Nov_-_FINAL_.pdf development bank with a distinct pri- group of investors is supportive of ESG 4. https://www.irena.org/-/media/Files/IRENA/Agency/ vate sector mandate, the EBRD recog- goals and they are not shy in directing Publication/2020/Oct/IRENA_REmap_CESEC_2020.pdf

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Responding to the emergency by Besides, the regulatory environment providing cash and short-term debt is only applicable to long-term investment part of our job. Financing the recovery by should not be discouraging so that providing long-term financing is another long-term financial players can part. Following a sharp increase in accomplish their role as a “catalyst”: indebtedness, strengthening companies’ from this point of view, vigilance is equity is another challenge. For that one, required, for example, on the possible we, NPBIs, must take risks and leverage reinforcement of capital requirements on other financial resources. This is why on banking investment in equity with the success of European Program like the Basel IV transposition. InvestEU is so important with the direct access to European guarantee granted As said above, recovery is only one to NPBIs. part of the job. The most substantial part of it is to ensure resilient growth, In a context of strong uncertainties sustainable development and digital and low interest rates (which pay transition and therefore adapt our poorly for risk taking and long-term economies. For this, we ought to commitment), it is quite difficult to build a diverse ecosystem of financial find long, patient capital in capacity to institutions with NPBIs playing a key bear risk. However, there is a paradox part and appropriate incentives in LAURENT on which we could count on. Because terms of long-term sustainable finance. of the current crisis betting on long Taxonomy, reporting, incentive ZYLBERBERG term is probably less risky than on short measures and many other elements Director of Public, term! Having said that, we shall not shall be defined towards this goal. International and European Affairs, shoot ourselves in the foot. Caisse des Dépôts (CDC) Finance of all sorts, unite! Together we All the actors should work for shall do more! establishing a positive and incentive regulatory framework. Financial robustness and stability shall not be regarded as incompatible with risk Public finance is not taking in the long term. Of course, this is lacework, especially for prudential the problem, it’s part and accounting concerns, but it is worth to do it rather than having a of the solution! holistic vision which could have so much collateral damages.

In this unprecedented crisis that our economies have gone through and from which we continue to suffer the Together we shall consequences, one must think without do more! blinders. We all see the new legitimacy of public intervention. We, NPBIs, have spared no efforts to contribute to the deployment of various and massive emergency measures. This is not In this context, because of our positive enough! Our role is also to prepare the track-record, our knowledge of local future by restoring today’s economies needs and the constant support we and preparing tomorrow. received from public authorities, we, NPBIs, have a major role. We Figures speak by themselves, in accompany our partners for taking France alone, in 2020, CDC via its risks and committing to long horizons, subsidiary Bpifrance has supported we help them into taking account 630,000 companies for an amount of of externalities in their investment loans guaranteed by the French State decisions. Based on that, we can be of €130 billion. Among many other considered as “enablers”. initiatives, we also set up regional funds with local authorities (more than But for them to give their full potential, €300 million) for small businesses and the NPBIs must benefit from support not social economy. only from their national governments (within the framework of domestic At European level, figures make dizzy (€ recovery plans) but also from European 750 billion of immediate measures in 2020 institutions as “implementing partners” in 5 Member states). European NPBIs of the EU financial instruments. In this gathered in ELTI1, were mobilized on all respect, InvestEU as a cornerstone fronts (loans, equity, guarantee) to support of the EU recovery plan illustrates their domestic economies and mitigate this new decentralized approach of the severe effects of the pandemic. investment policies. 1. European Long Term Investors Association

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not seem to have lost all traction, and negative territory and further loosened we will have to wait until well after refinancing conditions for banks. The the health situation normalizes to see latter might positively influence banks’ whether Covid -19 has pushed Europe ability to charge negative interest into the liquidity trap. rates on customer deposits, but the process remains slow and uneven, and In the context of the EU’s Capital still tilted more towards corporate Markets Union project, it is nevertheless deposits than households’ deposits (See unfortunate that the massive liquidity Bundesbank Monthly Report February injected during the pandemic has not 2021 Box pp34-35). found a more effective use. Europe already had a huge pool of savings While acting further on these two levers before Covid. The share of cash to might alleviate the risk of falling into a financial assets held by companies has liquidity trap, they would not make the increased by two percentage points to allocation of savings in Europe more an all-time high of 12.4% over the past effective. This can only be achieved by three quarters. completing the Capital Markets Union and, above all, by incentivizing retail More than two-thirds of households’ investors to increase their direct or financial transactions last year landed in indirect holding in equities. Beyond SYLVAIN bank accounts, while less than 2% were the planned reviews of the regulatory used to increase direct equity holdings. framework for institutional investors BROYER Cash and deposits replaced equities as (Solvency II, AIFMD, ELTIF, MiFID Chief Economist EMEA, the main class of financial assets held by II/R, CRR2), access to independent Fixed Income Analytics, European households in 2008. financial advisers and improvements in S&P Global Ratings Europe Ltd. savers’ financial literacy are essential. Since then, the return on bank deposits has fallen to zero, while dividends on Positive tax incentives for retail European equities offered a constant investors would also help shift savings 3% per year. The unproductive use of from bank deposits toward direct EU savings is not only unfortunate for or indirect equity holdings if banks The role of the savers. It is also regrettable for SMEs remain hesitant to pass negative in Europe which, as the IMF recently interest rates to retail depositors. In a Capital Markets pointed out, suffer from a substantial post-Covid world, the poor alternative equity gap of about 2%-3% of GDP (See to completing Capital Markets Union Union in avoiding IMF WP/21/56). This gap has widened would be for EU states to fill the SME due to Covid -19. equity gap. This would necessitate the liquidity trap direct participation financed by taxes. Europe can do better.

Capital Markets Union is vital to the The liquidity trap occurs when The Capital Markets economic recovery. It can help avoid consumers and businesses show an the liquidity trap and spur investment absolute preference for holding cash Union, spurring by providing a better return on savings. rather than investing because returns investment and are too low. This leads to the central return on savings, bank no longer being able to influence financing conditions. How can Europe is vital to the avoid the liquidity trap? economic recovery.

European households and corporates have hoarded a large share of the liquidity that governments and central banks have injected into the economy to There are two ways to escape a liquidity combat Covid-19 pandemic. However, trap, as Buiter and Panigirtzoglou that does not mean Europe has already described (See NBER WP 7245). The fallen into the liquidity trap. After all, first is fiscal expansion. The second Europeans have had little opportunity is for the central bank to lower the to spend amid strict lockdowns. effective zero low bound on interest When restrictions to demand were rates. Covid -19 has helped reduce lifted temporarily in summer 2020, the liquidity trap risk somewhat by households considerably scaled back triggering a bold policy response, both their savings. monetary and fiscal. The EU Green Deal would probably not have been Moreover, productive investment has endowed with €750 billion funding not decline further than GDP last year. without the pandemic. EU budget rules In fact, it has increased continuously would not have been relaxed. faster than GDP since the ECB introduced negative interest rates and The ECB would probably not have QE in 2014. So, monetary policy does pushed long-term yields further into

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investments in microprudential regu- lowered and the capital requirement for lation. When taking into account the fixed income instruments is increased. time horizon of insurers as going con- cerns, the schedule of their cash flows The French government has given and the structure of their liabilities, it much thought to the investment is clear that a balanced portfolio com- role of insurers for years and seeks to prising a sizable portion of well diver- address it in part by creating a sizable sified equity investments is a better pot of hybrid instruments. French match than the current mix of their insurers would invest in diversified assets, which is massively overweight funds of hybrid loans extended to in fixed income. However, once the de- French SMEs; these funds would cision has been made instead to devise benefit from a first loss guarantee capital requirements on the basis of a from the French government, so as mistaken one-year horizon, there is no to apportion the risk between the escaping the fact that equity values can issuer, the underwriter, the investor drop a lot in an accounting year, and and the taxpayer. Depending on the thus to require a larger amount of cap- quality of the underlying credits, the ital for investing in equity rather than interest rate charged, the attachment in debt instruments, notwithstanding point of the public guarantee and CYRIL ROUX their higher correlation and their lower the diversification of the funds, rate of return. these funds might help the national Deputy Chief Executive Officer, economy while providing a satisfactory Groupama It is unfortunately likely that the risk-return profile to their institutional revision of Solvency 2 will go even investors or to the life policyholders as further in turning insurers away from ultimate beneficiaries. equity instruments. The sharpness of the drop of the interest curve in the However, the regulatory treatment is Lighter capital recent years well below zero percent yet to be known, and the misalignment and the manifest flaws in the design of interest between originators, which requirements would of the standard formula has brought may own other exposures in the EIOPA to promote a large increase in capital structure, and investors makes allow European the capital charge for fixed income the structure a complex proposition. instruments. A cursory view would Although large in absolute terms, the insurers to provide welcome a reduction in the gap between overall pot of hybrid loans would be regulatory capital requirements for around 1 percent of life insurance capital to the equity and debt instruments; it would policyholders funds. Hence, reducing seem to reduce the disincentive to overall capital solvency requirements economy invest in equity. remains key for unlocking the investment capacity of the European insurance sector.

European insurance regulation is not primarily designed to nurture the role A set of capital these institutional investors can play charges reducing in financing the European economy. The primary objective of regulation the overall solvency weighing on European insurers is to ratios of the insurance protect policyholders, from a twin sector will bring prudential and consumer perspective. The detrimental effect of this regulation insurers to reduce on investment capacity is recognized, their investment but as a side-effect. in equities. Furthermore, whenever a thought is given to the macroeconomic import of the insurance sector as a whole by EU institutions, it isn’t primarily to A plurality of governments sought for address its investment capacity, thereby this reason to reduce the regulatory gap counterbalancing the aforementioned between instruments in the revision of detrimental effects of microprudential the delegated Act by lowering the capital regulation, but once again rather to charge for some equities. However, address the risk the sector as a whole this approach is mistaken and will might pose to the economy by adding not bring about the desired outcome. a further layer of so-called systemic What counts, first and foremost, is the regulation, thereby aggravating the absolute level of solvency ratios. A set investment disincentives already built of capital charges reducing the overall in Solvency 2. solvency ratios of the insurance sector will bring insurers to reduce their There wasn’t anything foreordained investment in equities, even if the in the unfavorable treatment of equity specific capital requirement in equity is

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 49 2

FINANCIAL RISKS AND STABILITY CHALLENGES

ISSUES AT STAKE

The Covid-19 pandemic, and its impact on macroeconomic prospects as well as sovereign, corporate and household balance sheets, continue to dominate the outlook for EU financial stability. Near-term financial stability risks are contained by massive monetary, fiscal, regulatory and supervisory support. However, lasting very low interest rates and actions taken during the pandemic may generate further financial vulnerabilities related in particular to stretched valuations and levels of indebtedness never reached before in peacetime.

Liquidity issues experienced by some open-ended investment funds in March-April 2020 have moreover revived the debate about fund liquidity and more generally about the resilience of non-bank financial intermediation (NBFI), although the sector generally demonstrated resilience during this period in Europe. Further liquidity management rules and tools are being considered together with a reinforcement of the macro-prudential toolkit.

Alongside financial stability challenges, further reducing money laundering and better countering terrorism financing in the EU require completing the deep redesign of the related EU regulatory and supervisory framework that has been initiated. KEY FINANCIAL SECTOR VULNERABILITIES...... 52

Francesco Mazzaferro - European Systemic Risk Board / Boris Vujčić - Croatian National Bank / Rolf Strauch - European Stability Mechanism / Jordi Gual - CaixaBank / Alastair Wilson - Moody’s Investors Service / Xavier Larnaudie-Eiffel - CNP Assurances / Andreas Dombret - Oliver Wyman

LESSONS FROM COVID ON NON-BANK FINANCIAL INSTITUTION RISKS ...... 60

Robert Ophèle - Autorité des Marchés Financiers / Francesco Mazzaferro - European Systemic Risk Board / Nausicaa Delfas - Financial Conduct Authority / Luigi Federico Signorini - Banca d’Italia / Gerry Cross - Central Bank of / Joanna Cound - BlackRock / Denis Gepp - Federated Hermes – International / Timothy Cuddihy - The Depository Trust & Clearing Corporation

EU ANTI MONEY LAUNDERING POLICY REDESIGN ...... 68

Alexandra Jour-Schroeder - European Commission / Pedro Marques - European Parliament / Marcus Pleyer - Federal Ministry of Finance, Germany / Hannes Mösenbacher - Raiffeisen Bank International AG / Matthew Elderfield - Nordea Bank Abp / José Manuel Campa - European Banking Authority FINANCIAL RISKS AND STABILITY CHALLENGES

KEY FINANCIAL SECTOR VULNERABILITIES

by the pandemic tend to have larger future solvency problems depends on programmes with greater uptake, the evolution of the pandemic, the while countries with a higher share performance of the different sectors of employment in vulnerable sectors and the appropriateness of policy rely more on direct grants. The uptake responses. Withdrawing fiscal support of moratoria is positively correlated too soon could exacerbate the effects with the pre-crisis debt levels of non- of the economic crisis and put financial financial corporations and households. stability at risk. Maintaining fiscal Macroprudential authorities reported support for too long would increase fiscal support packages related to budgetary pressures and could delay the COVID-19 pandemic of around structural change and subsequent 14% of member countries’ combined recovery. Managing this trade-off GDP (more than €2,400 billion) to the effectively requires access to timely European Systemic Risk Board (ESRB). and reliable information on the state of the economy and the effects of The packages include public guarantees policy measures. on loans, public loans, direct grants and tax measures. By September 2020, the To provide authorities with accurate reported uptake of these programmes information, the European Systemic was roughly 4% of member countries’ Risk Board is continuously monitoring FRANCESCO combined GDP. In addition, around COVID-19 related fiscal measures and 5% of banks’ total loans were subject their financial stability implications.1 MAZZAFERRO to moratoria. It has a broad mandate, which includes Head of the European Systemic the monitoring and prevention Risk Board Secretariat, of all risks affecting all types of European Systemic Risk Board (ESRB) financial intermediaries, markets and infrastructure. It is in this context Authorities need to that the ESRB considers the overall carefully manage the implications – and in particular the cross-border and cross-sectoral trade-offs related to implications – of the COVID-19 crisis. Financial stability the duration of the support measures. The ESRB is monitoring the measures implications of that are implemented directly through the financial system, such as moratoria, Covid-19 support public guarantees on loans and credit insurance, as well as measures of measures The longer the crisis lasts and the a fiscal nature that could have an weaker the economic recovery, the impact on the creditworthiness of greater the risk that liquidity problems borrowers, issuers and investors. turn into solvency issues and losses These include loans by public entities, During the first phase of the pandemic in the non-financial sector spill over direct grants, tax measures and public a liquidity crisis was avoided, and the into the financial sector. During this equity participation. financial system continued to function. phase of the pandemic, authorities Up to one-third of new bank lending to should focus on (i) targeting fiscal companies has been subject to crisis- measures to the most affected related fiscal measures, and the prompt sectors, (ii) monitoring private debt action taken by governments has been sustainability, given that some of the essential to mitigate the impact of the measures increase the indebtedness of crisis on households and firms. The borrowers, (iii) preparing for a scenario financial system has benefited from of increased distress in the corporate fiscal support programmes as well as sector by promptly addressing potential from monetary policy. Moreover, a administrative constraints with regard flexible approach within the existing to dealing with non-performing loans regulatory frameworks has supported and restructuring and insolvency these measures, also by temporarily processes, (iv) enhancing financial relaxing some bank balance sheets institutions’ balance sheet transparency constraints. Overall, spillovers from the and upgrading reporting, and (v) real economy to the financial system coordinating policies across policy 1. See Financial stability implications of support measures have so far been contained. areas and countries. to protect the real economy from the COVID-19 pandemic, ESRB, February 2021; and Recommendation Differences in fiscal measures reflect, Authorities need to carefully manage the of the ESRB on monitoring the financial stability implications of measures of a fiscal nature taken to to a large extent, different exposures trade-offs related to the duration of the protect the real economy in response to the COVID-19 to the pandemic. Countries hit harder support measures. The scale of potential pandemic (ESRB/2020/8).

52 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net KEY FINANCIAL SECTOR VULNERABILITIES

As the Covid-19 pandemic continues inflicted by Covid-19 on the potential to drag down European economies, output and growth amplifies the need growing hopes that the recovery is to foster productive investment. around the corner pose challenges to policymakers. Finally, although it is hard to answer the old “appropriate policy mix” First, inflation has remained below question which the current crisis has the medium-term target despite the put in front of policymakers, post-crisis accommodative monetary policy. recovery calls for a clear commitment Since low inflation may signal lower to countercyclical policies to mitigate growth in the future, the pandemic uncertainty and adverse effects of shock has amplified secular stagnation precautionary savings. As some concerns as it pushed core inflation empirical evidence points out that further below the target. Therefore, there are limitations to what monetary unresolved low inflation-related issues policy can do on its own in promoting and QE-related asset price inflation will recovery, the fiscal expansion will continue to occupy policymakers in the become an indispensable tool to post-crisis’s era. support demand and to reduce the costs of the pandemic.

BORIS VUJČIĆ Limitations of monetary policy and Governor, Croatian National Bank public indebtedness concerns, which Countercyclical will inevitably emerge when the crisis is over, will make targeted and efficient use policies going of the NextGenerationEU’s Recovery beyond the short and Resilience Facility funds a key Escaping run should not instrument to crowd-in investments. the paradox of distract investment- While countercyclical policies may be enhancing reforms. needed beyond the very short term, thrift in the they should not divert attention from regulatory and institutional factors liquidity trap which drag on private investments in some countries. In these countries, the Second, lasting ultra-low interest priority is not to “let a good crisis go to rates have encouraged the growth waste” by implementing investment- The Covid-19 pandemic induced of public and private indebtedness enhancing reforms. Without them, the an unpreceded shock to European and the holding of cash without reach of macro policies will likely be economies at a time when Europe promoting productive investment. very limited. was already concerned about secular Long-run implications of mounting stagnation issues. When the pandemic Covid-19 related public debt, which in hit, the conventional monetary policy some countries has accumulated on transmission mechanism was out top of already high indebtedness, are of order and the monetary policy still uncertain. On the one hand, low framework focus was already shifted to interest rates support and make high unconventional policy measures which indebtedness less of a concern, while expanded the ECB’s balance sheet. on the other, each in its own right, they pose a risk to financial stability and While the efficacy of these measures long-run growth. Sustainability of the is still being debated, many empirical QE-indebtedness nexus comes on top studies found evidence that reliance of these concerns. on non-standard instruments helped to escape the liquidity trap in the past. Third, Covid-19 has triggered an It is therefore not surprising that the unprecedented increase in the savings initial phase of the current crisis was rate in the EU. This raises worries related characterized by a massive expansion to Keynes’ paradox of thrift. In such a of the ECB’s balance sheet, which situation, monetary policy should focus helped stabilize financial markets. This, on mitigating precautionary saving in combination with a strong fiscal motives and fostering investment by response, saved labour markets and reducing uncertainty. While trying businesses from crashing down. to escape the paradox of thrift, it is important to ensure that investment Still, the ECB’s success during the activity is not constrained by banks’ first wave of the pandemic confirmed tight credit standards. the side effect of extensive reliance on QE and low interest rates during Not only that investments drive the a prolonged period: much of the demand side of the economy, but they monetary policy space was spent also determine the supply side of the without facilitating significant growth economy. The fact that we still cannot in productive investments. be sure about the extent of damage

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 53 FINANCIAL RISKS AND STABILITY CHALLENGES

actions. Together, they considerably balances so far, the impact will become reduced the depth of the recession: more sizeable in the coming years there has been a high uptake of credit as guarantees are called. This will lines by firms to continue operations, reduce fiscal space, particularly for default rates have been limited so hard-hit, highly indebted countries. far and unemployment has been Going forward, this government substantially contained. support, including the guarantee schemes, will therefore have to become However, these strong policy responses more targeted. resulted in a growing corporate and bank dependence on public policy Besides the fiscal implications, there support. This interconnectedness will is the crucial challenge of ensuring carry risks when the temporary policy that viable firms as well as new support is phased out. firms have access to additional, new financing as we emerge from the crisis. The pandemic has exhausted firms’ A comprehensive, gradual and well- own reserves and capital, and the sequenced promotion of post-pandemic necessary bank lending has resulted bank and capital market financing in higher levels of indebtedness - is critical for a strong and sustained backed by explicit and implicit state recovery. This includes the narrowing ROLF STRAUCH support. We will likely see corporate of public support schemes to viable Chief Economist and Member defaults and non-performing loans firms, restoring transparency, removing of the Management Board, (NPLs) increase with more firms facing forbearance in bank operations and European Stability Mechanism (ESM) solvency problems when the budgetary accounting, and remedying any capital and regulatory support is phased out. shortfalls that may have emerged.

While a certain increase seems This will not only help protect public unavoidable, the question is how high finances from further - potentially it will be and whether viable firms, that unsustainable - pressure but will also The corporate- would survive without the temporary reinstate the right incentives in the impact of the pandemic, will also face corporate and financial sectors which sovereign-bank these challenges. are essential for private-sector-led growth. In this context, the progress nexus and future being made towards banking and capital markets union is also very policy space relevant, as this will encourage risk- Any exit strategy sharing and financing flows throughout must consider both the euro area. While strong national and European corporate revenues policy responses have contained the and debt dynamics. economic impact of the pandemic, there are spill-over risks from corporates to banks and to sovereigns. Any exit strategy must consider both corporate revenues and debt dynamics. So far, the impact on banks has been limited. Banks entered the pandemic The pandemic severely affected the crisis with larger capital buffers than corporate sector; many firms saw during the financial crisis, and they their revenues collapse while they still have also been in a better position to needed to pay their bills. This caused absorb NPLs. Moreover, prudential and severe liquidity shortages with risks monetary policy as well as budgetary of corporate insolvencies, voluntary measures facilitate the extension of closures and defaults. While precise credit to firms during the pandemic estimates are difficult, economic studies crisis. But the expected increase in NPL suggest a large increase of bankruptcies rates will likely take a toll on banks’ due to the economic restrictions that profitability and their ability to lend. were imposed to contain the pandemic. The challenge is to sustain and phase out support measures in a manner that In response to these challenges, gov- minimises the impact on viable firms, ernments supported firms’ liquidity bank balance sheets and their ability through direct subsidies, tax deferrals, to lend. debt moratoria and state loan guaran- tees. Short-term work schemes enabled These developments in the corporate workers to keep their jobs while oth- and banking sectors are occurring ers were supported with unemploy- against a backdrop of a significant ment benefits. increase in sovereign debt due to the large fiscal expansion. While EU monetary and fiscal policies the government guarantee schemes complemented these government have not significantly affected fiscal

54 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net KEY FINANCIAL SECTOR VULNERABILITIES

pent-up demand (real disposable outweigh the drag from higher interest personal income managed to grow by rates – more so because the ECB has an astonishing 6% in 2020), this could the firepower and the commitment to happen as soon as mid-2021. keep financial conditions anchored in an accommodative region. In this context, the fiscal packages approved at end-2020 and in March But there are also risks. If a US 2021 (which together amount to ca. 15% overheating materializes and of GDP) have led many to warn about a inflationary pressures become more significant risk of overheating in the US. persistent, US monetary policy could This alarm has been raised before and face an uncomfortable dilemma: stick proved wrong. The scars of a balance to the ‘low interest rates for long’ sheet recession and a low money narrative that has supported markets multiplier hampered the inflationary in the past decade – risking higher pressures on goods and services of the inflation and future financial instability massive monetary expansion in the – or tighten the policy stance and risk Great Recession – while price pressures an abrupt readjustment of expectations were more visible among real estate in financial markets. In any event, and financial assets. no matter the response, global and European financial conditions could be JORDI GUAL But this time really could be different: set for a bumpy ride. Chairman, CaixaBank the huge fiscal stimulus has shifted much of the potential impact from the private sector balance sheet onto the public sector and a lot of the cash that the Fed has injected has gone directly Should the euro area into people’s pockets through fiscal transfers. While there was no doubt worry about the US that a locked-down economy needed income support, many voices across overheating? the political spectrum are warning that doubling down on a stimulus that will be implemented with a recovery well underway poses significant overheating One of the lessons of 2020 is that risks in the US. problems which many in the world had stopped worrying about can rear up with sudden force. There is a real risk that the overheating of the U.S. economy becomes one of them. If a US overheating In pre-pandemic times, a low growth materializes, global – low inflation scenario had led the and European financial mainstream circles of economic conditions could be policymaking to focus on subdued demand problems, anchoring an set for a bumpy ride. environment of low interest rate expectations. The initial policy response to the economic crisis of the Covid-19 reinforced these expectations. A few steps behind, Europe’s recovery Against an unprecedented shock, there could benefit from a booming US was a pressing need for central banks economy thanks to the positive to anchor accommodative financial spillovers on external demand – conditions with major liquidity raising euro area growth and, possibly, injections and low interest rates. nudging up Europe’s inflation. Economies steadied and most recently The euro depreciation against the they have even managed to adapt to dollar would also provide support to the restrictions that are still needed European exporters. to contain the pandemic. A sustained recovery is now in sight as the At the same time, an overheating US vaccination campaign gathers speed. economy could also imply higher interest rates not only in the US but also China’s case aside, the US is set to abroad. Changes in US rates tend to be one of the first countries to regain spill over to other economies in a highly pre-pandemic levels of economic synchronous manner. As a matter of activity. Supported by a comparatively fact, Europe has recently imported a fast vaccination campaign, the Fed’s bit of the increase in US yields. Overall, accommodative monetary stance, a positive spillovers from stronger major fiscal push and a boost from US demand and a weaker euro may

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 55 FINANCIAL RISKS AND STABILITY CHALLENGES

sponse from policymakers acting indi- to more productive sectors. Neither vidually and (reasonably) collectively. is assured.

Central banks’ actions have ensured Europe remains overbanked and that banking sectors and sovereigns the low-rate environment – so have retained access to affordable essential to managing public debt funding. Regulators have taken steps loads – exacerbates structurally to encourage the flow of credit. weak profitability. Weak profits National policymakers have launched and fear of losses may once again unprecedented fiscal support. EU hamper banks’ ability to support the agreement on initiatives such as the economic recovery. NGEU will support the recovery and help sustain investor confidence Relatively low default forecasts are in Europe. predicated on a rapid return to health of parts of the economy – for example Taken together, the first order impact the SME sector – currently on life on the financial sector should be in support. Even a relatively small increase stark contrast to the global financial in defaults in those sectors could crisis. In Moody’s view, corporate undermine weaker banking systems. ALASTAIR defaults will remain high through 2021, but the European spec grade default And most fundamentally, so much rate is projected to have already peaked rests on confidence. Confidence that WILSON at around 5%, well under half that in the vaccines will work – and be rolled out Managing Director and Head prior crisis. And while nonperforming effectively. That policymakers will of Moody’s Sovereign Risk Group, loans will continue to rise through 2022, (individually and collectively) calibrate Moody’s Investors Service we do not expect material pressure on the removal of extraordinary monetary bank balance sheets. and fiscal policy measures without either stoking inflation or choking off recovery. That economies will respond. And, looking ahead, that the crisis will revitalise the fiscal and economic Enormous policy The future is reform effort that had been fast running out of steam as the last decade neared challenges, but the unusuallyuncertain, its close. and risks are to financial sector is the downside. Because a less rosy narrative is easy to construct, in which lack of confidence holding firm – for now impedes the flow of credit to vulnerable sectors, and the flow of capital to more vulnerable sovereigns. That way lies The intuition behind this view is strong. a credit crunch and a debt crisis. And Even at the darkest times, there are Unlike prior crises, this crisis was not we’ve been there before. silver linings. As Europe weathers a the result of longstanding imbalances; humanitarian and economic crisis it was not at all ‘cyclical’. It resulted unprecedented in recent times, from an exogenous ‘black swan’ event. policymakers can reflect with relief on Policymakers have spared little expense the absence – for now at least – of signs to try to contain the resultant economic of financial instability. And take some scarring and to allow economies to credit for that. return to something approaching normality as quickly as possible. The financial system sat at the heart of the global financial crisis – in The inevitable consequence of those some cases the proximate source of actions – higher debt – has fallen largely instability, in others the channel by on the public sector. While household which it propagated, in all cases an and corporate debt has risen somewhat impediment to recovery. The financial over the crisis, the largest increase has system’s woes drove and magnified the been in public-sector debt. But with impact across multiple sectors. interest rates very low, governments can carry higher debt for longer. So far, this crisis has been a different story. The European banking sector But the future is unusually uncertain entered it from a position of relative and risks are to the downside. The strength. Capital has been built to return of growth is dependent on levels, and is generally of a quality, well successful rollout of vaccines and exceeding that prevailing ahead of the avoiding new strains which lead to last crisis. Liquidity is similarly strong. further lockdowns. A return to pre- More broadly, the sound banking sys- pandemic growth levels assumes tem has been accompanied by (and its minimal scarring (e.g., rises in long- resilience to some extent reflects) a term unemployment) and the smooth prompt, proportionate, concerted re- reallocation of resources from damaged

56 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net KEY FINANCIAL SECTOR VULNERABILITIES

will be necessary to overcome this penalizing propositions as interest unprecedented crisis further while at rate SCR recalibration and the change the same time it is a challenge for the of methodology for the extrapolation insurance industry. Ultra low or even the interest rate used for technical negative rates weaken insurers and provisions valuations. A balanced medium-term profitability as of now review of the prudential framework is solvency is undermined. The 2020 essential so that insurers can continue results showed substantial declines in to offer long-term products and be solvency for life insurers, until several actors in the economic recovery, by dozen points lost over the year due to promoting the investment of amounts the decrease in interest rates. entrusted by policyholders in the economy. Insurers must adapt and transform their business models to survive. They A sudden and disorderly rise in rates can no longer offer long-term products after a long period of low rates would combining security, liquidity and yield. also constitute a risk. Large capital It would take time to adapt the offers losses would expose insurers who and its success with customers. In the may then be unable to meet demand meantime and under pressure from for redemptions, especially since the low interest rates, insurers have already differential in return to market assets XAVIER implemented measures in order to seek would induce policyholders to invest yield, such as adjusting asset allocation outside of life insurance. However, LARNAUDIE- by focusing on riskier and sometimes there is an opportunity in case of a less liquid assets. controlled rise to slight positive levels, EIFFEL stimulating for savings and investment Deputy General Manager, In the medium term, the risk of low and not dissuasive for its financing. CNP Assurances interest rates could increase with the 2020 review of Solvency 2. Initially, the calibration of capital requirement in the standard formula did not foresee a risk of negative rates. There is no doubt about the reality of negative rates and the The combined risk formula has to be adjusted in particular in the computation of the interest rate of ultra-low interest SCR submodule within the standard formula. However, other items in the rates and too calculation should be adapted in order to achieve a balanced review that does restrictive (future) not result in a substantial increase in capital requirements. Maintaining the regulation for life very accommodating monetary policy helps reorient insurers’ investments insurers: the economy towards equities, unlisted investments or real estate. needs a balanced Solvency 2 review The risk of low interest rates Life insurers manage their balance sheet over the long term with savings could increase with and retirement products representing the 2020 review several trillions of commitments in of Solvency 2. on a European scale. Consumers have shown interest in these offers, especially with the growing aging of the population in Europe. Insurers are therefore committed and continue This movement is favorable to the this management to meet the needs of economic recovery at the end of the European citizens over several decades. pandemic crisis. In these conditions, it Based on this time horizon, very low is necessary that the Solvency 2 review rates are still recent for insurers. does not penalize this movement. In current EIOPA advice on 2020 Solvency This paradigm shift occurred with 2 review, there are positive adjustments the Quantitative Easing of the ECB such as slight reduction of risk margin in 2015 and now the Covid19 crisis or simplification of criteria for long- reinforces the scenario of low interest term equities investment qualification. rates for long. It seems likely that However, these propositions are not an accommodative monetary policy sufficient to compensate other very

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 57 FINANCIAL RISKS AND STABILITY CHALLENGES

That said, the 2020 financial statements as on the systemic level. This smoke will lead to a widespread deterioration screen may persuade investors and in credit ratings, particularly as almost banks to maintain, or even expand, all businesses will have less equity. This their exposures for too long, thereby is likely to put considerable pressure preventing a more proactive and on the capital situation of banks. An timely management of their position increase in non-performing loans can be with deteriorated credit quality. assumed certain, even while estimates vary widely with regard to the extent - Second, the risk of a sharp and of such increase. Banks themselves sudden correction in interest rates must be quick in providing both the has risen as evidenced by the recent necessary staff and the tools required to turbulences in US treasuries. In the deal with a higher number of company worst of cases, a reversal of the current failures. A certain standardization of environment could lead to a strongly restructuring approaches is helpful. correlated market environment in Banks should also make full use of which the prices of equities, bonds preventive restructuring. and real estate assets all experience downward pressures simultaneously. In such a scenario NPLs would jump considerably, adding to the already ANDREAS existing problems. The risk of such a Fiscal policy needs dynamic might become a constraint DOMBRET for monetary policy, severely limiting Global Senior Advisor, to carry most of policy space in case inflation were Oliver Wyman the burden, while to pick up markedly. Fiscal policy monetary policy therefore needs to carry most of the burden, and monetary policy needs needs to be targeted to be targeted more to aid recovery more to aid recovery and growth. Monetary policy’s and growth. Progress on vaccination shows a powerful role in the light at the end of the unexpectedly long tunnel. But to avoid negative wake of the pandemic consequences of the pandemic and to In addition, market-based mechanisms enable the system to work properly should be established to handle NPLs. through the inevitable rising amount This includes functioning secondary of bad debt all parts of the financial 2020 is now firmly behind us and the markets and a uniform framework for system will need to prepare, need to annual financial statements are being securitization rules - very much in the remain vigilant and proactive. finalized. While the balance sheets of spirit of the European Capital Markets most companies have weakened the Union. Mutualising credit risk across real consequences of Corona will only national borders, on the other hand, appear fully once the fiscal aid measures is still associated with far too high will have been withdrawn, and only political and economic side effects. then will a potential zombification become apparent. Regulators play a key role. Warnings of supervisors recommending banks to The effects of the pandemic are already build sufficient buffers and adequate visible. Several banks have profited in provisions have been plentiful. their capital markets business from Regulators will need to carefully the increased volatility. Central bank consider when and how to expire purchase programs and low to negative the regulatory relief granted on the interest rates have further reduced assumption of a short-term liquidity profitability of banks. The real surprise crisis, which is rather difficult to of the last 12 months, however, was that withdraw once balance sheets have loan provisions increased much less deteriorated. than most observers had predicted. The big open issue, however, is the role The key question is how long this state of monetary policy. The low interest of limbo can last. At the fundamental environment has without any doubt level, the evolution of the pandemic been a significant factor keeping and the speed and shape of the economies afloat. But together with the economic recovery are the key drivers, strong fiscal stimulus, which monetary both of which cannot be predicted policy has made possible considering with any certainty. Secondly, the the significant debt burden of many ability of sovereigns to maintain countries, it carries two important risks: their far-reaching support and the real economies’ ability to restart will - First, the funding glut may mask a determine how much of the economic deterioration in asset quality at the pain can actually be buffered away. level of the individual borrower as well

58 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net EUROFI MEMBERS FINANCIAL RISKS AND STABILITY CHALLENGES

LESSONS FROM COVID ON NON-BANK FINANCIAL INSTITUTION (NBFI) RISKS

investors in these instruments and thus And EUR-denominated MMF valued at participate directly in funding the real their market price (VNAV), the greater economy, absorbing a major part of part of which are registered in France, short-term funding of financial, non- underwent severe outflows which were financial and public-sector institutions, more sustained than with other types whilst enabling corporate treasurers, of MMF overall while bank deposits of institutional investors and investment their historical holders tended to grow. funds to place their excess treasury or cash. In fact, amid a particularly uncertain economic environment with the This episode was striking: the MMF closure of certain market segments, sector was one of the epicentres of the MMF holders reacted according to a 2008 financial crisis and, in order to given fund’s characteristics its asset reduce the risks to financial stability that profile and associated regulatory are associated with their functioning, constraints. Somewhat unexpectedly deep reforms were undertaken in some of these regulatory constraints all countries. Actually, the quality of could have spurred withdrawals and, assets held in their portfolio, notably in the case of EUR-denominated their credit quality, did not raise any MMF, measures taken by the European concerns in March or April. Central Bank, targeting first the bond ROBERT market, managed only belatedly to The 2020 crisis was a liquidity crisis steady the situation. OPHÈLE caused by exogenous factors and Chair, Autorité des Marchés it leads us to raise the question This should lead, at least in Europe, to a Financiers (AMF) of the need for further reform of review of the regulation and supervision this ecosystem and, ultimately, the of MMF and to find ways of enhancing legitimacy of bank disintermediation the liquidity of the underlying money for funds that are meant to be highly market, as well as to a clarification liquid and risk free, that are considered of the central bank’s role with regard NBFI put to the test as a substitute for cash and besides, fall to these funds that are considered as within the scope of money supply in monetary financial institutions. by March/April 2020 many countries when held by resident non-financial agents. At the same time, we must maintain events: the issue of the needs MMF fulfil: for an investor, holding a better yielding and safer liquid money market funds asset (more diversified than a straight bank deposit); for a financed entity, The framework finding cheaper and more flexible within which money funding via the short-term market as Open ended funds were buffeted by opposed to bank credit; for the bond the financial consequences of the market funds operate market, smoothing its functioning by Covid-19 pandemic, both on the asset must be reviewed offering counterparties for long-end side (drop in valuations, high volatility, and clarified. securities nearing to maturity. derivatives positions undergoing significant margin calls…) and on the Policy options currently considered are liability side (waves of redemptions). diverse and some of them very extreme; All of which constituted a live test we should find the right balance in our of their ability to weather problems Analysis of this episode however regulatory stance in order to increase of valuation and of liquidity. Amid highlights the broad diversity of the robustness of MMFs without losing these trials and tribulations, money situations, notably when it comes to sight of their beneficial purpose. market funds (MMF) came under a types of MMF. In the US, said Prime specific pressure: they recorded the MMF invested in corporate paper largest redemptions and in some cases recorded large redemptions while subscriptions while short-end debt inflows into MMFs invested in public markets, in which they invest, were paper (Government & Treasury MMF) themselves severely unsettled. were nearly eight-fold higher. In Europe, USD & GBP-denominated low Bank sponsors (Europe aside) and volatility MMF (LVNAV), registered in above all central banks intervened Ireland and and mainly to steady the short-term debt sector, held by non-Eurozone residents, which, although no accident was underwent large outflows, in these recorded, stood out as a major source same countries offset by inflows into of risk to global financial stability. USD-denominated constant price Indeed, MMF are one of the main public debt MMF (CNAV).

60 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net LESSONS FROM COVID ON NON-BANK FINANCIAL INSTITUTION RISKS

Regulation (EMIR) show that daily risks, and (iv) enhancements of data variation margin calls on euro area reporting requirements for all type investment funds rose fivefold, from of funds. around EUR 2 billion in the first half of February to over EUR 10 billion in the Another market that came under stress second half of March. during March 2020 amid substantial outflows from money market funds For 27% of the funds for which EMIR (MMFs) is the short-term debt funding data are available, daily variation market. In case of market stress, MMFs margins exceeded their pre-pandemic may be reliant on banks, corporates cash buffers on at least one day during or central banks to purchase their the period of market turmoil.2 commercial paper back in order to raise cash and accommodate heightened A number of EU investment funds, redemption flows. This materialised particularly high-yield corporate during March 2020. bond funds and real estate funds, used liquidity management tools to It is not the first time that MMFs help address outflows and valuation contributed to the propagation and uncertainties. Some funds used amplification of liquidity strains. In quantity-based measures, such 2013, shortly after its creation, the FRANCESCO as suspensions of redemptions or ESRB had sent a recommendation to redemption gates, while other funds the European Commission on MMFs, MAZZAFERRO used price-based tools, such as swing requesting that Union legislation would Head of the European Systemic pricing or redemption fees, which require MMF to have a fluctuating net Risk Board Secretariat, impose the liquidity cost on the asset value and that stricter liquidity European Systemic Risk Board (ESRB) redeeming investors. requirements be introduced. Despite the introduction of the Money Market In response to these developments, Fund Regulation in 2017, which the European Systemic Risk Board enhanced the regulatory regime for (ESRB) adopted a Recommendation MMFs, vulnerabilities remain within to ESMA to coordinate a supervisory MMFs and need to be addressed. Liquidity mismatches engagement with funds that have significant exposures to corporate debt in the NBFI sector and real estate assets.3 In its response to the ESRB, ESMA noted that only a few should be addressed funds have adjusted their liquidity set- up according to the pursued investment strategy and in light of liquidity strains they encountered.4 The spread of the pandemic and the lockdown measures imposed to contain Covid-19 triggered an adverse shock to the global economy and large falls in asset prices. Markets reacted by Liquidity management substantially repricing risk, as investors fled towards safe and highly liquid tools help address assets. Assets in the non-bank sectors outflows and valuation fell by EUR 1.2 trillion (3.3%) in the first uncertainties. quarter of 2020, mainly due to large valuation losses resulting from asset price falls.

Outflows rose and contributed to the The vulnerabilities highlighted by the fall in assets under management across Covid-19 pandemic are not new and a wide range of fund types. Redemption need to be addressed. In 2017, the ESRB flows appeared to largely reflect the issued a recommendation to ESMA and increased risk associated with the the European Commission on liquidity underlying assets and/or the demand and leverage risks in investment funds.5 for cash to meet short-term liquidity needs. Liquidity mismatches in certain The most important messages were: types of open-ended investment funds (i) the development of a common amplified market volatility in late set of liquidity management tools February and early March.1 for investment funds across EU 1. See EU Non-bank Financial Intermediation Risk Monitor jurisdictions, (ii) further setting out the 2020, ESRB, Oct 2020. The sudden rise in volatility led to a role of ESMA when authorities use their 2. See Liquidity risks arising from margin calls, ESRB, Jun 2020. large increase in variation margin calls, power to suspend redemptions, (iii) 3. See Recommendation of the ESRB on liquidity risks in putting additional pressure on some measures to limit the extent to which investment funds (ESRB/2020/4). investment funds’ liquidity positions. the use of liquidity transformation in 4. See Report on the Recommendation of the ESRB on liquidity risk in investment funds, ESMA, Nov 2020. Derivatives data reported under the open-ended alternative investment 5. See Recommendation of the ESRB on liquidity and European Market Infrastructure funds could contribute to systemic leverage risks in investment funds (ESRB/2017/6).

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market turmoil’, presented to the G20 • We want to further deepen our in October 2020 is the outcome of understanding of the redemption these initial deliberations. It sets out pressures and liquidity risk an ambitious roadmap for analysis and management practices in open-ended assessment, both of specific markets funds. Discussions about liquidity or actors, as well as the links that mismatch, and the tools to manage connect them. Considering global this, pre-date the COVID crisis, but regulatory issues in a joined-up manner have found a new urgency in its wake. such as this is precisely what the FSB In the UK, we have already begun was established to do after the last work on potential rule changes for financial crisis. property funds, which represent the largest portion of funds (by Assets A key lesson learned from this crisis under Management) that suspended must therefore be to reaffirm the value trading during March 2020. of a global regulatory architecture that • Liquidity in corporate bond markets reflects the globally interconnected over the course of the market stress, nature of financial markets. While a and in the wake of central bank holistic approach is more complex -and interventions, is an important can appear slow from the outside- the consideration. We want to understand consensus remains that a piecemeal trends in the liquidity, structure, NAUSICAA approach simply won’t work. and resilience of these markets as a core part of well-functioning DELFAS This is particularly the case when capital markets. Executive Director of International, considering vulnerabilities in non- • Finally, in a joint effort across relevant Financial Conduct Authority (FCA) bank financial intermediation (NBFI). global standard setting bodies, we are This has grown markedly over recent analysing margining practices and years and now shoulders much of the the extent to which elevated margin risk previously held by banks, prior to calls in cleared and Over-the-Counter global banking reforms in the wake of markets may in turn have transmitted How regulators can the 2008 crisis. liquidity pressures to the rest of the system. address financial All of this work will allow us to stability concerns in address the fundamental questions The financial system of systemic resilience, and if we see non-bank financial possible vulnerabilities, undertake has proved to be a reforms where needed. We neither intermediation (NBFI) reliable and resilient can, nor should, seek to eliminate risk source of funding [..] entirely from the financial system. Neither should we take steps which and we must ensure it shift risk from one part of the system Despite the scale of the Covid-19 remains able to be so to another without due consideration pandemic and the depth of the in the future. of the consequences, in particular on economic shock it has triggered, investors and the critical role that non- financial markets have proved largely bank financial actors play in funding resilient to significant volatility and the real economy and the recovery unprecedented operational strains. from this crisis. Market participants were able to switch To consider the resilience of NBFI as a on business continuity plans and whole, therefore, some of the key areas The financial system has proved to transition to remote working, while we are working on at the FSB and other be a reliable and resilient channel critical financial market infrastructures bodies are: for funding throughout the Covid-19 were able to withstand all-time highs in pandemic to date, and we must ensure trading activity. Nonetheless, the period • We are looking closely at Money market it remains able to be so in the future. of extreme market volatility in the funds (MMFs). Some funds experienced Spring of last year did see dislocations significant liquidity pressures over the in some parts of the market, and these Spring, in particular prime MMFs in need to be addressed. the United States. Given the key role MMFs play in funding and managing The response to the Covid market the cash of corporates across the real stress has been a global effort, economy, our priority is to ensure that spearheaded by the Financial Stability liquidity risk borne by these funds is Board (FSB) and coordinated across both well managed and adequately other bodies including IOSCO and the understood by investors. IAIS. Working with our counterparts in • We are working to shed light on the the UK, the EU and globally, it became behaviour of the broker-dealers active quickly apparent that the risks we had in short term funding markets, what seen were complex and intertwined, factors may have constrained their and that developing an adequate policy ability or willingness to intermediate, response would not be straightforward. and the knock-on effects of this The FSB’s ‘holistic review of the March for MMFs.

62 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net LESSONS FROM COVID ON NON-BANK FINANCIAL INSTITUTION RISKS

amplifying liquidity strains. Recent approach aimed at increasing the research shows that institutional effectiveness of the framework and funds tend to act procyclically, by preventing fragmentation. actively investing in higher yielding, longer-duration and lower-rated Last December, Italy assumed the Pres- assets as spreads compress, ultimately idency of the G20, with a commitment affecting asset price volatility. In some to the full implementation of the FSB cases, redemptions from institutional workplan on NBFI. Building upon the investors occurred due to the need FSB “holistic review”, the work pro- to cover exceptionally high margin gram includes a number of key deliver- calls resulting from heightened ables to be submitted to the G20 later market volatility. this year, including a report on policy options to enhance MMFs’ resilience, In other cases, liquidity pressures on as well as analytical work on vulnerabil- institutional investors were associated ities in open-ended funds that invest in with a significant mismatch between illiquid assets and on potential procy- assets and liabilities; this is the case, clicality issues on margin calls. for instance, of some unit-linked policies, where insurance companies The G20 Italian Presidency will lay out LUIGI hold assets whose liquidity profile the stepping stones of a macroprudential does not necessarily match with the approach to NBFI regulation, with daily redemptions frequency offered to the aim of contrasting the build-up of FEDERICO policyholders. risk in periods of market exuberance and reducing the probability of central SIGNORINI An increased need for cash amplified bank interventions. Senior Deputy Governor and both intermediaries’ demand for highly Member of the Governing Board, liquid assets and the potential for Banca d’Italia forced asset sales by investment funds. Interconnections among non-bank financial intermediaries’ balance sheets also contributed to propagating and amplifying the stress. Towards a more Non-bank financial institutions experienced broadly similar episodes resilient NBFI sector of stress. In general, liquidity risks in the NBFI sector contributed to the international transmission of the financial shock induced by the The resilience of European investment pandemic. The “dash for cash” episode funds, including money market funds in March 2020, for instance, led to (MMFs), was tested by the large and severe strains in the dollar funding widespread imbalances in the demand market, thus affecting entities that and supply of liquidity and the repricing borrow in US dollars worldwide. of risk caused by the economic impact of the Covid-19 pandemic. Between 20 February and 20 March 2020, several funds investing in illiquid assets experienced severe outflows, The G20 Italian sometimes in excess of liquidity Presidency will lay out buffers; cumulative redemptions from the stepping stones euro-area high-yield corporate bond funds reached 10 per cent of their of a macroprudential assets under management (AUM). approach to NBFI Outflows from MMFs in the central week of March reached 5 per cent of regulation. their AUM. Redemptions stabilised only after unprecedented central bank interventions that alleviated market stress. The increasing role of the NBFI sector in financing the economy and the Outflows from open-ended funds vulnerabilities seen last year renewed and MMFs were driven primarily by a policy debate on the adequacy of the institutional investors. Insurance regulatory and supervisory framework corporations and pension funds invest for these intermediaries. Given the largely in MMFs primarily for liquidity global dimension of the issues, the management purposes. Distress in multilateral setting provided by the other parts of the non-bank financial Financial Stability Board (FSB) and intermediation (NBFI) sector spilled the global Standard Setting Bodies over to the investment funds’ sector, is most suited to adopt a common

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of Ireland approaches regulation of the could include measures to ensure funds sector in the light of our statutory that the costs associated with such mandates of safeguarding monetary redemptions, including increased and financial stability, securing the liquidity premia in times of stress, are proper and effective regulation of fully borne by the redeeming investors. financial service providers and markets, and ensuring that the best interests Finally, there is a need to enhance of investors are protected. Following the macro-prudential framework the COVID shock, three areas require for investment funds. The lack of a particular scrutiny in our view. complete and operational macro- prudential framework for funds in As the Covid crisis began to unfold, Europe and internationally remains Money Market Funds (MMFs) saw a a key gap which is correctly gaining substantial increase in redemptions and more attention following the recent a deterioration in the liquidity of their market events. assets. Redemptions were concentrated in MMFs with investments in private Market-based finance, and the funds sector debt and this led to liquidity sector in particular, provides a valuable management challenges for those alternative to bank financing, support- MMFs. While all MMFs managed to ing economic activity. However, like all GERRY meet redemption requests, had any forms of financial intermediation, they been forced to suspend redemptions or may also contribute to the build-up of CROSS fail to meet key expectations, liquidity financial vulnerabilities. It is impor- Director Financial Regulation – stresses could have spilled over to other tant following the lessons learned from Policy and Risk, Central Bank parts of the financial system. Covid shock that well calibrated policy of Ireland responses are introduced in order to The interconnectedness of MMFs with mitigate such vulnerabilities. other parts of the financial system – including banks and other non-banks – means their resilience in periods of stress can be systemically important. Well calibrated Regulatory authorities are currently examining ways to strengthen MMF policy responses resilience in light of the lessons learned. required to Effective liquidity management in open-ended investment funds, particu- mitigate potential larly those which invest in less liquid assets, is also an area of particular focus vulnerabilities at present.

At the onset of the Covid-19 shock, as financial markets turbulence, a ‘flight Funds dynamics to safety’ and heightened demand for cash generally swept through a contribute to market- range of markets, investment funds wide pressures experienced a sharp increase in in times of stress redemptions and challenges in liquidity management. At an individual level, and requires the vast majority of funds managed to regulatory change. meet investor redemption requests. However, this needs to be seen in the context of unprecedented central bank interventions that played a key role in restoring market functioning. Such funds, as evidenced during the Covid-19 shock, are particularly Of particular concern to regulatory susceptible to the risk of large authorities were sector-wide dynamics redemption requests during periods evident during the period of stress. of market stress and may have to sell The potential for collective behaviour assets quickly in order to meet such of funds to add to market-wide redemption requests. The redemption pressures in periods of stress requires patterns observed during March and regulatory change. April 2020 in such parts of the funds sector are consistent with the operation As an integrated central bank, of first-mover advantage dynamics. prudential, conduct and AML/CFT regulator, macroprudential and There is a need to develop additional resolution authority, the Central Bank measures to address this issue. This

64 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net LESSONS FROM COVID ON NON-BANK FINANCIAL INSTITUTION RISKS

Funds suspensions were rare in by fund managers as a matter of course March 2020, and mainly a response and in line with regulation (indeed to idiosyncratic price uncertainty in in March 2020 EU fund managers regional real estate and bond markets: were mid-way through implementing Fitch estimate that 0.11% of global fund ESMA’s new liquidity stress test assets were subject to suspensions standards for UCITS and AIFs). during the turbulence; ESMA estimate 0.8% of EU-domiciled corporate bond Macroprudential policy measures UCITS were. Use of swing pricing – a would be at best ineffective, and at mechanism for allocating a variable worst pro-cyclical. Open-ended funds premium or discount to transactions in only hold a portion of assets: McKinsey or out of funds – was more prevalent, data shows asset managers accounted and meant redeeming investors paid for 27% of global financial assets by end- the higher cost of accessing liquidity. 2019, of which funds are only a sub- And while the primary purpose of section. Attempts to manage system- swing pricing is to protect fund wide conditions via macroprudential investors, from a systemic perspective controls on funds would therefore be it incentivised shareholders to remain ineffective, missing most assets. invested; or spread redemptions over time. And their effects may instead be JOANNA counter-productive: some recommend To fully realise these benefits going mandatory cash or liquid asset COUND forwards, use of swing pricing or buffers for funds, to be drawn down Managing Director, similar ‘anti-dilution’ measures must during stresses. Notwithstanding the Global Public Policy, be comprehensive. ESMA data on last performance drag, a buffer insufficient BlackRock year’s turbulence shows swing pricing to meet redemptions will likely leave was used by many but not all EU a portfolio more concentrated in risk funds. We strongly support extending assets to meet any subsequent outflows. implementation of the full liquidity risk management toolkit in all EU Achieving system-wide resilience should member states. This should also be follow a three-pronged approach. A lesson from accompanied by efforts to encourage the practical adoption of the tools by all First: make individual products and Covid-19: fund managers. activities as robust as possible, for example by giving all funds the full liquidity risk liquidity management toolkit. management Second: ensure banks can play their We strongly role as market intermediaries, setting is central to prudential limits that strike a balance support extending between safety and smooth market open-ended funds implementation operations. of the full liquidity Third: evolve market structure to reflect risk management bank balance sheet constraints: many March 2020 saw market liquidity toolkit in all EU fixed income markets would benefit deteriorate significantly – as many member states. from modernisation – with more use companies, banks, and investors looked of central clearing and electronic all- to cut their risk and raise cash – and to-all trading venues – while securing an extreme stress test of the previous quality, comprehensive, real-time data decade’s reforms. While UCITS and AIF for all asset classes through a European outflows rose sharply to relative levels An alternative suggestion – requiring consolidated tape would improve last seen during the Great Financial funds to hold more ‘High Quality transparency and liquidity. Crisis, they remained manageable, and Liquid Assets’ – misunderstands the overwhelming majority of funds fund liquidity. The notion that funds met all redemptions. went into March 2020 with depleted ‘liquidity buffers’ incorrectly applies Strong fund liquidity management was a bank regulation concept – HQLA – instrumental in achieving this, and to asset management. Funds aim to managers deployed tools ranging from meet redemptions while maintaining swing pricing to suspending redemptions a risk-constant position over time, to protect their investors. Their availability not by tapping cash buffers. In was thanks to efforts post-2008 by challenging market conditions, even IOSCO, ESMA, regional and national high yield bonds could be sold to regulators to raise the bar for liquidity meet redemptions. risk management. By 2020 best practises had been incorporated into many fund Asset liquidity, and fund liquidity in rulebooks, building on existing EU rules turn, vary with market conditions and – for example in the UCITS Directive – to position size. Assumptions around both manage liquidity risk. are continuously and rigorously tested

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issues that need to be addressed to requirements to maintain minimum ensure that financial markets operate in levels of liquidity and knowledge of a crisis. In a crisis, the implementation one’s investor base should remain, as of emergency liquidity assistance they are appropriate and necessary to financial institutions is a core safeguards for investors. The benefits responsibility of central banks. They of such requirements were evident are the lenders of last resort. They serve throughout the Health Crisis. this role, not to preserve MMFs, but to preserve liquidity and stability across The experience of MMFs throughout markets. Whether central banks serve the Health Crisis should be applauded, in this capacity once in 12 years, twice as despite frozen markets and delayed in 12 years, or 3 times in 100 is of no central bank action, all MMFs were consequence – it is the role they are able to fully meet investor redemption intended to serve when markets are requests. The Health Crisis was a real- placed under extreme pressure. life stress test of the global MMF reforms adopted after the Financial Crisis and The real problem to be addressed is not demonstrated that MMFs were not MMFs, but the systemic illiquidity and only resilient, but that are instrumental seizing up of markets that are essential to investors and markets and should be to financial stability. Many regulators protected – not eliminated. DENIS GEPP fail to distinguish between systemic Senior Vice President, liquidity events and systemic credit MMFs have been one of the most Managing Director and Chief events. This distinction is essential for successful market innovations over the Investment Officer, Cash, understanding today’s reform debate. past 50 years. They improve market Federated Hermes, International efficiency and stimulate competition Global regulators are currently focused by providing lower cost borrowing on potential MMF reforms included in for issuers and higher returns for the President’s Working Group (PWG) shareholders. Report. Most of the policy measures discussed in this report have been Since 1985, MMFs alone have The Global Health previously considered and rejected provided over Eur 500 billion more in because they would negatively impact incremental returns to investors than Crisis – A real-life the viability of MMFs to the detriment bank deposit accounts and over this of investors, issuers and the capital whole period only two prime MMFs stress test of markets generally. have “broken the buck” at no cost to taxpayers. Meanwhile thousands of MMF reform banks have failed, costing depositors and taxpayers Eur billions. The real problem The market stresses experienced in to be addressed is March/April of 2020 were the result of an unprecedented Global Health Crisis not MMFs, but the the likes of which has not been seen systemic illiquidity since the Spanish flu over a hundred and seizing years earlier. It was not a financial crisis. The stresses experienced were up of markets… the predictable and obvious result of chaotic and uncoordinated responses of governments around the world and their affirmative decisions to shut- However, one of the proposals does down global economies. address the key issue which impacted MMFs in the Health Crisis – and that The disruptions were not caused by is the decoupling of the weekly liquid structural vulnerabilities in money asset requirement from a necessity to market funds (MMFs). Conditions in consider the imposition of a fee or gate. the real world affected the markets, not This bright line trigger was adopted the other way around. And the market by global regulators, despite industry impacts were felt first in equities and warnings, and served as a catalyst commodities, later in bond markets, for investor redemptions. It should then in money markets and finally be removed. in MMFs. We do, however, believe that a The only appropriate comparison of MMF’s board should be permitted to the Health Crisis with the 2007/09 impose liquidity fees or redemption Financial Crisis is the perpetuation of gates when doing so is in the best a false narrative that MMFs caused or interest of the fund and its investors exacerbated each crisis. Accepting this to prevent unfair dilution, without false narrative blindly allows policy reference to any specific level of makers to ignore the more complicated liquidity. Additionally, we believe

66 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net LESSONS FROM COVID ON NON-BANK FINANCIAL INSTITUTION RISKS

spurred by the COVID-19 pandemic in and maximizing value for the industry 2020 - reinforced just how systemically through standardization and efforts important NBFIs have become. After to reduce risk, trade reporting enables all, NBFIs form an important part of regulators to assess traditional banking the bank credit intermediation chain, broadly, including concentration connecting with counterparties around exposures, for example in the OTC the world. But with these connections derivatives space. and the increasingly prominent role of NBFIs can also elevate risk. Most recently, CCPs played key roles in helping the industry navigate the Managing risks in a volumes and volatility as a result growing egment of the pandemic, with many key stakeholders across the industry stating One area of growing risk is around the that market stability was enhanced by connections that exist between NBFIs central clearing. Given the increasingly and other firms. Interconnectedness systemic importance of CCPs, future risk has become a growing area of focus international policy will likely focus on within the industry, as firms look more the evolving role of central clearing in closely at the NBFI activity, connections order to address risks that fall squarely and potential contagion risks that exist in the NBFI sector, including risks TIMOTHY between organizations. to financial stability, the interactions between banks and non-banks, and the CUDDIHY Policymakers are also exploring this resilience of NBFIs. Managing Director, important area as they work to identify Financial Risk Management, how to maximize the benefits of NBFIs The way forward The Depository Trust & Clearing while minimizing systemic risks. At Corporation (DTCC) the same time, NBFIs have different While NBFIs offer major benefits to requirements for liquidity and capital the industry, including their ability to buffers than banks. In the U.S., NBFIs provide liquidity, they also come with may build up leverage outside the their own set of unique challenges regulated banking system, which can and risks that could have far-reaching amplify shocks during market or firm- impacts. The use of an intermediary Balancing act: specific dislocations. The key question such as a central clearing counterparty becomes: how can we further protect this and services like trade reporting utilities maximizing potential, growing segment of the market, as they could provide the standardization, deliver increasingly critical services to the transparency and risk-reduction minimizing risk industry? We believe the answer lies in benefits that are greatly needed in the the increased resiliency and transparency. NBFI sector, while better supporting of NBFIs the industry’s growth and enabling it to continue reaping the benefits of all it has to offer.

Non-bank financial institutions (NBFIs) How can we further exist somewhat outside the traditional banking system, but they can play an protect this growing important market intermediation role. segment of the NBFIs support markets, as they can market - the answer broaden the availability of investment options, enabling risk diversification lies in the increased and financial innovation. These resiliency and types of firms are often more nimble transparency. than traditional avenues and can provide a faster source of credit and liquidity capacity.

Because of these key benefits, there has The value of CCPs been significant growth in this sector over the past decade as firms navigate Introducing central counterparties environmental factors including (CCPs) and trade repositories – proven, changes in bank regulation; capital best practice utilities – to the NBFI sector and liquidity constraints in traditional could deliver the same major benefits financing; strong capital flows into that they bring to traditional financial alternative venues that seek higher sectors, including transparency, risk returns; technology advancements mitigation, and standardization. including digital assets; and better Both central counterparties and trade addressing areas of the financial system repositories play a role in aggregating that are under-served. trade and counterparty information.

In fact, two market events - the global While central counterparties are financial crisis and the volatility focused on protecting market stability

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EU ANTI MONEY LAUNDERING (AML) POLICY REDESIGN

financial system and the security of our political support in all EU institutions for a citizens. According to Europol around more stringent EU framework that should 1% of the EU’s annual Gross Domestic allow moving forward quickly. Product is ‘detected as being involved in suspect financial activity’. Despite progress The single rulebook´s objective is to made in recent years, further reforms at achieve more harmonisation in key areas EU level are needed to address remaining of the AML/CFT legal framework (obliged shortcomings; these were identified in a entities, customer due diligence, beneficial package of Commission reports in July 2019 ownership and sanctions), and be directly based around a Communication on better applicable, in the form of a regulation. implementation of EU AML/CFT rules. Other provisions, for example concerning national supervisors and FIUs, will remain The EU Action Plan on Anti-money in a Directive. A proposal to create an laundering and countering financing of EU supervisor with direct supervisory ALEXANDRA terrorism (AML/CFT) of May 2020 sets competence over a limited number of an ambitious agenda for a comprehensive the riskiest financial sector entities and a JOUR- AML/CFT policy at Union level with six support and cooperation mechanism for pillars for future action: FIUs, possibly under “one roof” is supposed SCHROEDER to address the current deficiencies of the 1. Ensuring effective implementation of current decentralised supervision. Deputy Director-General, the existing AML/CFT framework in the DG for Financial Stability, Financial EU; On the international front, the Commission Services and Capital Markets Union, 2. Establishing an EU single rulebook on will continue engaging actively in the European Commission AML/CFT; Financial Action Task Force, as well as in 3. Bringing about EU-level AML/CFT su- bilateral dialogues with a number of third pervision; countries. The Commission will give its 4. Establishing a support and cooperation views on the way forward on pillar 5 of Anti-money mechanism for FIUs; the Action Plan, including Public-Private 5. Enforcing EU-level criminal law provi- Partnerships for information exchange, laundering and sions and improving information ex- in a publication in the autumn of 2020, change; along with an updated Supranational Risk countering financing 6. Strengthening the international dimen- Assessment report. sion of the EU AML/CFT framework. of terrorism – the way At the same time, enforcement remains The European Commission will shortly our key focus. Enforcement monitoring forward at EU level issue legislative proposals related to some includes how effectively the EU rules are of these pillars - the single rulebook, a applied in the Member States, including support and cooperation mechanism for the capacities and resources of the relevant Money laundering and terrorism financing FIUs, and EU-level supervision, which authorities; full population of registers of (ML/TF) continue to pose a serious threat will then be negotiated with the European beneficial ownership of legal entities and to the integrity of the EU economy and Parliament and the Council. There is strong trusts is also a priority.

deliver on an effective anti-money Upgrading the laundering framework.

EU’s anti-money The scale of this challenge should laundering framework not be underestimated. According to the United Nations Office on Drugs and Crime, up to EUR 1.87 trillion are In the past few months, more laundered each year, at the global level. scandals, such as Open Lux, FinCEN Currently, in the EU, despite several files or papers, exposed how AML directives, effectiveness in tackling complex schemes are still used for money laundering remains suboptimal. illicit financial transactions, including For instance, according to a recent money laundering. These revelations report by Europol, relevant authorities are particularly dramatic given the confiscated just 1% of criminal profits social and economic impact of the in the EU. To this background, the PEDRO Covid-19 pandemic. While honest European Commission has taken a people, families and companies still first step by adopting an action plan MARQUES struggle to recover, others enjoy the that aims to provide solid ground MEP, Committee on Economic and profits of criminal activity. This is for progress. To be successful, the Monetary Affairs, European Parliament not admissible; EU must act now and upcoming AML legislative package must

68 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net EU ANTI MONEY LAUNDERING POLICY REDESIGN address the main shortcomings of our need an EU supervisor and a common upgrade the financial analysis of cross- current framework. approach that fills in the gaps of national border suspicious transactions. supervision, thus contributing to better Firstly, the loopholes created by diverging compliance and enforcement. Furthermore, other resources should national implementation of the directives. also be considered for the upgrade of By turning some content of AML directives our AML framework. For instance, into a Regulation, we can set common If we want the leveraging digital technologies, such record keeping, internal controls, citizens’ trust, our as artificial intelligence and machine customer due diligence requirements fight against money learning, can deliver smarter checks and define a single way to identify laundering must and improve not only the outcomes, beneficial owners. We should also seize be relentless. but also the cost-effectiveness of the the opportunity to harmonise sanctions whole process, which must also be taken and establish penalties proportional to into account. the turnover of companies. Thirdly, the limited integration of financial intelligence units. Introducing The upcoming AML legislative package Secondly, the lack of a central supervisory a mechanism for coordination and is our best chance to prevent the body. Given the single market’s cross- support at the EU level would lead to EU’s economy recovery from being border economic activity, it is clearer better execution by Member States. undermined by illicit financial flows. If we that an effective AML supervision cannot It would improve data collection and want the citizens’ trust, our fight against be restricted to the national level. We exchange of information, as well as money laundering must be relentless.

However, it should be borne in mind This potential cannot be fully that the fight against money laundering exploited at present due to the lack of can only be successful if: unambiguous rules on how data can be exchanged effectively and in compliance • all parties involved in prevention work with data protection requirements, together effectively, and while fulfilling both interests. Because • links to law enforcement authorities of the untapped potential in this area, are further developed. the FATF is also addressing these issues within the framework of the “Digital A key aspect of such cooperation with Transformation” project initiated under added value is the exchange of data the current presidency. within the prevention system. Money launderers are neither restricted by Due to the enormous amount of data national borders nor are they limited to involved in such exchanges, the use of MARCUS PLEYER laundering their dirty money through RegTech must also be further developed only one institution. Therefore, illicit and promoted to analyse these data Deputy Director General, activity often becomes visible only volumes accurately, quickly and International Financial Markets, when obliged entities and authorities automatically. RegTech solutions also Digitization, Anti-Money Laundering monitor suspicious activities across enable complex processes to be designed & Counter Terrorist Financing, jurisdictions and different institutions. more cost-effectively. Federal Ministry of Finance, Germany Data sharing currently takes place only to a very limited extent between However, accurate STRs are not an end obliged entities. in themselves; they are only the starting point for law enforcement if suspicious Cooperation and cases arise. Therefore, once these STRs We must overcome have been forwarded to law enforcement information exchange any silo mentality authorities, it is vital to ensure that they and focus on a more fall on fertile ground. For the analysis as the key to fighting intensive cooperation and prosecution of suspicious cases, too, and possibilities to share the exchange of information between money laundering all responsible parties must become a data in the fight against daily routine. money laundering. The prevention of money laundering Public-private partnerships offer and terrorist financing has become a top More extensive forms of data exchange potential to better link prevention and priority on the EU’s agenda in recent – e.g. pooling transaction data – could law enforcement in the fight against years, also against the backdrop of money help prevent the exploitation of AML. Through such partnerships, laundering scandals. It is important that information gaps that enable arbitrage knowledge and experience can be we continue to step up our efforts in the by criminals who e.g. may attempt exchanged between private entities and fight against money laundering. But how? to engage with multiple financial competent authorities with the aim to institutions, each having a limited provide necessary information, but also The Commission’s legislative proposal and partial view of transactions. This valuable feedback to obliged entities. announced for May 2021 looks likely to would result in more accurate and Thereby obliged entities can minimize be a key building block. In particular, it valuable STRs that could significantly risks for their own institutions and will establish more harmonised rules improve the effectiveness of AML simultaneously improve prevention by and a more uniform application of these prevention and simplify the work of law the private sector. rules throughout the Union. enforcement authorities.

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conclude that AML regulations need to authority. We do not need more; we need a become smarter. more focused regulatory regime.

According to the Compliance Week While it is very much appreciated that the (2021) European banks annually spend existing legal instrument of a “Directive” 115 billion Euro on AML Compliance, will be changed into a “Regulation”, three to four times more than their we believe it is important to have a counterparts in North America. Yet all unified approach towards regulatory too often, we have the impression that examination. This is the only way to European supervisory authorities focus ensure we have an aligned understanding on sanctioning formal inaccuracies and interpretation of the supervisory made by banks, instead of managing regime within the EU, preventing AML risks in partnership with banks. regulatory arbitrage. Also, cross-border exchange of information within a group HANNES The EU Commission has recognised this like RBI, being active in 13 CEE countries, disparity. With the Action Plan for the and also between banks and banking MÖSENBACHER Prevention of Money Laundering and groups, should be made possible and Terrorist Financing presented in May 2020, strengthened. A starting point could be Chief Risk Officer, we see a window of opportunity to step up a central European Beneficial Ownership Raiffeisen Bank International AG our collective ambition by establishing Register, with complete and qualified a standardised anti-money laundering data, that market participants can rely on. framework throughout the Union. When Are AML regulations implementing this Action Plan, we expect The second strand relates to cooperation that the legislative proposal in May 2021 between the banking industry and the world’s least will consider two strands: public authorities. We need a stronger and more cohesive partnership between effective policy? the private and public sectors, as it is The time has come for successfully practised in Great Britain a more effective AML with the “Joint Money Laundering 30 years after the first steps in fighting approach and equilibrium Intelligence Force” or in the Netherlands money laundering in Europe, results between effort and benefit. in the area of transaction monitoring. are still negligible. The ratio between banks’ efforts in collecting data and European banks are committed to fight complying with subsequent tracking Firstly, the harmonisation of legal frame- money laundering. Enhanced collaboration obligations is disproportionate to the works and supervisory competences. We between banks and authorities based on actual prosecution and conviction of would welcome the introduction of a su- harmonised rules will help Europe not criminals. Of the 80% – 90% SARs1 pervisory authority at EU level, exclusively only to follow the money trail but to also that are filed, an alarming number and directly responsible for all institutions, become more effective in preventing crime. bring no immediate value and only banks, payment services, crypto-asset The time has come for a more effective 10% are investigated further (Kaiser, providers or brokers. Parallel supervisory AML approach and equilibrium between 2021). It should therefore not come as a structures incl. different regulatory ap- effort and benefit. First steps have been surprise that AML regulations have been proaches, loss of information and thus du- made by the European Commission in the described as the world’s least effective plications of costs must be avoided. EBA’s right direction, but there is still a long way policy (Pol, 2018). Add to this a reluctance and ECB’s AML competences, which re- until it becomes an effective framework to embrace digital opportunities by cently have been strengthened, must be re- against money laundering. regulators and unwieldy formulaic defined, and national supervisory authori- requirements for customers, it is easy to ties should be integrated into the new EU 1. Suspicious Activity Report

compliance every year but that only A paradigm-shift is about 1% of the proceeds of crime are confiscated illustrates that the current needed to efficiently system is not working. This is a complex combat financial area, where there is a lot to consider but at its heart, I would suggest that the crime in Europe reforms need to have three key elements. First, that the public authorities in this The European defence against financial area need to be better resourced and better crime has not been working effectively in coordinated. This argues in favour of the the past. Banks have been found to have Commission proposals for an EU AML Au- been ineffective compared to the size thority and for taking action to strengthen and complexity of the problem. But the and support the FIUs. This is needed for public authorities have also been found a number of reasons: to help the smaller MATTHEW to be ineffective, as has the European member states that are out-gunned by the regulatory framework. criminals, to recognise that this is an inter- ELDERFIELD national problem, to create a more consist- Chief Risk Officer, Head of Group Risk The fact that European firms spend ent framework that is less burdensome to and Compliance, Nordea Bank Abp over a hundred billion euros on AML comply with for businesses and consumers

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- and many other factors. Until a credible collaboration. The UK model, the Joint targeted transaction monitoring on the EU-level authority is in place it is de facto Money Laundering Intelligence Task typologies of organised crime, where the US that is the financial crime regulator Force, is a forerunner in this. This specific criminal names were provided for European banks. allows sharing of information between to allow sophisticated network analysis the banks and the public authorities and using AI to find associates, seize more of Secondly, there needs to be better use of allows for targeted and intelligence-led the proceeds of crime and make arrests. technology and data in the fight against activities. In the Nordics, we have been financial crime. part of a pilot to establish a similar I am humble about the historic track approach in , called SAMLIT, record of the banking sector. And I Thirdly, there needs to be more public- which is showing great promise. know the sheer size and complexity of private collaboration between banks the problem and indeed the complexity and authorities. of the compliance requirements means Banks want to be partners we will make mistakes and criminal The facts around transaction in a better system that money will get through. But banks want monitoring illustrate these last two catches the real criminals. to be partners in a better system that points. Research notes that only 10% catches the real criminals. Given how of suspicious activity reports are much money is being spent throwing investigated. I am skeptical it is actually Imagine an EU-level approach, where hundreds of thousands of SARs at that high. This makes the point for the new AML Authority and well- under resourced FIUs each struggling in better resources, for better use of resourced and data-driven FIUs worked their own country, we can collectively data and technology and for better in partnership with the banks to have do much better.

in different EU Member States do not First, we need rules that are have the same powers; where prudential homogeneous and apply directly to all supervisors consider financial crime financial institutions wherever they risks differently across countries and operate in the single market. Greater sectors; and where the common EU harmonisation should be conducive to rules that determine what financial an approach that is proportionate and institutions do to prevent and detect risk-based and guarantees that the same ML/TF are interpreted differently in risks are managed consistently. each Member State. Secondly, we need a more integrated One year ago, the EBA was given a and sufficiently intrusive approach new legal mandate to lead, coordinate to supervision where prudential and and monitor the entire EU financial AML/CFT competent authorities work sector’s fight against money laundering together to ensure that ML/TF risks are JOSÉ MANUEL and terrorist financing. We have been addressed effectively across all Member working hard to make the best use of States, across all sectors and throughout the new duties and powers to tackle an institution’s life cycle. Active CAMPA ML/TF. For example, we have published cooperation and information exchange Chairperson, European Banking regulatory products, strengthened among supervisory authorities and Authority (EBA) cooperation between AML/CFT and stakeholders in the public and private prudential supervisors, created AML/ sector is a prerequisite for this and has CFT colleges and assessed competent to be enhanced. The EBA moves authorities’ approaches to AML/CFT supervision. We are also creating a Third, we need direct supervision at forward in the fight central AML/CFT database. EU level of the highest ML/TF risk institutions as part of a harmonised, against financial crime proportionate approach to the AML/ Greater harmonisation CFT supervision of all obliged entities of rules with cooperation throughout the Union. Europe is at a crossroads. The approach and direct EU supervision to stemming the tide of dirty money is needed to embrace a Embracing a bold, new and integrated into the single market has until now bold, integrated approach approach to tackling financial crime, and focused on a succession of minimum emphasising the roles and responsibilities harmonisation directives, specific to tackle financial crime. of each of us in government, supervision, provisions in sectoral laws and a strong law enforcement and the financial reliance on national governments, But while our new powers are an services industry in stamping out supervisors and financial institutions to important step in the EU’s journey financial crime is the right way forward. take the steps necessary to fight money towards a more effective and The EBA’s ongoing work harnessing the laundering and terrorist financing comprehensive AML/CFT regime, they synergies between AML/CFT policy and (ML/TF). are not sufficient to ensure financial other policy areas such as prudential, crime in Europe is contained once and resolution, deposit guarantee schemes Not surprisingly, we ended up with a for all. For this, a much more ambitious and consumer protection will be crucial fragmented approach. An approach approach is needed. We have set out to this. where financial sector anti-money what this should entail in our response laundering and countering the financing to the Commission’s call for advice on Together, we can make a difference. of terrorism (AML/CFT) supervisors the future AML/CFT legal framework.

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GLOBAL OUTLOOK

ISSUES AT STAKE

Financial fragmentation is a significant challenge for regulatory authorities and policymakers. It can have detrimental effects such as less competition, higher costs of capital, and reduced availability of services. The Covid-19 crisis has put the global economy under extraordinary stress. But rapid and coordinated public policy responses have largely averted fragmentation in the global financial system. It will be equally important to coordinate exit strategies from public support measures in order to maintain a level playing field for healthy competition among the major jurisdictions. Multilateralism remains the most efficient way to finding solutions to common issues affecting our global economy, provided there is a common will.

Brexit is a further potential source of fragmentation and continues to raise many questions 4 months after the end of the transition period. At this stage no equivalence agreements have been agreed in the financial sector and risks of regulatory divergence are appearing. The recently agreed MOU is a step forward but it is unlikely that the future EU-UK financial services relations can be built solely on the Joint UK-EU Financial Regulatory Forum that is due to be established. GLOBAL FRAGMENTATION...... 74

John Berrigan - European Commission / Bernard Mensah - Bank of America / Markus Ronner - UBS / Shinsuke Toda - Mizuho Financial Group, Inc. / Mizuho Bank, Ltd.

POST-BREXIT PROSPECTS ...... 78

Katharine Braddick - HM Treasury / John Berrigan - European Commission / Verena Ross - European Securities and Markets Authority / Stéphane Boujnah - Euronext Paris / Patrick Thomson - J.P. Morgan Asset Management / Keiichiro Nakamura - SMBC Bank International, Sumitomo Mitsui Banking Corporation & Sumitomo Mitsui Financial Group GLOBAL OUTLOOK

GLOBAL FRAGMENTATION

control over risks to their financial financial markets and a series of stability, even if they also wish to legislative and regulatory measures exploit the opportunities deriving from brought forward by the Commission international integration. and supervisory authorities.

The Covid-19 crisis has put the global These measures complement the wider economy under extraordinary stress. policy response reflected in the €750 However, a remarkable feature of bn recovery effort, Next Generation the crisis has been how rapid and EU (NGEU), and major fiscal support coordinated public policy responses measures in the Member States. The to support the economy, including EU has also intensified its efforts to the financial sector, have largely complete the Banking Union and the averted fragmentation in the global new CMU Action Plan will result in financial system. This has confirmed deeper and more integrated capital the economic rationale for policy markets. On the other hand, while the coordination at the international level. EU is committed to a more resilient and open global economy, it must also Regulators and supervisors have reinforce its open strategic autonomy in coordinated their response via the financial services as well as its capacity various fora and bodies that had to protect the EU’s financial stability. JOHN been set up in the aftermath of the global financial crisis. They have also While there is no “one-size-fits-all” BERRIGAN learned from one another in designing approach to finding the appropriate Director-General, and implementing their respective balance between financial integration DG for Financial Stability, measures. Going forward, it will be and financial stability, equivalence is Financial Services and Capital equally important to coordinate exit a key tool in this regard. Equivalence Markets Union, strategies from public support measures decisions in financial services are European Commission so as to avoid possible fragmentation mutually beneficial for the EU and for from this source and maintain a level third-countries, and serve the EU’s playing field for healthy competition objective to promote the international among the major jurisdictions. integration of financial markets while preserving financial stability. By narrowing cross-border divergences Global financial and incompatibilities, equivalence reduces global market fragmentation fragmentation: can Multilateralism, and enhances the EU’s regulatory and when there is a supervisory cooperation with third- progress be made? country authorities in a sustainable way. common will, remains the most efficient Multilateralism, when there is a common will, remains the most efficient Financial market fragmentation is a way to finding way to finding common solutions to significant challenge for regulatory solutions to common common issues affecting our global authorities and policy-makers. The issues affecting our economy. In the financial sector, challenge is between ensuring and convergence towards international promoting financial integration on the global economy. standards helps all jurisdictions one hand and preventing contagion to ensure that similar risks can be and maintaining financial stability on addressed in a similar way and that the other. Fragmentation in financial races to the bottom - prone to creating markets can have detrimental effects The EU takes concerns about market financial instability and contagion risks such as less competition, higher costs fragmentation seriously. The EU in global markets - are avoided. of capital, and reduced availability financial sector entered the Covid-19 of services. However, as noted for crisis from a position of strength, due example by the FSB in its Report on to the regulatory reforms introduced Market Fragmentation, some types after the global financial crisis and to of market fragmentation are justified the sector’s own efforts to overhaul and legitimate, and are inevitable business models and build resilience. consequences of measures taken to The financial sector is “part of the safeguard financial stability1. solution” to this crisis. Nevertheless, the EU has responded to the crisis with a Indeed, fragmentation can be an set of measures to support the financial inevitable result of the fact that sector, notably actions taken by the jurisdictions across the world must to facilitate retain an appropriate degree of bank lending and ease pressure on 1. https://www.fsb.org/wp-content/uploads/P040619-2.pdf

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International Business Council (IBC) firms; and they will need to describe on a common core set of metrics to the connection between sustainability standardise ESG reporting. The IBC, and longer-term financial results. For chaired by our CEO Brian Moynihan, this purpose, we propose that any along with the Big Four and in new standard follows the IBC’s four collaboration with all stakeholders, pillars that are aligned with the SDGs built on the wide range of existing and principal ESG domains: Principles standards – such as TCFD, GRI, of Governance, Planet, People and and SASB – and identified those Prosperity. Metrics like Sustainability ESG factors material to business reporting should be developed with the performance. The IBC’s “Stakeholder same level of governance and controls Capitalism Metrics” provides a core and that support financial reporting and expanded set of metrics that will lead hence be auditable. It is not an easy to greater consistency, comparability task and will require some imagination and compatibility with the existing and creativity. sector-specific approach and will serve as one of the building blocks for a The time has therefore come for all global standard. parties, including companies, investors, regulators, and governments to These metrics are NOT a new ESG work together to achieve these ends BERNARD standard in themselves, but rather a and establish a single sustainability foundational set of existing metrics standard-setter. This should be MENSAH and disclosures deemed most critical independent and properly funded, with President of International, for sustainable value creation – distilled broad stakeholder composition and the Bank of America together to help deliver a new kind of requisite expertise at both the board corporate leadership. and staff levels, to address the full suite of ESG reporting. We support the IFRS The EU is also reviewing its own rules Foundation in leading the discussions for non-financial reporting, as part of on developing a global sustainability Why non-financial its Green Agenda to progress towards reporting standard. the disclosure of more meaningful and reporting matters comparable data to support financial To address the challenge of climate decisions. We would suggest that such change, ambitious international solu- work at EU level should be informed tions are called for. An international- by and build on already existing and ly-accepted common reporting frame- Europe needs sustainable, environ- verified standards. work embedding non-financial and mentally-friendly growth, and the EU’s financial considerations will lead to Green Deal promises to deliver the a better allocation of capital – and in green transformation that society needs turn will help address one of humani- – while at the same time supporting an ty’s most pressing challenges. inclusive economic growth. The time has come to establish a single The UN Sustainable Development Goals provide the target society is sustainability aiming for. A key component of standard-setter. reaching this target will be measuring companies’ sustainability practices. Environmental, social and governance factors relevant to sustainable value creation are increasingly material Looking more widely, we recommend to business performance. Investors, that standards on non-financial regulators and other stakeholders all reporting should be established at want to know how companies perform international level, as achieving the UN in these areas. SDG goals must be a global ambition. Moreover, any standards should However, for an accurate measurement converge towards the development of long-term sustainable value creation, of a systemic global solution – there needs to be a single framework similar, for example, to international integrating all ESG reporting metrics. accounting standards. Today, companies face challenges in measuring and reporting on their long- Ideally in our view, a reporting standard term value creation in a consistent should cover the entire range of ESG manner at international level – the reporting, including the broader range various ESG metrics and frameworks of environmental factors. The metrics hinder companies from demonstrating will need some uniform characteristics. value creation in a comparable and They will need to be industry and meaningful way. business model agnostic, while remaining relevant and material to Bank of America fully supports the each; they will need to be measurable, work of the World Economic Forum’s verifiable and comparable across

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negatively impact the pricing and interconnected, reflecting both supply availability of financial services within and demand needs across jurisdictions. the EU. First, authorities need to follow The lack of consensus around the through consistently on the reforms finalisation of the Too-Big-To-Fail already started, such as completion of (TBTF) reforms illustrates the scale of the Banking Union, the TBTF reforms the challenge we now face. The industry and consistent implementation of has made great progress in terms of Basel 3. It’s also key to step up efforts to self-sufficiency (financial, processes remove existing impediments to cross- and governance) within individual border consolidation, which is the best entities – around USD 300bn of TLAC route to attain financial integration. built up globally in the first half of 2020 alone. Yet the global implementation Furthermore, regulatory cooperation of agreed reforms – highlighted by will continue to be critical to address the FSB itself – remains uneven in the global challenges posed by climate- important areas. These include cross- related financial risks, cyber risk and border coordination and allocation operational resilience, the digitalisation of internal TLAC, while open issues of finance and financial crime / AML, remain to be addressed consistently to name just a few. Ideally this should MARKUS through closer regulatory cooperation, be moderated by global fora such as avoiding uncoordinated measures the BCBS, the FSB and IOSCO and RONNER across host jurisdictions. potentially broadened even further to Group Chief Compliance and a wide range of public authorities and Governance Officer, UBS stakeholders due to the cross-sectoral nature of many of these issues. We will otherwise risk ending up with a To direct capital scattered landscape of rules across major towards facilitating jurisdictions for an additional range of More international highly critical topics which are, by their the transition to net nature, global. coordination today zero carbon emissions, internationally Taking sustainable finance as an to improve financial example, global principles would fill a harmonised key gap, enabling regulation focused on system resilience definitions and rules disclosure, climate risk measurement are essential. and taxonomy to become clear, tomorrow actionable and truly purposeful. The inflow rate for sustainable investing funds by the third quarter of 2020 amounted to 36% year-on-year in an Following decades of global financial Open issues include ‘funding in otherwise fairly static fund market. integration, we have begun to see resolution’ and ensuring a robust some retrenchment, as evidenced framework for the increasingly If we want to unleash the full potential by declining euro area portfolio significant activity related to non- of private investors to direct the flow investment flows since their peak in bank financial intermediation, where of capital towards facilitating the 2016. With global flows being reshaped lessons need to be drawn from the transition to net zero carbon emissions, as a result of geopolitical tensions, we market liquidity issues experienced in internationally harmonised definitions have also seen continued financial March 2020. A reliable, internationally and rules are essential. fragmentation within Europe – not consistent approach to central banks’ just as a result of Brexit but also due to Lender of Last Resort role will be crucial continuing frictions between home and as a key enabler of an effective and host countries. credible bail-in tool.

The trend towards financial fragmen- Together with other measures outlined tation has been aggravated further by below, this should encourage in COVID-19. While the banking industry particular host authorities to limit appreciates the bold and swift policy excessive pre-positioning requirements, reactions to the pandemic, the su- as intended by the FSB in designing the pervisory response to common issues TLAC framework. As a consequence, brought about by the crisis appeared the increase in costs for banks, which somewhat disjointed, with capital and would over time feed through to the liquidity relief measures diverging sig- economy, would be limited. Clearly this nificantly across major jurisdictions. is important to support the recovery.

An inward-looking focus may Moreover, there are several actions unfortunately undermine the which could be taken to foster further encouraging progress in financial international integration to the benefit integration made since the 2008/09 of each individual country, given the financial crisis. Over time, this could global financial system remains highly

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be harmonised globally as far as possible, application of regulations dependent to attract investors from around on the client’s circumstances. the world and, to this end, the EU’s International Platform for Sustainable In respect of Brexit, the envisaged Finance (of which Japan is a member) memorandum of understanding will have an important coordination covering financial services should role. Regulatory harmonisation is provide a platform for EU-UK critical for a common understanding of cooperation on regulatory standards the rules and how various activities are to mitigate the effect of overlapping categorised from an ESG perspective. and inconsistent rules. An immediate concern for firms is how to find and However, regulatory harmonisation interpret the law post-Brexit, due to should be balanced against ensuring the complexities introduced by the that the rules appropriately consider tangled web of statutory instruments the varying economic circumstances, promulgated as a result of the energy needs, infrastructure constraints onshoring regime and the piecemeal and cultures of different jurisdictions temporary waivers set up to delay the and industry sectors. This means anticipated “cliff-edge” effects. focusing on high level global standards, rather than detailed prescriptive rules, Further regulatory divergence may SHINSUKE particularly early on when there will be also affect the competitiveness of material disagreement amongst market the European financial market, with TODA participants on the minutiae. the average cost-to-income ratio of Chief Executive Officer for Europe, European banks being higher than Middle East and Africa We note that sustainability-linked that of US or Asian banks. This crucially Mizuho Financial Group, bonds have been eligible for the ECB’s affects third country banks operating in Inc. / Mizuho Bank, Ltd. Asset Purchase Programme since Europe, who may look to allocate capital January and further initiatives are elsewhere if their EMEA business is under consideration to achieve the not sufficient to maintain sustainable objectives of the European Green growth. In addition to the increased Deal. We appreciate the need to cost that regulatory fragmentation gather momentum towards a carbon brings for financial institutions, a key Drive globally neutral economy and support the point that is often overlooked is the Commission’s drive for a long-term consequent impact for clients through balanced attitude towards transition, noting direct cost increases, poorer service the risks of “greenwashing” amongst quality and more limited choice. sustainability market participants in order to meet certain targets or take advantage of We urge policy makers to move towards through regulatory applicable funding schemes. global regulatory harmonisation and to enhance mechanisms for coordination continuous and systematic cross- border cooperation, with appropriate deference for national and industry The mission for banks idiosyncrasies, so that all enterprises In response to the Covid-19 pandemic, can thrive without being burdened fiscal relief policies have been and policy makers unnecessarily with the cost of introduced to a greater extent in is to support clients’ incremental compliance. developed economies, notably in sustainable finance the EU and the US, than emerging markets. Consequently, revenues in transition pathways these markets are more at risk of any with appropriate economic downturn in the aftermath liquidity provision… of the pandemic. The divergence in national responses has exacerbated existing regulatory fragmentation and its impact will remain even when Covid-19 subsides, but conversely Policies that reward short-term actions the Covid recovery presents a real may result in a pricing gap based on an opportunity to re-orient capital flows entity’s transition status, harming its towards sustainable investment. access to funding and consequentially its ability to transition, and ultimately Europe is the world leader in the the economy as a whole. This is vital for burgeoning frontier of ESG reform enterprises with high climate change and we fully support the EU’s risks globally, where transition requires Renewed Sustainable Finance Strategy. a huge amount of investment. The Regulation aims to bring certainty to mission for banks and policy makers is an arena where there is rapid change, to support clients’ sustainable finance considerable financial and legal risk, transition pathways with appropriate and a keen focus on organisational liquidity provision, recognising that governance. These regulations should there should be a proportionate

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POST-BREXIT PROSPECTS

investors. In November, the Chancellor make Task-Force for Climate Related outlined the Government’s plans to Financial Disclosures fully mandatory ensure that the UK moves forward as across the economy by 2025; implement an open, attractive and well-regulated a green taxonomy; launch our first market, that continues to lead the green gilt; and offer a green retail world in pioneering new technologies savings product. Our G7 and COP26 and shifting finance towards a net presidencies come at a critical time for zero future. us to champion sustainable financial flows and work collaboratively with Central to our strategy is maintaining partners. This is a key area where the a predictable and transparent UK and EU share ambitions to drive environment for business, backed by global change. high-quality, proportionate regulation. Our key aim of the Future Regulatory Maintaining openness is also integral Framework Review is to achieve an to strengthening our international re- agile, coherent, and democratically lationships and has always been a cor- accountable approach to financial nerstone of our financial services poli- services regulation. In parallel, we cy. To foster further collaboration with are undertaking a series of policy partners, we are developing ambitious reviews to ensure regulation effectively trade and regulatory relationships with KATHARINE addresses the risks arising in the UK’s several jurisdictions. The proposed financial system and enhances its UK-Switzerland Mutual Recognition BRADDICK competitiveness. Agreement is a truly exciting opportu- Director General, nity to develop our tool kit for appro- Financial Services, To take just one example, we have priately managing cross-border finan- HM Treasury announced that we are going to consult cial services business between advanced on wider capital markets reforms financial centres. I would like to think to build on the UK’s reputation as a that a successful agreement might set hub for high quality capital markets a new international standard for open- underpinned by high standards of ness and the benefits that brings when regulation and market efficiency. We underpinned by global standards and The future of financial do not plan to significantly overhaul close cooperation. the current regime but rather enhance services in the UK the effectiveness of our regulation. At the time of writing, we’re working towards a Memorandum of Understanding on regulatory cooperation with the EU. Providing The global financial sector is certainty and stability for the industry experiencing a period of rapid The UK continues remains at the forefront of our minds, change. The Covid-19 pandemic to advocate for and I’d like to thank the sector and has transformed the behaviour the regulators for their extensive of individuals, organisations and a global financial preparation for the end of the economies. The balance between system that is Transition Period. protectionism and free trade is being built on open and tested in many major economies, Constructive engagement between and the European banking sector is competitive markets. industry and the authorities will be under increasing pressure while the essential for the UK/ European financial US and Asian markets grow. There are sector to thrive, pioneering solutions also unprecedented challenges and to global challenges and tackling opportunities on the horizon, as the Innovation-friendly regulation is also novel challenges as they arise. The UK urgency of the climate crisis increases a key component of the UK’s sector, will continue to build on its vision and technology diversifies our financial to promote the adoption of safe, for financial services in the coming markets, pushing the boundaries of cutting-edge technologies in financial months, to strengthen the role it plays how our financial institutions operate. services, and the growth of the fintech in global financial markets – now and sector itself. We are considering the in the future. This direction of travel will have recommendations of Ron Khalifa’s unknown consequences on the shape FinTech Review and have announced of Europe’s future financial landscape. the introduction of a new unsponsored In the face of this uncertainty, the points-based route and visa process UK continues to advocate for a global for UK ‘scale ups’, that will allow us to financial system that is built on open attract talent from overseas. and competitive markets, which preserves financial stability and market We’re pursuing an ambitious agenda integrity and protects both citizens and in Green Finance, committing to

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Market participants were prepared. Over time, there is scope for a broad While there have been some necessary and deep relationship with the UK adaptions, there has been no volatility in financial services. There are many or disruption. areas of common interest in regulatory developments, such as risks to financial The Agreement last December brought stability, digital finance, or new issues to an end a four-year period of prepa- like green finance where the UK rations and negotiations. However, will play an important role with its for financial services, 2021 is the start presidency of the COP26. I would also of a new, complex period. The EU-UK anticipate close cooperation with the relationship in financial services will UK at international level in the FSB and have to be developed over time. While other standard setting bodies. Brexit is unfortunately a fragmenting event, we will strive for close coopera- The past four months has marked tion with the UK. As set out in the Joint the beginning of a new phase in the Declaration on Financial Services Reg- trade of financial services between ulatory Cooperation, annexed to the the EU and the UK. Given the level of TCA, our aim is to establish a durable interconnectedness between the two and stable relationship between the EU jurisdictions, it is essential that we get JOHN and the UK. Our bilateral relationship the basis for our new relationship right with the UK will be based on voluntary from the outset. I remain hopeful that, regulatory cooperation outside of the over time, through cooperation and BERRIGAN TCA structures. trust, we will manage to build a stable Director-General, and balanced relationship with the UK DG for Financial Stability, The purpose of a regulatory cooperation in the area of financial services. Financial Services and Capital framework will not be to restore market Markets Union, access rights that the UK has lost, Let’s not forget that London will remain European Commission nor to constrain the EU’s unilateral a very important global financial centre equivalence or regulatory process. on our doorstep, and although a third Equivalence is an area which we will country, the UK will remain one of our discuss with the UK – progressively, main partners in the area of financial taking into account the UK’s regulatory services. It will be important for the EU intentions, on a case-by-case basis. The to strategically manage the significant Nearly 4 months EU is an open financial jurisdiction. level of interconnectedness between We use equivalence as a tool to manage the two jurisdictions so as to maximise after Brexit: interactions with third countries, the benefits of our new relationship including the UK. Our third-country while, at the same time, avoiding any where do we stand regimes allow EU consumers and element of dependency that would investors to benefit from the services translate into reduced autonomy for and what way forward provided by third-country firms, whilst the EU. ensuring adequate risk management. for the EU and UK?

The Trade and Cooperation Agreement I remain hopeful that, (TCA) between the EU and the UK covers financial services in the over time, through same way that financial services are cooperation and trust, generally covered in the EU’s other we will manage to free trade agreements with third (non- EU) countries. The TCA provides for build a stable and limited market access commitments balanced relationship. for cross-border provision of financial services and preserves the sovereignty and regulatory autonomy of the EU (and the UK), in line with the Commission’s mandate. When it comes to UK equivalence decisions, the EU, just as we do with all A regime change took place in third countries, must consider our own financial services on 1 January 2021. interests. Given the close links between UK firms have lost their passporting the EU and UK financial systems, our rights and are now treated as third- risk-based and proportional approach country firms for the provision of needs to be particularly thorough in financial services in the EU. Market order to capture, across all sectors, all fragmentation is an unfortunate, but potential risks for financial stability, inevitable consequence of the UK market integrity risk, investor decision to leave the EU and the Single protection and the level playing field. It Market. Nevertheless, the transition in is clear that there cannot be equivalence financial services has gone smoothly. and wide divergence.

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Any future equivalence decisions will additional requirements and to ESMA’s be unilateral and in the interest of the direct supervision. These additional EU, just like the equivalence decisions safeguards ensure that any risk which adopted by the UK towards the EU in is imported into the EU via third- November 2020. country entities can be appropriately managed, in particular when it comes The EU is an open financial jurisdic- to third-country entities that may be tion and ESMA is a strong proponent systemically important in the EU. of the use of deference in financial services, as a means to reduce market Aside from the ongoing question fragmentation and limit cross-border of equivalence, the most important divergences. Unfortunately, Brexit is by thing from ESMA’s perspective is that its nature a market fragmenting event cooperation and information sharing and with the UK signaling its intention between EU and UK regulators remains to diverge from EU rules, the task for open and constructive. In 2019 ESMA the Commission on equivalence be- concluded two cooperation agreements comes more complicated. Equivalence with the UK Financial Conduct normally works by fostering coherence Authority (FCA), which have ensured between EU rules and the correspond- that ESMA, the FCA and EU securities VERENA ROSS ing framework in a third country. In markets authorities can cooperate this case, with one jurisdiction likely to effectively on supervisory and Executive Director, increasingly diverge from the other, it enforcement matters, and exchange European Securities and makes sense for the EU to also be for- information to allow all authorities Markets Authority (ESMA) ward-looking in its assessments. to discharge their duties regarding investor protection, orderly markets and financial stability.

Similarly, we intend to continue …the most important our cooperation with the UK at EU-UK regulatory and international level in the work of thing from ESMA’s standard setting bodies like IOSCO. supervisory relations perspective is that cooperation and in a post-Brexit world information sharing between EU and UK regulators remains The end of the UK’s transition from the EU on 1 January 2021 marked open and constructive. the beginning of a new era in the relations between the EU and UK financial sectors, both for firms and for the authorities overseeing those The EU’s equivalence model, which sectors. The good news was that the focuses on achieving the same transition period ended without any outcomes, remains the tool which the notable disruption. Since then, the EU Commission will use to determine and UK have turned their attention to equivalence for the UK. It should be establishing a framework for structured noted however that there are heightened regulatory cooperation, which will be level-playing field concerns and the foundation for a strong, balanced increased systemic risks due to natural and fruitful future relationship. and historic interconnectedness of the UK and EU economies and financial Separate to this, the EU and UK begun markets. The European Supervisory the process of assessing the equivalence Authorities, with their new equivalence of each other’s rules and supervisory monitoring powers, will assist the arrangements in early 2020. On the Commission through technical advice EU’s side, the Commission (with the and monitoring of ongoing compliance technical assistance of ESMA and other by third countries with the conditions EU bodies) undertook a comprehensive of equivalence decisions. assessment of 28 areas of EU law where the most relevant equivalence In addition, the EU’s third-country provisions exist. With the end of the supervision model has been enhanced transition period approaching in late in recent years. The most notable 2020, in the interest of mitigating enhancement, which was first used in potential risks to financial stability, the context of the 2020 time-limited time-limited equivalence was granted equivalence decision for the UK, was to by the Commission for UK Central the EMIR regime for third country CCPs. Counterparties (CCPs) and UK Central ESMA must now tier and recognise Securities Depositories. For all other applicant CCPs and, depending on the areas, the assessment remains ongoing. tiering decisions, they may be subject to

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the Covid-19 crisis assumes its full listed companies, boosting access to importance and significance. growth for European companies, thanks to our single order book and our single Euronext believes a competitiveness liquidity pool. On the other hand, retail test should be introduced within the investor participation is increasing, new CMU to assess the impact of any often with a local outlook. Both these new proposals on EU competitiveness dynamics should be enhanced by CMU. as compared to major third country Ultimately, an efficient combination of jurisdictions. This is obviously the global, European, national and local important in respect of the UK, but market participants is required. also the US. The EU must remain attentive to significant policy and An effective CMU will be essential regulatory changes in those countries for the recovery of the EU economies and adjust when necessary. Alongside because the economic transition impacting on any consideration of initiated by massive injection of debt possible equivalence measures, the EU programs must be coupled with an must also ensure that its rule-making efficient injection of equity to fund processes are agile enough to be able risky projects and innovation. to adjust the European rulebook to respond promptly where necessary. Beyond factoring in the consequences STÉPHANE of Brexit, the CMU will also have to The recent evolution of Euronext into enable green finance, contribute to BOUJNAH a stronger pan-European financial the strengthening of the role of the Chief Executive Officer and markets infrastructure is a key enabler euro and adapt to the lasting impacts Chairman of the Managing Board, to build the backbone of the CMU. With on markets of the recent massive Euronext Paris the Italian capital market expected to central bank interventions and fiscal join Euronext, investors and issuers stimulus measures. will be able to benefit from the largest capital and liquidity pool of the internal It is now time for European financial market, across eight countries in market infrastructures to meet Europe. This transformational project the challenges of building strong Following Brexit, for Euronext will also contribute to the integrated financial centres distributed objective of better funding the recovery across Europe. Through the expected a strong and of the EU economy, with a positive inclusion of the Borsa Italiana Group impact in terms of efficiency as well as into its successful federal model, multipolar capital market and product availability. At the Euronext will continue to prove that same time, this evolution strengthens building European capital markets is market is rising Euronext’s federal model, closing the the core of its project. gaps between the different financing in the EU needs and ecosystems at European, national and local levels.

In the first weeks of 2021, there has been a massive shift of trading in European shares from London to Amsterdam. It is my strongly This trend is likely to continue in held conviction other areas because of the quality of European financial centres and that the EU must increased uncertainty stemming from act as a strong and Brexit. It is my strongly held conviction competitive finance that the EU must now act as a strong and competitive finance maker, not maker, not merely as merely as an open territory of finance an open territory of takers. Brexit has been a clarification finance takers. moment and a wake-up call for the EU.

But the EU will not strengthen its capital market without strong European financial institutions and market This capability is very much needed infrastructures. We must stop the to build an effective CMU to deliver unilateral disarmament of the European integrated capital markets across the EU financial system to the sole benefit to the benefit of European companies, of non-European players. Building a investors and the real economy, whilst fertile and innovative ecosystem in the nurturing and developing the often EU will be critical. In this context, the diverse ecosystems on which these work on delivering Capital Markets markets depend. The Euronext markets Union to build a powerful integrated reflect this reality. On the one hand, European financial system and ensure our markets benefit from a significant the financing of the recovery from presence of global investors in European

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weight. This view is understandable and and increasingly AIFs. The European rational, but, importantly, this is not a funds market is almost €19 trillion. zero-sum game. And yet recently, we have faced a In the political heat, it has, at times, debate about the global supply chains seemed like the impact on clients has of European funds. Third country been secondary to which jurisdiction delegation, a key pillar of the global will ‘win’ more business. This is success of UCITS has come under regrettable. Ultimately the success or constant supervisory and regulatory failure of the EU and the UK should be scrutiny since 2016. Delegation allows judged on the impact on clients and the global investors in UCITS funds economy, rather than the relative size of access to the benefits of talent and financial sectors. We need to continue expertise across the globe with robust putting customers and the economy at investor protection. the heart of everything we do. Some policymakers have asserted that Recent years have seen increased third country delegation presents geopolitical tensions. Logically, the EU supervisory risk. We have not seen wants to look after its strategic interests evidence of any inefficiencies or risks in in a more uncertain geopolitical this model, nor have these policymakers PATRICK landscape. However, as a global firm raised any concrete or specific issues. with an almost-200-year history in Customers recognise the delegation THOMSON Europe, we are concerned when we hear model as a good one; a model that Chief Executive Officer, EMEA, concepts like ‘strategic autonomy’ and has enhanced the attractiveness and J.P. Morgan Asset Management ‘financial sovereignty’ voiced as tenets competitiveness of Europe. Why tamper for policy. The openness of financial with this model now or, needlessly, put markets has long been a source of investors’ trust in UCITS into question? their strength. Due to its nature as a supranational organisation, the EU Investors will be better served by Putting customers has a natural knack for cross-border investing time and energy into the many financial services. My sector, investment positive areas that will, collectively, first means management, is a perfect example drive our economies forward. The UK of this. has left the EU, but it has not turned its cooperation over back on the sustainability agenda. The UK has doubled down on helping make competition finance flows consistent with a pathway to net-zero. Whether we are promoting Ultimately the success corporate governance toward a carbon- or failure of the EU free future, or fine-tuning climate- The UK’s departure from the EU related financial reporting, getting remains a source of political tension. It and the UK should be the balance between consistency and also comes with an economic price for judged on the impact flexibility is key. So is striving for business large and small. On a personal on clients and the global consistency. note, I have a French mother and a British father. I served for five years in economy, rather than The EU is charting new courses and the British armed forces and my first the relative size of leading the way with the ESG agenda. J.P. Morgan project was based in Paris, financial sectors. The US, with a new administration, so I have been lucky to work in both the is starting to engage. The UK has a UK and EU and understand the myriad leadership role to play, alongside the opportunities for growth. But political EU, in fostering global partnerships or personal, we cannot afford to dwell on especially with the US. In my view, what has come to pass. COVID-19 and EU lawmakers’ vision to create a pan- the UK is showing genuine eagerness other challenges facing the EU and UK EU fund product, UCITS, in the early to be a world leader, not least with its collectively – the region of Europe – are 1980s, remains commendable. Forty ambitious net zero targets and its role in too significant and too urgent. Equally, years later, UCITS have become an co-hosting COP26. there are huge opportunities to be international gold standard, marketed gained by working together, especially in Europe, Asia and Latin America. J.P. But the sustainability agenda is just one when it comes to supporting a thriving Morgan Asset Management Europe, of many examples where the UK and EU investment culture in Europe and established in Luxembourg in 1988, can thrive together, putting differences promoting the sustainability agenda. was an early adopter of UCITS. Today aside. Together, we can support financial Intense and constructive cooperation we have branches in Austria, France, technology and lead policy on cyber must be our North Star moving forward. Germany, Italy, Netherlands, Spain, resilience. Together, we can tackle issues Sweden, and a subsidiary in Switzerland, related to gender, sexual orientation and Debating about financial market access 330 staff and nearly €390 billion in AUM. ethnic diversity and promote a more has been constant over the past few We distribute across thirty-six countries diverse and inclusive financial services years. The reason is obvious: the UK worldwide. Our European funds are sector. Last but not least, together, hosts a large amount of our region’s sold in, for example, Croatia, Korea, we can support the development of capital markets. And the EU has a Poland and Peru. We are just one of the Capital Markets Union, especially strategic interest in housing financial many firms enthusiastically embracing through increasing the level of retail markets more in line with its geopolitical the global success story that is UCITS, participation in Europe’s capital

82 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net POST-BREXIT PROSPECTS markets, supporting greater financial We need concerted cooperation to to make the next chapter a positive and literacy, pension initiatives and helping achieve the best outcomes for investors constructive one. As we write this next more Europeans make the jump from and our economies. The agreed Memo- chapter, let us never lose sight of the saver to investor. In other words, how randum of Understanding between the end-users of financial services – busi- can we better help European individuals EU and the UK gives us hope. It formal- nesses, investors, savers. They must be and families achieve their life goals ises a technical dialogue, helps to park prioritised. The notion that ‘cooper- through investing, while channelling the politics and fosters trust. But this ation is a higher moral principle than more money into companies, is just a starting point and frankly, the competition’ feels particularly pertinent transport networks, hospitals, schools minimum we would expect between here. Constructive cooperation must be and housing? partners. There is an opportunity here our North Star moving forward.

Looking ahead, it is possible to see will create a positive environment for that, notwithstanding Brexit, there international business. may in the future be a return to close EU and UK regulatory alignment. It As a basic matter, it is hoped that seems possible that the benefits of free the EU and the UK will continue to market access which have been enjoyed be “open” rather than “protective” by both the EU and the UK – making financial services markets. Being both the EU and the UK attractive “open to business” has made London, international centres of business Frankfurt, and other European financial – may continue through bilateral services hubs global centres of financial “equivalence” arrangements. excellence. It is hoped that even outside of areas of regulation which are deemed “equivalent”, the EU and the UK will be able to work closely together to formulate regulatory objectives which Close regulatory ensure broadly similar standards. Close co-operation going forward on the green cooperation will agenda, for example, is a high priority. ensure the continued KEIICHIRO attractiveness of While there are clear benefits to equivalence in being able to enjoy free NAKAMURA UK and EU financial market access across borders, this will markets. always be subject to the possibility Chief Executive Officer, of equivalence being withdrawn by SMBC Bank International / either the EU or the UK at short Managing Executive Officer, notice. Businesses, of course, need Head of EMEA Division, time to react effectively. Where Sumitomo Mitsui Banking Corporation “Equivalence”, however, depends on equivalence is taken away, there may & Sumitomo Mitsui Financial Group regulation achieving outcomes which not be an easy solution to ensuring are comparable between the EU and that businesses are protected from the the UK, and it is up to the EU and adverse impacts of sudden regulatory the UK to agree equivalence in key change; in particular, where they have areas. Although developments towards structured their business based on equivalence have so far taken place at equivalence decisions. After Brexit - a measured pace, it is hoped that an agreement on financial services will Regulatory cooperation should Looking towards be reached between the EU and the therefore not just be an area-by-area UK in due course. In many areas, in assessment, but should be an exercise closer regulatory particular, derivatives and securities at the highest level of regulatory policy business, there is otherwise the risk in financial services; closer cooperation cooperation of fragmented markets which are will, hopefully, reduce the risk of the EU inefficient and costly to navigate. and the UK taking a radically different Equivalence would not only benefit path from each other. Equivalence UK businesses, who would be able should, therefore, be easier to maintain. Now that the UK has left the EU, the fi- to easily access EU markets, but also Where rules are broadly aligned, they nancial services sector is looking ahead European consumers and corporates are easier to understand, and they at what the future might hold. The UK needing liquidity. provide a more comprehensible basis is now a “third country” under the EU for structuring international business. financial services regime, and UK banks Equivalence – although very important have lost important access rights to the for financial services – is clearly only part The ultimate aim in close regulatory EU markets, in particular, the ability to of the picture. Regulatory cooperation cooperation – across the full spectrum freely “passport” financial services across in the purest sense means countries of financial services – is to create EU member states. As a result, UK banks working together to determine the an environment which ensures the must now carefully navigate the regu- appropriate direction of regulatory continued attractiveness of the latory framework in each EU member policy, all the while being able to react UK and EU financial markets for state in which they look to do business. appropriately to real-world events. This international business.

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BANKING AND INSURANCE REGULATION

ISSUES AT STAKE

European banks entered the Covid-19 pandemic with stronger capital positions, higher liquidity buffers and better asset quality than the 2008 financial crisis. So, this time European banks have been part of the solution. The EU banking crisis management framework however needs reviewing to ensure that the banking system can face future episodes of stress. In addition European banks suffer from a persistent low level of profitability caused by excess capacity, low interest rates and insufficient efficiency that need tackling for preserving their capacity to support the post-Covid recovery going forward. Further challenges include the competition from non-banks and tech companies, digitalisation costs and Basel III standards.

Policy changes are also needed for supporting the role that insurers play in the long-term financing of the economy. The European Commission has launched a review of Solvency II in this perspective that also aims to preserve the soundness of the insurance sector and adapt the framework to new risks and opportunities - such as climate and environment- related risks, digitalization and cyber risks - and the unprecedented monetary conditions. These new risks and opportunities for the insurance sector also need further assessing at the global level. In parallel the monitoring of the ongoing reforms of the International Capital Standards (ICS) and the Holistic Framework for assessing and mitigate systemic risk in the insurance sector are underway. CHALLENGES FACED BY THE EU BANKING SECTOR ...... 86

Edouard Fernandez-Bollo - European Central Bank / Jean Lemierre - BNP Paribas / Luís Máximo dos Santos - Banco de Portugal / Denis Beau - Banque de France / Jonás Fernández Álvarez - European Parliament / Boštjan Vasle - Bank of Slovenia / Per Callesen - Danmarks Nationalbank / Klaus Wiedner - European Commission / Diony Lebot - Société Générale / Santiago Fernández de Lis - Banco Bilbao Vizcaya Argentaria

BASEL BANKING STANDARDS EVOLUTION ...... 96

Ana Paula Serra - Banco de Portugal / Luigi Federico Signorini - Banca d’Italia / - European Parliament / Gottfried Haber - Oesterreichische Nationalbank / Philippe Bordenave - BNP Paribas / James von Moltke - Deutsche Bank AG / Alban Aucoin - Crédit Agricole Group

POLICY PRIORITIES FOR THE EU BANKING SECTOR...... 102

Sebastien Raspiller - Ministry of the Economy, Finance and the Recovery Plan, France / Fernando Vicario - Bank of America Europe / Luis Garicano - European Parliament / Dr. Stefan Simon - Deutsche Bank AG / Philippe Heim - La Banque Postale / José Manuel Campa - European Banking Authority / António Simões - Group Santander

EU BANK CRISIS MANAGEMENT FRAMEWORK ...... 108

Elke König - Single Resolution Board / Maria Velentza - European Commission / Helmut Ettl - Austrian Financial Market Authority / Martin Merlin - European Commission / Karl-Peter Schackmann-Fallis - Deutscher Sparkassen- und Giroverband / Jacques Beyssade - Groupe BPCE / Diederik van Wassenaer - ING Group

SOLVENCY II REVIEW...... 114

Dominique Laboureix - Autorité de Contrôle Prudentiel et de Résolution / Margarida Corrêa de Aguiar - Portuguese Insurance and Pension Funds Supervisory Authority / Justin Wray - European Insurance and Occupational Pensions Authority / Frank Grund - Federal Financial Supervisory Authority, Germany / Gorazd Čibej - Insurance Supervision Agency, Slovenia / Aylin Somersan Coqui - Allianz SE / Mireille Aubry - Covéa / Gianluca Sanmartino - Generali / Alban de Mailly Nesle - AXA Group

INSURANCE SECTOR GLOBAL ISSUES ...... 122

Jonathan Dixon - International Association of Insurance Supervisors / Peter Braumüller - European Insurance and Occupational Pensions Authority / Alberto Corinti - Italian Insurance Supervisory Authority / Stefanie Ott - Swiss Re Management Ltd / Jean-Jacques Bonnaud - EUROFI BANKING AND INSURANCE REGULATION

CHALLENGES FACED BY THE EU BANKING SECTOR

challenges facing the European banking Consequently, a significant increase sector. When loan moratoria and other in banks’ exposure to domestic policy measures (such as government government debt could potentially give guarantees) that have been used to rise to a sovereign‑bank nexus, which support the real economy are phased could, in turn, trigger the return of out, solvency risk may rise at the most adverse feedback loops between weak affected firms, potentially resulting in fiscal positions and weak banks in an increase in non‑performing loans. some countries if concerns regarding Consequently, banks should proactively the sustainability of public debt were to manage credit risk, reclassifying loans re-emerge. on a case-by-case basis and ensuring prudent provisioning. All of these challenges have been addressed in our supervisory priorities While it is true that banks went into for 2021, with credit risk being our this crisis with improved asset quality, key area of focus this year. However, they may find, when support measures this is not something that we can expire, that their asset quality and deal with on our own. It is essential capital adequacy deteriorate again. to have a harmonised European crisis Banks need, therefore, to have a management framework to make comprehensive and forward-looking Europe’s banking sector healthier and EDOUARD credit risk strategy that allows for more resilient. adequate provisioning and efficient FERNANDEZ- management of asset quality. For example, it is important to avoid “limbo” situations after banks are BOLLO declared failing or likely to fail (FOLTF), Member of the Supervisory Board, thus ensuring that a bank which is European Central Bank (ECB) declared FOLTF and is not subject to What challenges resolution is wound up and exits the market within a reasonable time frame. are European banks It seems that national implementation facing as regards of the revised version of the Bank their financial health Recovery and Resolution Directive How healthy is (BRRD2) will not be sufficient to achieve and how can they this objective in all Member States, so the European be addressed? further legislative amendments should be considered in order to harmonise banking sector in the definition of “orderly winding-up”. the pandemic? Furthermore, in order to foster such Second, banks’ interest income and orderly winding-up, it is important to profitability levels have fallen further expand the available toolbox across the in the course of the pandemic as a EU with a view to properly managing On 11 March 2020, the World Health result of increased impairment, loan exits from the banking system for all Organization declared Covid-19 a moratoria and declines in lending types of unsustainable bank (including pandemic.1 The very next day, ECB rates. At the same time, commission those not eligible for resolution as Banking Supervision announced its and fee income has also declined amid defined by BRRD2) in full consistency first supervisory relief measures with a strong competition. with the aims and mechanisms view to giving banks the breathing space provided for in that directive. they needed to continue supporting Third, pre-existing vulnerabilities (such viable households, small businesses and as banking overcapacity, lingering corporations. That policy, which was cost inefficiencies and increased fully consistent with the decisive action competition from non-banks, taken by other public authorities in the particularly fintech and firms) EU, has been a success. At the end of are putting additional pressure on 2020, the ECB was generally satisfied banks to adjust their business models with the prudential situation in and make them more sustainable. Europe’s banking sector. Nevertheless, Banks should, for example, increase many uncertainties remain, with their use of digitalisation in response to European banks facing four clearly the pandemic. identifiable challenges as regards their financial health. Fourth, the COVID-related protection schemes that have been established 1. https://www.who.int/director-general/speeches/detail/ The first issue relates to credit risk, by European governments have who-director-general-s-opening-remarks-at-the-media- which is one of the most immediate resulted in surging public debt ratios. briefing-on-covid-19---11-march-2020

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will show robust recovery potential. - Contributions to the Single Banks will again be at the core of the Resolution Fund should not be new phase, unavoidably affected by inflated by the significant increase in some rise in NPLs, and at the same time deposits resulting from the abundant actively involved in financing liquidity liquidity creation by the ECB, and the needs, consolidating debt, and providing flexibility embedded in the regulation equity or quasi-equity to enable viable to increase the IPC from 15% to 30% corporates to absorb the shock and should be used. invest into the future recovery. - The Basel finalization package needs to be implemented in Europe in While regulatory and fiscal support the respect of the “no significant is likely to be progressively phased- capital increase” mandate, respecting out, monetary policy is expected to the European specificities and the remain accommodative to support the level playing field with other key economy but will continue to weigh jurisdictions, notably as regards on bank’s earning generation. EU to FRTB. and national recovery plans must be deployed urgently to boost growth and In the current environment, this is also job creation. crucial to ensure Europe’s financial sovereignty, preserving the capacity of JEAN The experience of the last year has European banks to serve sovereigns and shown the resilience of diversified corporates, in the highly competitive LEMIERRE and integrated bank business models, capital markets activities. Chairman, BNP Paribas which have benefitted from a more robust earnings generation capacity and have been able to gain market share by supporting their clients across a broader range of financial needs, from What are the priority cash to capital markets. Diversification as a factor of resilience is not embedded measures that in the regulatory framework, which rather penalizes size, and should be would enable the EU taken into account by supervisors. financial industry to contribute to a strong For banks to continue and rapid recovery to efficiently support in Europe? the European economy, they should not be handicapped Since the beginning of the Covid-19 by unnecessary crisis, banks have provided support to regulatory pressure their clients, through moratoria, credit lines drawn, and loans, with or without that would have public guarantees. The economy was recessive effects… also supported by massive measures at European and national levels, considerable fiscal support, prompt resumption of the ECB asset purchase programs and TLTROs, as well as EU banks’ earnings generation targeted measures to operationalize the capacity is already affected by the flexibility embedded in the accounting combination of structural (competition and regulatory framework. by unregulated entities such as non- banks and BigTechs) and conjunctural From a policy standpoint, this response (low/negative rates, decreasing credit to the crisis has been a success, with quality and NPLs) factors. Such earning corporate bankruptcies still at a low streams should be mobilized by the level, job losses contained, and financial banks to the benefit of their clients, to stability maintained, despite the restore a productive, innovative, job- unprecedented drop in EU GDP. creating, and greener economy.

While we can see positive signals of For banks to continue to efficiently recovery in 2021, notably given progress support the European economy, in vaccination, uncertainty remains they should not be handicapped by high, and the crisis will have profound unnecessary regulatory pressure that impacts in some sectors, while others would have recessive effects:

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ments were used, and similar ac- changes in international investors’ risk tion was taken in terms of conduct perceptions, a significant reduction in supervision. operational costs and even a gradual recovery in profitability. Acting in this way produced results that were very positive inasmuch as they We do not know yet the depth of avoided greater ills: financing capacity the structural changes that will be to enterprises and households was caused by the present crisis. How maintained and liquidity was ensured, will consumers behave? How will productive capacity was preserved, investment be encouraged, especially more falls in employment in the private sector? were avoided and drops in income were mitigated. On the other hand, With the data already known, it the approval of an unprecedented seems clear that the asymmetries and volume of European funds to support inequalities tend to intensify within the recovery of the European Union’s each country and across the European economies, a large part in the form Union. If it is true that the effects of of straight grants, gives credence to the pandemic crisis are cross-cutting, forecasts for growth in the near future. they are, however, quite far from being LUÍS MÁXIMO symmetrical, given for example the We should learn a lesson from this different composition of the economies fact: the instruments at the disposal of of each Member State, clearly penalising DOS SANTOS public authorities are quite powerful if those economies most dependent Vice-Governor, Banco de Portugal managed in a timely, coordinated and on tourism. In this context, it will be convincing way. difficult to understand why the banking union is not completed sooner.

The global geopolitical framework Unusual crisis, is also at a stage of notable tension The near future will and readjustment, which in itself is a unusual measures, factor of instability. Even if the most be very demanding for optimistic scenarios come to fruition, big challenges the European banking the near future will be very demanding sector. The pressure for the European banking sector. The pressure on profitability and asset on profitability and quality, for example, will be high. In November 2020 at the ECB Forum, asset quality, for in the recent past ordinarily held in example, will be high. The time we live in requires banking Sintra, Portugal, the President of the management much more focused on ECB, classified each customer, their problems and the economic crisis caused by the potential. In turn, Portuguese and Covid-19 pandemic as being a “highly European authorities must remember unusual recession”. We are still at a stage of the crisis where that to be successful in their policies, we are hostages to the health situation notably in defining a moratorium exit This is undoubtedly a deeply and developments in the pandemic. strategy, they will once again have to be uncommon crisis for having originated This means therefore that we are timely, coordinated and convincing. in a pandemic (something we knew in a situation of high and atypical could be a real risk, but in fact only uncertainty. The vaccination process, admitted in the abstract), due to its notwithstanding its difficulties and global and strongly synchronised setbacks, has changed expectations for nature, for a supply and demand shock the better, giving a feeling of hope even materialising simultaneously and, to those sectors most affected by the of course, for the dimension of the pandemic, that is, those that depend damage caused to the economic and more directly on people’s mobility. social environment. We know that a recovery path is But the response of the political, forecast for 2021 and 2022, but its real economic and supervisory policymakers dimension is still quite uncertain. has also been uncommon due to its speed, the high degree of convergence The European banking sector is and coordination at Portuguese and currently much more capitalised and European level, and to the fact that robust than during the financial crisis different instruments were used in and therefore much better prepared to hitherto unseen dimensions: monetary take on the pandemic-induced crisis. For policy and budgetary policy, as well example, Portugal has seen a significant as employment policy, social policy, reinforcement of capital ratios in recent regulatory and supervisory policy. years, a very considerable improvement in the quality of credit portfolios, a In regulatory and supervisory terms, structural adjustment in liquidity that macro and microprudential instru- reduced the system’s vulnerability to

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(SGL have accounted for 130 bn euros in risks, especially those related to climate 2020, out of 436 bn euros of new loans change. As stated by the Network for to French NFCs). greening the financial system (NGFS) last June, the sweeping disruption of The way these supporting measures the economy following the onset of the will be removed is flagged as a risk for pandemic could illustrate to a certain financial stability in Europe. While extent what we could potentially the exit strategy is to be carefully experience in an increasingly unstable tailored, the cliff effect scenario climate or following a disorderly remains a low probability event, given transition shock. that the consequences of sudden exit from supportive measures are These risks must be proactively on the governments’ screen. But the tackled. Significant work initiated by alternative risk, meaning the risk of the NGFS in recent years are finally overindebtness and “zombification”, in finding their route towards regulatory particular of the corporate sector and developments, with Europe and France the associated build-up of financial being front-runners: the European vulnerabilities must be also taken care Banking Authority is mandated to of and not underestimated. propose venues to integrate ESG risks in the three pillars of the prudential DENIS BEAU For banks, this means that, while for frameworks while the European First Deputy Governor, the time being the pandemic economic Central Bank will implement a climatic Banque de France impact has not resulted in an increase of stress-test exercise in 2022, following non-performing loans, globally for SSM the path of the Banque de France. banks, an increase in corporate defaults is not to be overlooked. Credit risks Initial reflections by the Basel must be therefore proactively managed, Committee and the Financial Stability Challenges for and provisioning must remain prudent. Board at a global level respectively on In addition, uncertainty remains high the adequacy of the current prudential the EU banking and strong structural challenges still framework to allow the inclusion of afflict the European banking landscape. climate change-related risks and the sector in the Covid The profitability of European banking way to close data-gaps are essential institutions remains a source of developments which needs to be context: no time concern: while they displayed returns forcefully pursued. on equity close to their main US for complacency competitors before the great financial crisis, they now lag far behind.

The Covid-19 pandemic has strongly hit the economic tissue worldwide. Nonetheless, the absence of major The profitability of impacts on the banking sector European banking vindicates the Basel III framework put in place over the last decade. The quick institutions remains action taken by European supervisory a source of concern. institutions, like the dividend ban, the CRR “quick fix” or the release of the P2G, and macroprudential buffers by national macroprudential authorities also brought additional support. As The causes of this discrepancy a consequence, banks have been able are manifold and so are ways of to keep strong solvency and liquidity improvements. Among them is the positions, while continuing to finance shift to digital banking, which could the real economy. ultimately lead to a reduction of operating costs and increase the Indeed, credit has remained dynamic ability of banks to compete with across Europe: for instance, in 2020, non-banking actors. Moreover, the France has recorded a 13.1% growth European banking system remains too of loans to resident Non-Financial fragmented, and consolidation would Corporations (NFCs, including SMEs). provide significant improvements. The Here again, the policy response to the institutional setup being completed crisis is to be credited, as governments with and effective Single supervisory have implemented ambitious measures mechanism and European resolution to support the economy and lending, framework, the conditions are now such as moratoria and state guaranteed favourable for the emergence of cross- loans (SGL). Banks have also been border banking and insurance groups. strongly committed: in France, they have distributed widely and swiftly the Lastly, the pandemic is a reminder of the scheme enforced by French authorities need to anticipate emerging financial

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of these fiscal efforts have been backed (CRR) ‘quick fix’ revision. Predictably, by the ECB, particularly through the revision of the CRR/CRD (Capital the Pandemic Emergency Purchase Requirements Directive), which stems Program (PEPP), which, together with from the implementation of the Basel previous asset purchasing programs, Framework, should become more has allowed for the financing, at the end flexible to allow banking entities to of the day, of public deficits through the absorb the increase of bad loans. This secondary market. adaptation should also affect the management framework for banking In one way or another, the short-term crises, the BRRD, whose reform response to survive the confinement proposal is foreseen for late 2021. economic impact have included direct financing by member states, with At this time, the final impact of this European coverage, as well as, starting recession upon the banking system in 2021, additional efforts to stimulate remains unclear, with medium-term the economic activity financed directly return rates currently unsustainable. and more thoroughly by the EU (MFF For all of these reasons, the EU must + NGEU). That said, the health crisis swiftly prepare itself and invigorate is lasting longer than expected and the debate for the construction of the has been deepened by the subsistence European Deposit Insurance Scheme, JONÁS of structural problems that already facilitating the implementation existed in the pre-pandemic world, of a European crisis management FERNÁNDEZ thus likely leading to structural changes framework. The Union must, among in our economy. This prolongation other things, revise the definition of ÁLVAREZ of the crisis is making difficult the “public interest” in order to facilitate MEP, Committee on Economic functioning of previously planned access to European funds in case of a and Monetary Affairs, support policies, which, in turn, is bank resolution or liquidation. Priority European Parliament pushing member states to create new must be given to a strategy of “business solvency support instruments. for sale”, thus reducing national discretions within the Banking Union.

Until now, the banking sector has been key in supporting the European Time to complete the It is now in our hands economy, making part of the European solution. However, the prolongation of to avoid this and to Banking Union for a this health crisis will heighten the risk finally complete the of a spillover into the financial sector. strong recovery Banking Union. It is now in our hands to avoid this and to finally complete the Banking Union.

The EU institutions have thus far re- sponded adequately and in a timely However, the longer the health fashion to the economic and financial crisis endures, the bigger the public challenges stemming from the impact intervention needs to be in order to of the Covid-19 health crisis and the avoid an economic collapse. At the resulting measures. same time, underlying structural The Commission quickly adopted a changes will happen more rapidly and flexible interpretation of the Stability will lead to necessary reforms in some and Growth Pact in order to allow for sectors. Thus, the stretching of the the use of more expansionary fiscal health crisis makes it more difficult to policies by member states. In addition, implement micro programs that are it spearheaded the process of building more adjusted to the medium-term. support for national unemployment in- This environment would therefore surance (through SURE) and presented impede the so-called Schumpeterian a revision of the Multiannual Financial concept of ‘creative destruction’. Framework (MFF), supplemented by the Next Generation EU (NGEU). This being true, the current situation is also hampering a sufficiently ‘micro’ Furthermore, the European Stability approach to the deployment of support Mechanism established a Pandemic measures. As such, we will observe Crisis Support instrument, based on an increase in the amount of Non- its Enhanced Conditions Credit Line, Performing Loans in the upcoming available to all euro area countries, months that, at this moment, is difficult by which to cover direct or indirect to measure. This will impact on bank’s expenses derived from the pandemic, balance sheets and, for that matter, the but still unused until now. In addition, stability of the entire financial system. the EIB has broadened its program of The EU has proposed certain measures guarantees to support the efforts of to slow this impact through the the national development banks. All Capital Requirements Regulation

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financing), (iii) provided favourable due to higher exposure to SMEs. Even prudential and accounting treatment of before the current crisis, they had on EBA-compliant debt service moratoria, average relatively high forbearance and and (iv) increased banks’ credit NPE ratios, and in the last year they potential with the relaxation of capital have notably reduced the coverage and liquidity buffer requirements. ratio of NPEs. While they have less staff and expertise to address increasing In the face of extensive support NPEs, they now have some experience measures, the effects of the crisis on from the previous crisis and detailed banks’ balance sheets have so far been guidelines for monitoring of clients and limited, though visible. The early signs management of NPEs. of asset quality deterioration can be seen in the form of an increase in the volume The pandemic crisis has exacerbated of forborne loans and a rising share of the chronically low profitability of stage 2 loans (in line with the IFRS European banks, reflecting ultra-low 9), and some countries have reported interest rates and depressed margins, moderate increases in the NPE ratio. legacy assets from the previous crisis Banks have started increasing loan-loss and competition from non-banks. provisions, which together with further This further increases challenges to net interest margin compression has banks’ business models, even more BOŠTJAN dampened their profits. so for smaller ones. Searching for higher returns by focusing on riskier VASLE The negative impact of the crisis on loan segments, as observed in the last Governor, Bank of Slovenia banks is likely to become more visible few years, is not a viable path. In this this year and fully over the coming crisis, banks have taken a step forward years, as various relief measures phase in digitalisation. out or narrow. Banks have more insight and knowledge about their clients than While this can help to streamline New and old the government, so it should soon be operations and offer new digital up to them to evaluate the eligibility services, it poses a disproportionate challenges for of their clients for loan restructuring. cost burden on smaller banks. Banks should recognise troubled loans Partnerships with FinTech firms might European banks in a timely manner, form adequate help to overcome such challenges. loan-loss provisions, identify viable Overall, the way forward is also further firms and embark on case-by-case consolidation, which accelerated last treatment of struggling clients. year and is likely to continue in the In less than a decade, banks in the EU coming years. have gone through post-crisis cleaning up of balance sheets, recapitalisations, and strengthening of regulatory and supervisory frameworks. The banks For smaller banks, entered the COVID-19 crisis better addressing structural capitalized and more liquid than in 2008, but many still had pre-existing changes and rising fragilities such as subdued profitability, NPEs might be while others also had elevated NPEs. more challenging. The current economic crisis reverses some of the favourable trends in the banking system and exacerbates pre- pandemic challenges. They should not hesitate to recognize The imposition of pandemic-related incurred losses and dip into capital lockdowns led to a faster GDP decline buffers, and some might have to than the 2008-2009 financial crisis. consider raising fresh capital. It is Due to a sharp decline in revenues, important to support the timely enterprises in many countries were resolution of NPEs, so that they do not urgently seeking liquidity relief, accumulate on banks’ balance sheets, deferrals and new financing. Banks where clear supervisor expectations responded well to such demands. regarding the recovery of capital The flow of liquidity from banks buffers and development of a secondary to households and businesses has market for distressed assets play an remained smooth also thanks to swift important role. and wide-ranging policy measures. Damage to the banks’ balance sheets These have: (i) provided banks with will depend crucially on the duration of cheap access to abundant liquidity the crisis and thus the consequences it (ECB’s TLTROs and PEEP), (ii) will have on the economy, unwinding transferred some of the credit risk of crisis intervention measures and the to governments (public guarantee composition of bank assets. Smaller schemes for deferred loans and new banks are in a less favourable position

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from doing business as a result of the and earning risk premia, invoke moral lockdowns. Once restrictions are lifted, hazard and revoke the bank-sovereign direct support measures towards firms nexus. Some cases might test the resolve should be phased out as well, and firms of governments to apply the BRRD. Yet, should go back to doing business on the role of the financial sector during market terms. Business dynamics have and post COVID-19 should be seen as been hampered by the lockdowns, an opportunity to demonstrate how and some unviable firms have been we have built a financial sector which kept alive by support measures. Large is part of the solution and which reductions in revenue are not an can adjust dynamically to changing unusual event for firms. A Danish study environments, on market conditions. shows that, even in the best of times, Harvesting this opportunity will be 6 percent of firms experience a year- important for years to come. to-year drop in turnover of 30 percent or more. That has been the national threshold to qualify for government compensation for fixed costs.

Furthermore, the pandemic may lead to structural changes and a shift in PER consumer preferences. Some firms may experience decreased demand CALLESEN and ultimately default, and banks will Governor, Danmarks Nationalbank experience losses. This is a natural part of the workings of a market economy. Firms default and new firms enter. We must not hamper this dynamic. Once restrictions are lifted, firms Back to markets should do business on market terms – without government aid. As always, existing labour market policies etc. can assist transition. The outbreak of the Covid-19 pandemic has caused significant declines in economic activity. As opposed to the financial crisis, banks have not been part of the cause of the crisis, and have A financial sector so far not been substantially affected. Suspension of dividend payments which is part of the and release of capital buffers have solution and which increased capital levels, and banks can adjust dynamically have made provisions expecting a large deterioration in asset quality with lower to changing profitability as a result. Large losses are, environments. however, yet to materialize.

This is not least due to extraordinary support measures from governments and the EU. Crisis-related discretionary Once bankruptcy levels start to increase, fiscal support measures in 2020 banks will inevitably experience amounted to close to 4 per cent of increasing NPL levels. The strong fiscal GDP, automatic stabilizers added a lot and monetary measures, temporary to this and liquidity support is close macroprudential and supervisory relief, to 20 per cent of GDP. The support dividend restraint and prudent bank measures have helped prevent a wave behavior imply that this is manageable of bankruptcies. Bankruptcy levels in by viable banks and should not act as a 2020 were in fact below the previous squeeze on lending capacities. year. Administrative delays, temporary relaxations of bankruptcy regulations In the long period in between the GFC and loan repayment moratoria in and the pandemic, we have improved some instances have contributed to the financial sector a lot. Risk levels this. Bankruptcies can be expected to in the EU banking sector have been increase once the support measures reduced, capital levels have increased are lifted, with higher NPLs in the and we have the system and institutions banking sector as a result. This raises to resolve non-viable banks. The the question of how to best phase out BRRD made great strides to ensure support measures. that orderly resolution can be applied without costly government funds, Support measures have been warranted which would distort competition, for firms which have been prevented break the link between facing risk

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and kept many firms alive that would be destabilised by problems in a small otherwise have quickly gone under. number of Member States. Some of these firms should perhaps have exited the market and there is a risk that It is therefore vital to to ensure the extensive public support might lead that banks can continue to play a to a certain degree of zombification in constructive role in the recovery the corporate landscape. However, this following the economic downturn has been a risk well worth taking, which and to closely monitor possible risks was mitigated by the condition that to financial stability. Banks and fiscal only firms in good financial health at authorities need to work together to the start of the pandemic were elegible identify debtor distress early and engage for support. Furthermore, it may still be in timely and appropriate restructuring too early to tell which companies will be to prevent insolvencies of fundametally viable post-Covid and which might only viable firms. If this objective would not survive as ‘zombies’. be attained, banks’ asset quality – and in turn their lending capacity – could A key determinant of post-Covid deteriorate sharply as a result of the business viability is the amount of Covid-19 crisis. corporate debt that was also driven by the extensive use of liquidity support Public authorities need to be mindful KLAUS measures. Higher debt levels may be that banks may be capital-constrained affordable thanks to lower interest and may need the right incentives to WIEDNER costs, but many companies with engage in restructuring. This requires Director, Financial systems and Crisis viable business models may need a an adjustment of support measures, Management, DG for Financial Stability, restructuring of their debt. This is and in many Member States also Financial Services and Capital Markets what banks and policy makers have to improvements to national insolvency Union, European Commission prepare for as crisis support measures frameworks, notably to facilitate are being phased out. Redesigned fiscal preventive restructuring, in line with support measures focusing on debt the 2019 Directive that Member States restructuring for fundamentally viable have to transpose. firms will be key to avert a wave of insolvencies, which would transmit the However, a rise in non-performing Addressing the fall- Covid-19 shock to the banking system. loans (NPLs) will not be avoided entirely. Early and decisive action, as out of the Covid-19 outlined in the Commission’s Action Plan on NPLs adopted in December, pandemic on the should be taken now to: Banks and financial system governments must (i) develop further secondary markets for NPLs; continue to support (ii) improve the efficiency of insolvency viable firms. Banks’ frameworks across the EU; lending capacity (iii) support the voluntary establishment of national asset management The Covid-19 pandemic has led will be preserved by companies; to a sharp economic downturn. keeping them sound (iv) allow possible precautionary public Governments reacted promptly by support measures, where needed, taking measures to compensate income and by addressing to ensure the continued funding of losses of households and, to a lesser possibly rising non- the real economy. extent, of businesses, which were mostly performing loans. supported through liquidity measures The end of the pandemic will not be the such as moratoria, loan guarantees end of the crisis, but there are good ways and public loans. EU regulators and of dealing with its legacy and to create supervisors took measures to bolster the conditions for a swift recovery. banks’ lending capacity. This includes The temporary suppression of eco- the Commission Covid-19 banking nomic activities, through lockdowns package, which addressed issues in and social distancing measures, could the Union’s accounting and prudential then still morph into a crisis with the frameworks, aimed at ensuring that vicious cycle of business failures, bank banks were able to continue lending retrenchment and public finance crises. during the most acute phase of the crisis. The EU finds itself in the comfortable position that the financial health of These measures, combined with its banking sector remains strong, and suspensions of the obligation to file private and government debt affordable for bankruptcy and the impact of thanks to low interest rates. Yet risks lockdowns on courts, reduced corporate are tilted to the downside, with large insolvencies to record lows – in the disparities across Member States. As midst of a deep recession. This shielded we know from the experience of the banks from the impact of Covid-19 sovereign debt crisis, the euro area can

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high as in 2008 and soon became a behaviours, adds to the uncertainty that primary channel of support, rolling policymakers must take into account to out government guaranteed loans and prevent error. providing moratoria. With liquidity assured, many firms found the financial Avoiding a replay of another partial space required not just to stay afloat but recovery, that the euro area suffered also to invest in adaptations and others in the wake of the previous crisis, yet have sprung up. Just taking France furthermore, requires that European as an example, new start-ups surprised policymakers deliver on long overdue with record numbers. Encouragingly, promises; a robust framework to tackle experience from last summer also NPLs, completion of Banking Union shows that once social distancing and Capital Markets Union. measures are eased, economic restart can be swift, aided by pent-up savings. The EU Action Plan of December 2020 to prevent a future build-up of NPLs Back in June, the ECB warned that a is welcome but far from sufficient severe scenario could leave the euro to complete Banking Union, which area with a cumulated real GDP loss most importantly requires single of 27.7% over 2020-2022 compared to jurisdiction. The Capital Markets 2019 levels, with NPLs near tripling Action Plan of September 2020 is DIONY from just under €500bn to €1,400bn. likewise encouraging yet also falls short The ECB’s latest projections see a loss in recognising the parallel need for LEBOT of 14.9% in the severe scenario, 9.3% public risk sharing, and notably a single Deputy Chief Executive Officer, in the baseline scenario and 4.3% in safe asset, absent which the euro area Société Générale the mild scenario. While still marked, financial architecture will continue to these new scenarios nonetheless bear the high cost of fragmentation. ease fears of the most adverse NPL outcomes. Banks, moreover, have built As warned by the ECB, reform important provisions and cost of risk policies are particularly important in Only strong remains contained. addressing long-standing structural and institutional weakness and in European banks accelerating a fair, green, and digital transitions. Europe today, moreover, can limit future has a unique opportunity to become a European banks global green leader, lowering the risk sudden stops of future sudden stops triggered by the entered the present natural world. crisis with capital levels twice as high Strong European banks in a complete The moment that turns a downturn Banking Union are a prerequisite, not into a deep recession is, in peace time, as in 2008 and soon just to pave the way for the necessary most often tied to a sudden-stop became a primary private investment and jobs, but also to in cross-border financial flows; any channel of support. ensure that Europe is sovereign in its dry up in liquidity translates rapidly choice of economic growth model and into insolvency. With the Covid19 to limit the risk of future sudden stops crisis, however, the sudden stop was in cross-border financial flows. triggered by measures imposed to protect public health. Vaccine rollout Once the health crisis allows economies offers the prospect of reopening to reopen, policymakers must calibrate economies yet concerns linger that as the lifting of temporary measures temporary support measures are lifted, while still rolling out sufficient support a large number of firms could still fail, for the real economy to recover. triggering a wave of non-performing This observation holds true also for loans (NPLs). banking measures. Last spring, the Commission’s Banking Package offered Adaptability and well-adjusted policies temporary flexibility to accounting and suggest such fears are likely overdone. prudential rules. This, combined with Ensuring a full recovery of the euro the decision to defer the transposition area, however, requires a much more of the final Basel III package by one determined effort to complete Europe’s year to 1 January 2023, increased the architecture. capacity of both banks and supervisors to respond to the Covid-19 crisis. When Covid-19 first struck the global economy back in early 2020, financial The appropriate timing of when markets were gripped by fear, but to roll back policy support is well large-scale and fast-track action known from previous crises, but the by central banks and governments extraordinary nature of the current quickly dispelled it. Equally important, one, with its unprecedented sector European banks entered the present heterogeneity and likely permanent crisis with capital levels twice as changes to consumer and business

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debt or capital constraints may need anti-cyclical role of bank lending. a combination of public aid, fiscal The degree of effectiveness of the incentives for the injection of fresh different measures adopted has been money and debt restructuring. uneven, but in any case, this relaxation is by definition temporary, which Non-viable firms require an efficient reinforces the case for direct public and quick resolution framework that support measures to compensate for facilitates a fresh start. The latter the eventual return to normality of requires in many European countries financial regulation, which should improvements in the insolvency in any case be calibrated carefully by framework, making it swifter and regulators and supervisors. more efficient. European institutions acted decisively In Spain several measures have been and boldly in the early stages of adopted in this regard in February 2021: the crisis, especially with the Next Generation EU funds. Now that the (i) a new direct aid line of €7bn will funds are beginning to flow to the facilitate the repayment of fixed recipient countries, we need to make costs and debts of the most affected sure that the additional measures sectors; adopted by national governments are SANTIAGO (ii) a €1bn fund will be used to harmonized to the extent necessary recapitalize SMEs, on top of another to ensure a preservation of the level FERNÁNDEZ €10 bn line approved a few months playing field in the single market. earlier for bigger firms and And governments, banks, corporates DE LIS (iii) €3bn will be destined to and SMEs need to cooperate in Head of Regulation, restructuring financial debtsa constructive way to create the Banco Bilbao Vizcaya Argentaria with public guarantees (via term conditions for a robust recovery. (BBVA) extension, conversion into equity loans and, as a last resort, direct grants to reduce loan principal). Regarding the latter a voluntary code of good practices will be agreed by financial entities. These Public aid, measures are welcome, although perhaps they are late and too timid level playing field compared to other EU countries. and the role of banks Banks have a key role to play Corporates and SMEs all over the world in distinguishing have suffered from the lockdown and solvent from the drop in demand. Bold support measures have been adopted by many insolvent firms. governments, which postponed payment difficulties, but a wave of bankruptcies and non-performing loans seems difficult to avoid. It is Banks have a key role to play in crucial in this context to ensure the distinguishing solvent from insolvent viability of solvent firms that face firms, in particular in countries where temporary problems and/or an increase the average size of firms is small in debt as a result of the pandemic. and previous knowledge of the firm becomes crucial. But direct support In Europe there were significant measures should come from the differences in the degree and modality government. Banks will always have of support of national governments, skin in the game as a result of the some of which relied more on previous lending relationship with the credits with partial public guarantee affected companies. Incentives should whereas others used direct aid to be designed carefully for all the parties a greater extent. Indeed, different involved to play their role. In this problems require different solutions, process it is particularly important to but variation in national approaches avoid that a potential corporate crisis across Europe seem to reflect more the is compounded by a banking crisis that willingness to use the fiscal space of would exacerbate the exit problems. each country than the size and nature of the problems. Viable firms with Financial regulation has been relaxed temporary liquidity problems and/or to a certain extent to facilitate an

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BASEL BANKING STANDARDS EVOLUTION

current crisis to support the economy set to incentivize banks to finance our and preserve financial stability, economies and absorb losses are still additional relevant initiatives have in place, flexibility should not be offset been adopted at the regulatory level, by conflicting requirements that could some of them on a temporary basis. lead to a sudden halt of credit supply In this context, (i) the amendments of and magnify bank losses. the EU regulation anticipating some of the flexibility embedded in CRR2 and The adequacy of the international implementing transitional provisions banking regulatory framework is also to defer impacts in a context of higher being tested for the first time in crisis uncertainty, (ii) the EBA clarification on times. While some debates emerged the flexibility embedded in regulation over the last year, for example on regarding default and forbearance, whether existing releasable capital and (iii) the flexibility provided on buffers were adequate and sufficient in ANA PAULA the use of capital buffers should be crisis times, it is too early to evaluate particularly highlighted. the effectiveness and resilience of the SERRA Basel III framework. Only in a few The Covid-19 crisis has stressed years, it will be time to take stock of the Member of the Board of Directors, the importance of having prudent lessons learned. Banco de Portugal standards. Thanks to the progress in building capital and liquidity The adoption of the latest Basel buffers, most banks continue, as of III reforms has been delayed and it Building resilience today, to meet the minimum capital raises some challenges in the current requirements. Moreover, most of the juncture. However, even if some of the EU banking regulatory relief measures taken since additional transitional arrangements, the outbreak of the crisis made use of beyond those already envisaged for system through the flexibility available in forthcoming the output floor, may be needed, the Basel standards or were granted using adoption of those standards in the EU regulation transitional arrangements. should not be jeopardized or weakened. Notwithstanding short-term priorities, But the pandemic crisis is not over it is important to ensure the return to The Global Financial Crisis evidenced yet. As the situation evolves, more normality in regulation, implementing clear shortcomings in the regulatory information on the impact of the the reforms in a gradual manner. Basel framework that the BCBS aimed to pandemic becomes available but the III standards are a structural piece of address with the Basel III reforms, level of uncertainty is still high. While the prudential framework to continue notably by improving the quantity and assuring that banks rigorously reflect strengthening EU banks and make quality of regulatory capital, setting up credit risk in their balance sheets, both them better prepared to face future a new global liquidity framework and regulatory and supervisory authorities crises. Failing to fully and consistently introducing macroprudential elements. need to continue following a consistent implement the standards may have a Included in the wide-range set of approach. In a context where detrimental impact on the resilience of support measures taken during the temporary relief regulatory measures the EU banking system in the long run.

by far ranging measures taken by the How should Basel supervisory community under the aegis of the Basel Committee. The banking standards Committee encouraged banks to fully evolve now? exploit the flexibility embedded in the prudential standards on capital and liquidity buffers making clear that a Banks faced the pandemic crisis in measured draw-down of such buffers a significantly stronger capital and in time of stress was appropriate. The liquidity position than they had at same encouragement was made with the onset of the Great Financial Crisis regard to the use of the flexibility in (GFC), also thanks to the Basel III the accounting framework. Further, the standards adopted in response to it. For Final Basel III standards was deferred this reason, the international banking by one year, to 2023. The overall system acted as a shock absorber rather effect of such measures will be subject LUIGI FEDERICO than amplifier and kept lending to the to a continuous monitoring by the SIGNORINI real economy. Committee. Senior Deputy Governor and Member The positive role of banks in dealing The dramatic events of last year of the Governing Board, Banca d’Italia with the crisis has also been facilitated underlined the importance of having a

96 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net BASEL BANKING STANDARDS EVOLUTION resilient banking system supported by a the new regulatory framework is ready On the latter, the pandemic has shown comprehensive and effective regulatory to address also the structural changes the large potential benefits of the framework. The latter needs to evolve that will emerge in the ‘post-Covid 19’ increased digitalization of the economic to keep up with the challenges that the environment. environment. The banking business and financial sector will face in the future. the financial sector in general made no Looking ahead, the regulatory agenda exception to this trend. The regulatory should focus on the implementation …global standard setters framework should evolve to keep up and evaluation of the reforms adopted should be ready to look with the spread of technology-enabled in response to the GFC as well as on beyond the crisis and start innovation in financial services in order how to deal with emerging issues. a comprehensive discussion to develop appropriate safeguards to deal on future trends… with such new risks, such as cyber risks. An Notwithstanding the flexibility granted additional challenge for supervisors and by the Basel Committee, the latter called regulators is also posed by the potential the supervisory community to a full and The more forward-looking line of impact of the Fintech environment on timely adoption of the Basel standards at evolution refers to how the regulatory banks’ business models, as the competition a national level. Furthermore, having in agenda should deal with emerging in the provision of certain financial place the revised prudential framework risks such as those posed by the ESG services is rapidly increasing. While still will also facilitate the Committee in framework and the FinTech evolution. tackling the emergency, global standard evaluating whether the new prudential setters such as the Basel Committee framework has achieved its policy goals On the former aspect, works should should be ready to look beyond the crisis or whether there is still room for a fine continue to assess how to adequately and start a comprehensive discussion on tuning or simplification. The evaluation incorporate ESG factors in the future trends and challenges in banking process will also shed light on whether prudential framework. and finance.

frameworks so that the financial sector economy. Even though Basel-III is can effectively contribute to optimal postponed, it is not off the table. We financing conditions for citizens and must continue to implement global companies. On the road to recovery, standards while taking due account of we have already made important steps. European specificities. Both, in terms On the one hand, we have adopted in of a primarily bank-financed economy record speed targeted banking rules to and in terms of the different business mobilize 450 billion Euros in fresh loans. models. Because in Europe, the diversity On the other hand, we have realized a of our banking landscape is a strength. comprehensive recovery package for the capital markets. What the European Parliament has adopted in November 2016 still applies However, key building blocks still need today: “no significant increase in overall to be put together. Our effort to complete capital requirements”. In this context, OTHMAR KARAS the EMU yields a high return: The EPRS some elements must remain undisputed estimates the added value of a complete in my view: the stronger SME Supporting Vice-President & MEP, Committee Banking Union, a stronger CMU and on Economic and Monetary Affairs, closer fiscal policy coordination to be up Factor and the CVA exemption. At the European Parliament to 275 billion Euros per year. At the same same time, concerning the Output time, we need to make the financial Floor – our “elephant in the room” – all rules future-fit. Let’s just think about options remain on the table as long as Making financial digitization, sustainable finance and the we achieve a Basel-compliant solution expected rise of NPLs and bankruptcies. that implements our common goals. markets work for Also, “Next Generation EU” can be more European solutions are also needed than a recovery fund: It is a forerunner in the areas of equity investments, the future of Europe to new shared fiscal tools to complement un-rated corporates and specialized our monetary policy. lending. And we need to move forward on capital and liquidity waivers to It has been over a year that we have improve the integration of cross-border been gripped by the Covid-19 pandemic Our Banking Union is banking groups. and its profound impact on our lives, only as strong as its economy and financial markets. The foundation. We must 2021 also marks the start of the debate European legislator has continued to continue to implement about the Future of Europe. This is function through all these difficulties. global standards while much more than an answer to crisis. It While many important measures have is about the vision to actively shape our been adopted, we need to learn the taking account of common future. And it is about realizing lessons to be much better prepared for European specificities. what we have already planned to do – future shocks. At the same time, we need such as deepening the EMU. Let us be to complete our common projects to Our Banking Union is only as strong ambitious and bold. And let us always be realize a genuine EMU. as its foundation. I strongly welcome aware that Europe is all of us – citizens, that the BCBS has postponed the politicians, stakeholders, regions, Clearly, the financial markets are part of implementation of the finalisation of nations. We all share the responsibility the solution in dealing with this crisis. Basel-III to increase the capacity of in further developing a strong, efficient We must continue to create suitable banks and supervisors to support our and credible EU in the world.

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the pandemic with significantly higher consistent manner in the EU. Moreover, capital levels and more stable liquidity considering the lessons from the and funding positions. As a result, banks pandemic, an evidence-based evaluation so far could cope well with the current of the effectiveness of the already economic deterioration. However, implemented Basel III framework, the impact of the pandemic on banks’ especially the usability of capital buffers, balance sheets is not yet fully evident should be conducted. as several support measures will phase- out during 2021 and credit impairments Third, future developments in materialize with a time lag. the financial sector need to be tackled. New risks from the ongoing Banks have responded to the pandemic digitalization in finance should be by pursuing strategic overhauls, reflected in the regulatory framework. implemented restructuring programs, ESG (Environmental, Social and GOTTFRIED and in some European countries the Governance) risks are another topic, pandemic has started a long overdue which must be incorporated into HABER consolidation in the banking sector. In banking supervision in the coming addition, the pandemic has accelerated years. However, isolated regulatory Vice Governor, Financial Stability, innovation projects and digitalization. initiatives regarding ESG risks in the Banking Supervision and Statistics, However, banks are expected to financial sector will not be sufficient Oesterreichische Nationalbank strengthen their reporting framework as to address climate change. These with the increasing use of technologies initiatives must be embedded within a timely and accurate data will become holistic, cross-sectoral approach based Lessons from the even more important in the future. on the comprehensive . It is important to focus on a true Covid-19 pandemic and accurate inclusion of such risks The future regulatory on a risk-by-risk basis and within the and how regulatory agenda needs to focus context of existing risk models. on a comprehensive and banking standards risk adequate inclusion In addition, supervisors themselves need of future risks like to make better use of digitalization as should evolve digitalization, data issues regulatory and supervisory technology has tremendous potential to improve and ESG. analytic capacity and quickly scan for In response to the Covid-19 pandemic unusual developments. European authorities acted swiftly How will the post COVID-regulation to help mitigate the impact on the look like? Banks and regulators are in this together: economy, secure lending and ensure Like the banking sector, regulators a smooth functioning of the financial First of all, regulators will have to phase must adapt to a changing environment. sector. Coordinated policy measures out the temporary COVID-19 relief Regulation must evolve constantly to comprise fiscal public support measures, measures and restore pre-COVID-19 ensure a framework which addresses public loan guarantees and moratoria, regulation standards. While some new developments and changing monetary policy interventions as well simplifications might be warranted in risks appropriately. But, changes in as capital, liquidity and operational this respect, regulatory and supervisory the regulatory framework have to be relief measures enacted by banking standards should remain on high level. decided upon sufficiently in advance in supervisors. In addition, compared to Second, the remaining Basel III reforms order to ensure stable expectations and previous crisis European banks entered need to be implemented in a timely and smooth adoption.

In parallel with unprecedented fiscal What are the and monetary stimulus, regulators, at international and European levels, policy mistakes decided targeted and temporary to be avoided, revisions to the accounting and prudential frameworks, to allow banks to foster a stronger to channel fiscal and monetary support programs to the economy. economic rebound Those measures have indeed alleviated in Europe? the consequences of the pandemic on banks’ balance-sheets, but, at the same time, they are the testimony One year after the unprecedented that regulatory requirements were too Covid-19 lock-down, a lot of lessons high, and too pro-cyclical, as banks had PHILIPPE should be learnt from the policy responses argued for years. The EU had also over- that have been implemented by political transposed international standards: solo BORDENAVE and regulatory bodies in Europe. They application of capital and liquidity rules, Chief Operating Officer, should help Europe to choose the right EU specific buffers, MREL requirements BNP Paribas way to foster a strong economic rebound. above TLAC levels, contribution

98 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net BASEL BANKING STANDARDS EVOLUTION to deposit guarantee scheme AND deteriorates further banks’ profitability, growth deficit compared with the US resolution fund, … and investors’ appetite to invest in bank and China. equity and debt securities. Setting excessive, non-flexible levels of In this context, it should not be a capital in good times, to discretionarily surprise that European banks have relieve pressure in crisis times is not a Now should be become unattractive as compared with healthy nor sustainable regulatory re- the time to relaunch US banks or with other EU sectors. Such gime. Indeed, stability and predictability the economy. perception by investors has been further of regulation are crucial for economic anchored by the decisions on dividend agents like banks to set dynamic strat- distributions, where the supervisors egies and invest over the longer term. There are currently no signs that solemnly “recommended” not to apply Contra-cyclical flexibility has to be built- the EU has recognized the risks of the Minimum Distributable Amount in and transparent. this approach. Instead, the EU is (MDA) rules that had been carefully considering a costly transposition of designed at international level and voted Excessive levels of capital and liquidity the “final Basel III” rules, which, as by European co-legislators in the CRR! requirements during good times are per the Basel Committee itself, only counterproductive. They constrain hits European banks, with a +18.5% Now should be the time to relaunch the banks to curb lending to the economy, increase in capital requirements. Such economy. With banks balance sheets which affects investments andcombination of continued downward having been reinforced for more than 10 competitiveness. Banks’ balance sheets pressure by low rates on banks’ years, regulators should allow banks to may be extremely robust, but growth capital generation capabilities, and of fully deploy their lending capacity rather is subdued, and economy is more upward pressure on regulatory capital than devoting their efforts to comply vulnerable. This in turn leads monetary requirement will dampen the EU with additional and ever-changing authorities to lower rates, which economic recovery, aggravating the EU regulatory constraints.

A year into the crisis, Europe’s banking Regarding the second: a clear path sector has proven its resilience, with to competitiveness, innovation and a total capital ratio above 16% and growth is vital for Europe. Digitalization liquidity well above 100%. Banks are and the transition to a low-carbon well placed to continue to play a vital economy both offer significant role in Europe’s recovery. Two priorities opportunities; however, both require stand out. First, dealing effectively financing on a scale which goes beyond with insolvencies and other impacts conventional balance sheet lending – of withdrawing government support; still the dominant source of financing second, seizing and supporting for most European companies. Here, opportunities to boost growth. too, Europe’s banks can play a central role, but two factors will be decisive. Regarding the first: the impacts so far have been contained. Non-performing First: further progress on banking union JAMES loans have not risen appreciably as and capital market union. This will spur government measures are still in place. consolidation in the banking sector and VON MOLTKE They are expected to rise in 2021- help Europe’s leading banks close the 2022, although with important local ‘scale gap’ to their US and Asian peers. Member of the Management Board, differences as the economic impact and Enabling Europe to develop deeper Chief Financial Officer, Deutsche Bank AG scope of government support both vary capital markets helps finance economic across different nations. growth and creates opportunities to boost returns for savers and investors. European banks after As we re-build after Covid, Second: a regulatory level playing Covid – Challenges Banks can play a vital field. This is all-important as Europe role in setting Europe on completes implementation of Basel and opportunities for the path to growth. III. If we raise capital requirements for lending, Europe’s businesses, the years ahead particularly smaller companies, may So far, flexibility on all sides has been find financing more expensive or key – for example, through moratoria less available at a critical time in our The Covid crisis saw a remarkable or other forbearance measures. Going recovery. The high impact on large turnaround for Europe’s banks. In forward, this is vital; entire sectors will banks may translate into higher cost 2008-9 they were part of the problem; need restructuring to become viable. across all types of financing. through Covid, they were part of the Working with clients to identify workout solution, deploying much-strengthened solutions has proven successful, and Europe’s path ahead is clear. We will only balance sheets to maintain the flow of regulation needs to enable this to make progress on that path by working financing to the EU economy. Loans continue. Excessively onerous capital together. Governments, regulators and to companies are expanding at the requirements on non-performing loans banks came together and worked in strongest pace since the financial crisis would have the opposite effect: forced partnership to steer Europe through the (+5.5% yoy in December 2020), while asset sales, collateral enforcement and Covid crisis. Let’s keep that partnership retail lending also maintained its solid insolvencies, and thereby choke off the spirit as we set the course for recovery, momentum (+3.2%). post-Covid recovery. competitiveness and growth.

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tions absorbed most of the shock. They banks now have over regulatory mini- were indeed the only ones able to do so, ma. The trick of a long phasing-in has due to the nature and magnitude of the already proved its inefficiency in in the crisis. Bankruptcies and NPL have not past, since markets always priced a fully soared. For the time being, most of the loaded approach of regulations such as impact on banks comes from the ex-an- Basel III. te provisioning of possible risks. Second, at the very time when Europe In any case, banks will absorb part of the needs financing to continue support- shock. However, the materialisation of ing businesses and to support the green these risks depends on public policies. and digital recovery, this reform would The pandemic crisis is not over. We freeze hundreds of billion euros repre- still need strong support from public senting a financing capacity of thou- authorities to back the economy and sands of billion euros, with no possible ALBAN the most affected businesses. If this compensation by the financial market. occurs, casualties will be limited. In the meantime, pessimistic forecasts feed As supervisors have repeatedly said that AUCOIN old habits: self-protection, mistrust and the capital level of European banks is Head of Public Affairs, the comeback of the usual bureaucracy. adequate, the urgency is not to increase Crédit Agricole Group The implementation of Basel IV it further. Rather than finalising the an- is especially worrying. Indeed, the swer to the previous and different cri- Commission plans to release its draft sis, we should try to solve the present We need to breathe legislation next July, in the middle of one, with timely solutions. Americans the economic crisis. are pragmatic. They are faithful to the political mandate of no significant in- During the covid crisis, banks have crease in capital requirements. They been part of the solution, together with All we need said they would stick to it, noticea- the support of monetary and fiscal pol- is appropriate bly for FRTB. This will not hamper icies. They provided liquidity to the implementation, their recovery. European businesses and households, respecting the political to bridge their cash needs when the mandate. Third, Europeans are not lagging be- economy stopped due to the pandem- hind as regards prudential regulations! ic. This has been crucial, because the They have gold-plated European financial market is too small First, legislators should not transpose to substitute banks’ ongoing external the Basel agreement until the EBA has Basel III with pillar 2 and MREL. Anoth- financing. Banks have enough liquidity completed a deep analysis to provide er layer of gold plating is not necessary. and capital to weather this “live” stress the full picture of the Covid impact All we need is appropriate implemen- test, as recognised by supervisors (SSM on banks. An estimated impact by su- tation, respecting the political mandate vulnerability analysis, July 2020). pervisors of between 200 to 800 bp of not significantly increasing overall on solvency ratios confirms that addi- capital requirements, and not resulting So far, the impact of the economic crisis tional capital requirements may dest- in significant differences for specific on banks’ balance sheets has been limit- abilise the financial sector by seriously regions of the world. ed. It is no wonder, since public institu- narrowing capital buffers European

100 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net NEXT EUROFI EVENT

THE EUROFI FINANCIAL FORUM 2021

LJUBJANA – SLOVENIA 8, 9 & 10 SEPTEMBER 2021 BANKING AND INSURANCE REGULATION

POLICY PRIORITIES FOR THE EU BANKING SECTOR

It is not the only criteria to measure diversified, profitable and attractive EU the strength and success of our BU. banking sector. Concretely, this means: Today, EU banks are facing increased competition, at a time when Europe - First, fulfilling the promises of the loses pace both globally and within 2nd pillar of the Banking Union (i.e. the Single Market. Their market share no more bailouts, better protection has fallen over the last 15 years. Even of taxpayers, more market discipline within the Euro area, cross-border and more consolidation). It implies banking activity is on a continuous more intrusive supervision for downward trend. “less significant institutions” which concentrate most vulnerabilities in the At the same time, although banking current environment. Zombie banks groups have to answer the immense cannot remain on the market at the funding needs of the twin green and expense of taxpayers and competitors, digital transitions, they should be able it is crucial to reduce overcapacities. to invest in their own digitization If making resolution for more banks where there are many potential levers means reviewing the conditions to for growth: the EU payments initiative access funding in resolution for banks should strengthen the independence pursuing such market exit strategies, of banks and allow them to start assorted with adjusted contributions SEBASTIEN (re) conquering important markets. to existing safety nets, this should The ongoing development of the be envisaged. RASPILLER regulation on crypto assets should Director, French Treasury, allow EU banks to invest more in the - Second, we need to reaffirm that we Ministry of the Economy, market opportunities offered by this aim for a single jurisdiction in all Finance and the Recovery Plan, new segment. prudential and regulatory dimensions, France taking full advantage of our single currency and BU. It is greatly needed to develop European and international banking groups able to foster the We should move international role of the euro and reap its economic and strategic benefits. The completion of the beyond the “risk Without it, there would be no “Union”. reduction-risk sharing” Steps towards this goal – even small – Banking Union should slogan, to gather on a need to be pursued in the shorter run. aim at improving the vision of a diversified Last but not least, we should be and profitable EU careful not to inflict new burdens profitability and the on the competitiveness of our own banking sector. sector, especially compared to our competitiveness of competitors’ jurisdictions. In the short run, the implementation of the Basel 3 EU banks package may put the financing of the Moving forward, we need to address EU-recovery at risk. The forthcoming the lack of competitiveness and EU Commission proposal must respect structural under-profitability ofthe G20/ECOFIN mandate not to So far, the Banking Union (BU) agenda our banking system, which drives a induce a significant increase of banks has been focused on building a more persistent reliance on extraordinary capital requirements. resilient banking sector, through public interventions. In 2019, return stronger prudential requirements, on assets was three times lower for EU France, with Germany, has proposed addressing legacy risks, active banks compared to US banks, putting a ways to achieve this in a compliant supervision and preparation of drag on their ability to rebuild lending way with the Basel agreement, and resolution. The ability of the banking capacities to finance the recovery. From counts on the Commission to take sector to continue funding the a financial stability standpoint, the them into account, especially at a time economy throughout the Covid crisis, weak profitability of the EU banking when US authorities are considering supported by pragmatic regulatory sector is a serious hurdle endangering a capital-neutral implementation. and supervisory measures, proves that public finances and market discipline. It is particularly important not to we have successfully built a resilient affect wholesale banking business and banking system. Some progress remains Our focus must therefore shift from market activities: the EU’s Capital to be seen at individual level, notably on resilience to competitiveness and Market Union cannot succeed without less significant institutions, but overall strategic autonomy. We should move competitive EU banks able to serve risk reduction has largely been achieved. beyond the “risk reduction-risk sharing” corporates’ needs globally. However, risk reduction is not the only paradigm, which brings more divisions challenge facing the EU banking sector. than results, to gather on a vision of a

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the implementation of Basel III in a and undermines scale efficiencies, not fashion that is as consistent as possible to mention an environment that opens with the internationally agreed Basel the door to regulatory arbitrage. Above capital framework. This will ensure a all, the EU must promote a level playing global level playing field and will limit the field around innovative technologies costs and risks of global fragmentation. in financial services, ensuring that the The new iteration of EU’s prudential golden principle of “same activity, same rules should also address the issue of risks, same rules” remains the norm national ring-fencing: a true European throughout the digital transition. cross-border banking sector should be fully integrated to reap the benefits of Last but not least, NPLs. With ECB the single market. Trapping liquidity projections showing that the pandemic and capital behind national lines goes is likely to lead to a significant against the principles of the single proliferation of distressed assets, swift market and does not help to foster action by the EU must remain a priority. economic growth in all member states. As such, a European unified approach Introducing a fully-fledged EDIS is also to simplify and potentially harmonise key to solving this issue; in the interim, the licensing requirements for third- we welcome the recent ECB’s position party loan servicers or some common on the cross-border mergers of banks. base parameters, would be a major step FERNANDO forward. Once again, harmonisation Intertwined with the Banking Union, of rules and supervisory measures is VICARIO the EU needs well-functioning and crucial, and we support the recent plan Chief Executive Officer, fully integrated financial markets, to tackle Member States’ divergences Bank of America Europe making the CMU project of paramount on insolvency, debt recovery and debt importance for the swift recovery from restructuring frameworks. the crisis. CMU is needed to support the EU’s Hamiltonian moment, but any For all of these reasons, it is essential future rules and frameworks in place that the EU continues to develop a A harmonised banking should be outward looking, capital strong and integrated banking sector markets should not be ring-fenced alongside deep and liquid capital sector is essential for across national lines. The EU’s capital markets in order to deliver the much- market should be developed in a global needed finance to support the twin financing the EU’s context. The transition to net-zero transition of the EU – the digital and is also dependent on private finance the green transformation. twin transition - which in turn needs fully integrated capital markets to allow money flows to go towards green assets.

More than a decade on from the financial crisis and despite the unprecedented economic impact, the banking sector proved to be much The new iteration of better prepared this time in terms of EU’s prudential rules resilience, capital, and liquidity. This is mostly due to the regulatory overhaul should also address that the international community the issue of national carried out over the last decade. In the ring-fencing. EU, the ECB has responded swiftly to the pandemic by providing banks with regulatory / supervisory relief (such as capital requirements, liquidity) to allow continued lending to the economy. The pandemic has also made clear the importance of digital issues for This decisive and coherent action the resilience of the economy and would not have been possible without the financial sector. Technological having a single supervisor across the development has also been identified as continent. The pandemic showed us an essential component for building a not only how important the recent solid foundation for long-term growth, reforms are, but also reminded us supporting the EU’s recovery and that completing the Banking Union modernising its economy. In order to and the Capital Markets Union achieve these objectives, regulation remain fundamental to improving the and supervision should be technology- efficiency of the financial sector as well neutral - in other words it should be as enhancing the financing options principle-based and forward looking. available for the real economy. This is why tackling fragmentation is of utmost importance. Europe will As a first positive step towards not be able to compete globally if it completing and strengthening the has a fragmented legal and regulatory Banking Union, the EU should finalize environment that stifles innovation

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These kinds of measures are welcome. in favor of it, and there is a growing However, they do not address the basic consensus on the so-called “hybrid” reasons why we have barely seen any model. Indeed, the upcoming review interest from banks in undertaking of the crisis management framework cross-border mergers. It is quite simple: presents the much-needed opportunity the central barrier to cross-border to finally get it done. mergers is the lack of the single market for banks, and the reason for this lack The second main obstacle we face is of a single market is the fact that the that our crisis management framework Banking Union is not complete. is not fit for purpose. European institutions went to great lengths In this way, there are three political to establish a common resolution challenges ahead of us: the absence of framework and a Single Resolution a common deposit insurance, which Board. However, Member States, each LUIS means that banks are expected to build in their own way, have figured out how excessive buffers in host countries; the to circumvent it. GARICANO absence of a credible and predictable resolution framework; and addressing Unless we have a predictable and MEP, Committee on Economic a whole host of other regulatory uniform framework to deal with and Monetary Affairs, differences that make it extremely troubled banks and to facilitate market European Parliament difficult to operate as “one bank” across exits, we will continue to have an the Union. amalgam of smaller, more regional, more inefficient, and more politically connected banks. To have bank The EU should not try mergers the to undertake a new Lastly, we must address the regulatory “industrial policy” differences across countries that banks priority must for its banking sector. continue to face. These span areas as The priority must broad as insolvency frameworks and tax be to complete be completing the regimes. However, a clear area where decisive EU action is possible in the Banking Union. the Banking Union short term is anti-money laundering. It is well known that one of the main Today’s framework leaves too much Over the last few months, the impediments to cross border mergers is discretion to local regulators and European Central bank has taken the fact that banks have to meet capital supervisors. This creates divergences in some steps to encourage consolidation requirements both at the European how rules are applied and understood in the banking sector. For instance, and at the national level. However, it is that are inefficient to comply with it published a new guide on their crucial to emphasize that this issue, the across borders and that seriously supervisory approach to mergers and home-host problem, will not be solved undermine joint efforts to eliminate suggested that they could start grating until we have achieved a meaningful any risks derived from financial cross-border liquidity waivers if European deposit insurance. A common crimes. There has been enough talk of adequate intragroup financial support deposit insurance has been stalled for “coordination” on this issue, it is time agreements are included in bank more than five years now, but recently for common AML supervision and for recovery plans. the German government finally turned a European Financial Intelligence Unit.

data protection/localisation, onshoring The next five years – of euro related investment banking Europe to outline its services, but also Basel implementation. blueprint for future The right choices need to be made if European policymakers expect banks generations to play their part in financing the European economy. Especially against the background of the post-pandemic Europe’s plans for open strategic economic recovery and the fact that autonomy include several priorities it will still need time to develop any designed to strengthen the financial meaningful European capital market to sector. Central to this is promoting fall back on. the euro and fostering its status as an international reference currency. In September 2020, the EC set out DR. STEFAN its digital finance strategy, outlining Legislative choices will greatly how Europe can support the digital SIMON influence to what extent the European transformation of finance while Member of the Management Board, Commission (EC) will be successful regulating its risks. While this should Chief Administrative Officer, in delivering strategic autonomy. The provide opportunities for banks and Deutsche Bank AG various legislation covers a digital euro, their clients via better use of data, the

104 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net POLICY PRIORITIES FOR THE EU BANKING SECTOR focus on crypto-assets and issuance of a investors and businesses. This should For the financial industry, crypto-assets digital euro, it also entails clear risks. be based on the “same risk – same have the potential to feature many of rules”- approach by relying on existing the elements needed in a digital and Crypto-assets as a means of payment and regulations, adapting these or, where globalized financial market place e.g. exchange of value will play an increasingly necessary, introducing new rules that real-time finality of transactions or important role in the financing of the EU address the novel nature of crypto-assets frictionless cross-border availability. But economy. As the digital agenda of the EU while retaining financial stability. further institutionalization is needed: economy progresses, an increasing num- the establishment of a regulatory ber of industry processes will be based on The digital finance strategy includes many foundation followed by at-scale blockchain/DLT e.g. pay-by-use concepts concepts which are new to policymakers participation of key members of the and machine-to-machine payments. This and do not fit into the traditional regulated financial ecosystem. creates a demand for compatible payment financial regulatory architecture. This solutions and the financial industry is might lead to an overly conservative While Europe should focus on shaping its digital strategy accordingly. framework, especially for banks. Linked embracing new technologies as part to the push on European sovereignty, a of its goal of strategic autonomy, it is A strong and robust EU regulatory likely reaction is to close the European clear to us that this should be paired regime for crypto-assets is essential to market for outside stakeholders and with remaining open, as many of the ensure that this technology supports focus on data localisation. Closing new policy developments have cross- a competitive, financial and economic markets has however never led to better border impacts. ecosystem that protects consumers, client services.

disintermediate major segments of Likewise, taking into account European the value chain, is also affecting their economic specificities in prudential regu- profitability. Furthermore, digitalization lation, ensuring a fair treatment between generates very significant costs, linked banking and non-banking actors for the to the development of digital tools and same activities, and pursuing unified su- self-care, and goes hand in hand with pervision at European level should be a an efficient policy in terms of security concern of paramount importance as they (AML-CFT, cyber risk, fraud, etc.). are closely related to European sovereign- ty and sound international competition. The weakened retail banking models This also means establishing a balance must be less vulnerable to these risks: La between market and banking finance Banque Postale has resolutely engaged in through capital calibration and avoiding diversification since its creation in 2006, national gold plating or successive layers the most recent being the subsidiarising of supervision. PHILIPPE of CNP Assurances in March 2020. Finally, I see two major priorities in HEIM This is why I consider the EU’s political the years to come: digitalization and priorities to be the following: financing the energy transition. Chairman of the Board, La Banque Postale • Slowing down of legislative measures, Digitalization has been magnified by the • Reinforcing unified and fair European pandemic and open finance responds to supervision customer needs. But it should be clear Supporting • Accelerating digitalization and sustain- that seamless user experience and widely able finance policies connected tools be not detrimental to proportionate cybersecurity nor genuine control by the customer of its personal data. regulation and EU should take international The EU has rightly initiated a very hastening sustainable leadership in building active approach in the funding of energy extra-financial transition. Such dynamic should lead finance policies reporting standards. to international leadership in building extra-financial reporting standards and fostering access to related data. This is Retail banks have played a major role As European banks face a growing risk of a matter of sovereignty and reliability of during the crisis (financing the economy, paradoxical requirements and regulatory information for end-users. supporting State guaranteed loans, etc.) fatigue, unproportionate procedures and will be key in facilitating the way should be limited and legislative Consistently, these European ambitions out of the crisis, by financing recovery initiatives need to be carefully assessed should be shared by private and public and investments. and selected. This is all the more true actors in terms of green and transition as prudential measures and the first projects. In dedicating €1.5 billion for However, banking models face steps of the Banking Union have been green projects in 2020, targeting €3 severe challenges: persistently low widely implemented in recent years. billion in 2023 and supporting citizen or even negative market rates, new Reporting burdens, for example for non- responsible consumption, La Banque customer demands or reduction of performing loans or climate risk, should Postale aims to be a major actor of a fair the intermediation margin. The rapid not be further increased nor duplicated transition for all, including containment growth of bigtechs/fintechs, which between supervisory silos. of social inequalities.

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was then at the centre of the turbulence ure was announced it remains elusive, and that event started a decade long notwithstanding the improvements we process of regulatory reform that have seen in risk metrics across the EU. fundamentally reshaped the framework for financial institutions. The Banking Next is the absence of a harmonised Union was the flagship reform in the insolvency regime for banks. National EU. However, those reforms have not insolvency regimes are not bank specific been completed. and generally not aligned with the provisions of the BRRD. As a result, the On the positive side, the regulatory requirements deeming a bank as failed framework and status of banks today or likely to fail are inconsistent with is unrecognisable from a decade the domestic regime for determining ago. Capital requirements increased insolvency. substantially and liquidity/funding JOSÉ MANUEL restored to its role at the heart of At the micro-prudential level, there are banking regulation. The Bank Recovery a range of issues that have the potential CAMPA and Resolution Directive came into to act as impediments to the effective force and gave us a modern framework use of the single market. Cross-border Chairperson, European Banking for dealing with failing or failed banks. banking activity needs to be fostered Authority (EBA) These reforms have certainly helped through increased competition, banks bringing their core support to the elimination of undue burdens and the real economy in the current context. increase introduction of technology Regulatory completion that enhance cross-border activity. However, the worst economic effects and effective of the crisis are still ahead of us for the Beyond enhancing the regulatory banking sector. Banks will continue framework, banks need to continue to implementation lending to the economy but those that enhance their strategies to ensure the entered the crisis with lower capital sustainability of their business model. levels, poor business models and riskier The challenges from low profitability, exposures will face challenges. So, what excess capacity and digitalization have Covid-19 has sent shock waves around are the regulatory priorities in this accelerated during the COVID-19 pan- the world and caused significant period of relative calm? demic. Cost adjustment, restructuring personal and economic loss. It has (including exit) and enhancement of evoked memories of 2008 when, First, it is imperative that the third pil- the value-added propositions towards following the collapse of Lehman lar of the Banking Union, a common customers should be at the core of their Brothers, the financial world was shaken deposit insurance framework, is es- restructuring. to its foundations. The financial sector tablished. Nine years after the meas-

Covid-19 has accelerated the challenges It is crucial to advance more quickly in European banks are facing, but also aligning policies and removing barriers, creates opportunities, especially if developing a clear single rulebook and authorities and the private sector completing the banking union with a can share a vision and work together. deposit insurance scheme. Working closely with banks, European governments, the Commission and Because of this fragmentation, monetary authorities acted swiftly European capital markets remain and convincingly to protect people woefully underdeveloped, unable to and business s the pandemic severely provide the scale or financing options disrupted reduced economies last year. available in competing geographies. A true single market for financial European leaders seized the opportunity services in Europe would provide the to design a multi-year plan not just for foundation for banks to achieve the ANTÓNIO recovery, but for digitalization and the scale, efficiency, and resilience needed greening of the economy. The biggest to finance more growth and jobs. SIMÕES opportunity lies in building on this renewed unity of purpose. A second opportunity lies in the Regional Head of Europe, digitalization of the economy. FinTechs Group Santander The biggest opportunity is to create and BigTechs have entered financial a true single market for financial services, providing a new source of services. Banks in Europe today competition to banks. However, the Now is the time operate in a fragmented market with tech companies that provide financial an incomplete banking union. To do services are not subject to the same to be pan-European cross border business, we face barriers regulations as banks. Rules governing in everything from how deposits can innovation, access to data and be deployed to different customer platforms, and well as taxation, should protection and bankruptcy rules. We be brought up to date to ensure a level cannot freely move capital or liquidity. playing field for incumbents and new

106 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net POLICY PRIORITIES FOR THE EU BANKING SECTOR entrants. Banks are not seeking any new digital entrants. Third, the costs of In Santander, with the One Europe favours, simply not to have to compete regulatory compliance and maintaining project I am leading, our goal is to build with one hand tied behind our back. higher capital and liquidity ratios as a a better and simpler bank that puts the result of post-financial crisis reforms. customer at the heart of everything we Thirdly, while regulatory and supervi- Finally, the expected increase in do. One Europe will exploit synergies sory responses to the pandemic have business-related NPLs as a result of across our businesses in Spain, Portugal, been prompt and quick, certain meas- the pandemic, especially among small Poland and the United Kingdom to take ures did not work. Specifically, banks and medium-sized enterprises and the a truly regional approach. did not use the flexibility provided to most-affected sectors. draw down their countercyclical capi- We must seize the opportunity to We expect to grow by serving our tal buffers, which could have support- customers better, simplifying and ed more lending. We should use this Europe’s biggest transforming our mass market business opportunity consider how to develop opportunity is and accelerating our digital offer truly countercyclical regulation, as well to create a true through a common omnichannel as take into account the challenges to single market for strategy. We expect this will enable us the sector from green transition and to realize significant efficiency savings digitalization. financial services. in the next two years, even as we improve our products and services. Last is the challenge of declining mitigate this last factor by maintaining profitability, especially in Europe. measures to support firms until the Doing this is the best way we can There are four main factors behind recovery is well under way. This would contribute to a strong and rapid low returns. First, low interest rates help viable firms remain solvent, and recovery in Europe. are pressuring margins despite higher thus avoid the drag on the economy public and private indebtedness. Second, and the banking system that their non-bank competition, especially from failure would entail.

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EU BANK CRISIS MANAGEMENT FRAMEWORK

are not a free lunch, and they come at a Relying on national DGS funds and cost. Indeed, where a key driver of value national decisions could put pressure for the main assets transferred are the to circumvent resolution and go for client relations, any transfer strategy national solutions, especially in case must reflect the need to maintain these access to DGS has lower burden-sharing client relations. Bailing in non-covered requirements than the SRF. We cannot deposits might in such cases damage afford to go back to past mistakes based client relationships and thereby on inconsistent national solutions possibly deplete the franchise value. that inevitably reinvigorate the Therefore, banks must build up the sovereign-bank doom-loop. Banking necessary MREL calibrated to ensure a failures in the single market require a successful exit from the market in case European approach. of failure. All of the above is also closely linked to the need for a targeted harmonisation of the key features of bank liquidation regimes, to set the basis for a BRRD3 must grant harmonised EU liquidation regime. This is important for us in order to carry ELKE KÖNIG the SRB with stronger out our Public Interest Assessment powers to deal with and respect the “non-creditor-worse- Chair, Single Resolution Board (SRB) bank failures in off” principle. The SRB would have administrative liquidation powers the Banking Union, for banks under our direct remit, together with the and National Resolution Authorities management of EDIS. would have more consistent and A European solution efficient powers to transfer assets and liabilities in liquidation, to be to deal with failures of funded through EDIS with a robust governance system within the Single medium-sized banks The European Deposit Insurance Resolution Mechanism. Scheme (EDIS) is the main missing in the Banking Union element of our Banking Union, “Aller guten Dinge sind drei.” BRRD3 intended not least to break the bank- must ensure that we have a well- sovereign-doom-loop. It is closely functioning European solution for related to bank resolution. Indeed, we all banks. This requires ultimately In Europe, we have built our resolution support further exploring the use of granting the SRB with stronger powers framework from scratch in just a few EDIS in resolution, in combination to deal with bank failures in the Banking short years. This required prioritising with the SRF. However, the existing Union, together with the management tasks in the initial phases. Up to restrictive rules for the use of DGS of EDIS. now, we have mainly focused on the funds to support a sale of business put operationalisation of the bail-in tool, into question its operationalisation. I believe in completing our framework as it is the preferred resolution strategy Thus, we call for the removal of DGS to reduce value destruction, increase for most of the banks under our direct super priority in the creditor hierarchy, and harmonise deposit protection, remit. We have done so because the and a review of the “Least Cost Test” ensure transparency and reliability, largest institutions are those that imply to provide stringent and harmonised safeguard public funds, and improve a larger risk for financial stability. criteria across the Banking Union. financial stability.

One of our current priorities at the SRB Such amendments could provide solid is to work on the transfer tools at our funding options for the transfer tools, disposal. The latter serves the purpose and subsequent exit of market of of improving the resolvability readiness ailing medium-sized banks. Of course, of Significant Institutions falling under the review of the crisis management our direct remit with transfer tools as and deposit insurance framework preferred resolution strategy. Indeed, is inextricably intertwined with the experience has taught us that the discussions on EDIS that are taking failure of medium-sized institutions place in parallel. Only EDIS would can also hamper financial stability, so ensure a harmonised and European all banks must be resolvable. approach, guaranteeing the same level of protection for all depositors. In such cases, the MREL targets are modulated through bank-by-bank If this were not the case, it would adjustments to the recapitalisation lead us to an undesired outcome: the amount. However, such transfer tools renationalisation of bank failures.

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introduction of the EU bank resolution funds and eligible liabilities, which framework in 2015, financial-sector serve as a bail-inable buffer to protect State aid control de facto served as taxpayers and depositors in case of a the Union’s bank resolution regime, bank failure. Further revisions of the ensuring a level playing field at a crisis management framework are time when many Member States ongoing or being discussed, including mobilised their public budgets to as part of a public consultation; the support their banks. It is worth noting economic effects of the COVID-19 that these guidelines introduced pandemic - which represent a serious loss-sharing by the shareholders disturbance in the Member State and subordinated creditors of aided economies - further underline the need banks. And, finally, they supported to proceed thoughtfully. fair competition by requiring aid beneficiaries to make efforts to mitigate The Commission is now set to review competition distortions. the State aid rules for banks in the context of a broader review of the EU Since 2015, State aid control in the fi- bank crisis management framework nancial sector has fulfilled these roles which is to be completed by 2023. While in complementarity with the new financial sector State aid guidelines and MARIA EU bank resolution and deposit in- the EU bank resolution and deposit surance rules. For instance, the Bank insurance regime each follow their Recovery and Resolution Directive own logic, these frameworks are highly VELENTZA explicitly recognises the applicabili- interdependent, and so are the decisions Director Financial Services, ty of the State aid framework in the of the various public actors involved. DG Competition, context of precautionary recapitali- European Commission sation or resolution; in its State aid Given these interdependencies, a decisions, the Commission has con- holistic approach towards the review sistently taken into account the new of State aid rules for banks and the EU regulatory setting. bank crisis management framework is the best way to ensure a coherent set of The EU bank crisis management rules in both frameworks in the future. Developments framework has also entailed the creation of new actors, attributing A holistic analysis and revision of all in the state aid the role of bank supervisor to the the pieces of the crisis framework European Central Bank within the “puzzle” will support consistent and and banking crisis Single Supervisory Mechanism, and predictable outcomes which safeguard the Single Resolution Board as central fair competition, promote financial management resolution authority within the Single stability, protect taxpayers and set Resolution Mechanism. However, the appropriate incentives for banks and framework Commission’s role as competition their shareholders and creditors. authority – contained to assessing the compatibility of State aid measures – has remained unaltered. Since the beginning of the financial crisis in 2008, the European Commission has exercised its duties as competition enforcer by assessing the compatibility of support from the In the future, a holistic public budget to the financial sector with the State aid provisions enshrined assessment of the in the EU Treaty. Specific guidelines crisis management (a series of “communications”) were framework will ensure adopted establishing minimum criteria for this compatibility consistency between assessment. Through state aid control State aid and Banking the Commission has contributed to Union rules. safeguarding financial stability by facilitating the orderly market exit of unviable banks and preventing the disorderly failure of otherwise viable entities. This has contributed to a more Six years after the entry into force of this robust EU banking sector by fostering new regulatory setting, the EU banking deep restructuring. sector is in general more resilient, but some pockets of vulnerability remain The 2013 Banking Communication, – and the effects of the COVID crisis which is the latest revision of the are still unknown. The implementation financial-sector State aid guidelines, of the bank resolution framework has been a stable guide as to the is still ongoing, in particular with Commission’s exercise of State aid respect to banks’ compliance with control in that sector. Until the the minimum requirements for own

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stability – leaving the supervisory down. Let me try to outline one of these authority in kind of a limbo situation options: One could argue that only the to forbear the ultimate supervisory systemic banks should be eligible for measure, declaring a bank failing or resolution. For smaller banks, it should likely to fail. be either ordinary insolvency including triggering the DGS or an alternative Moreover, the resolution regime as administrative wind down procedure, such was developed to counteract the which could be developed alongside the “too big to fail” hypothesis. Thus, it following principles: was created for the big, systemic banks. Therefore, it might be not proportional 1. Losses have to borne by shareholders and too intrusive for smaller banks. and holders of regulatory capital (AT1 and T2) first. The failing bank must exit the market. Only relevant parts HELMUT DGS could play of the bank should be safeguarded a role in supporting (e.g. covered deposits) by transferring ETTL the wind down of them to other market participants. 2. There might be the need for external Executive Director, non-systemic banks, given prior financing (capital and liquidity) to Austrian Financial Market Authority support the transfer-mechanism. As fixation of strict covered deposits are concerned, DGS least-cost-tests and could step in and support. A strict Winding down adequate loss sharing. least-cost-principle-test should be a pre-condition. smaller and mid-sized 3. Internal preparation of banks for For this and various other reasons, it the implementation of such a banks – A possible is a consensus that there is the need transfer-tool will be necessary. Such for a further improvement of the preparation could include a certain way forward crisis management and resolution financial cushion for supporting the framework for these so-called small transfer (reserved assets) or bearing and mid-sized banks – banks that are losses (additional gone-concern Since the establishment of the new too small for resolution, but potentially instruments beyond regulatory crisis management and resolution too big for ordinary insolvency. For sure capital requirement). framework in 2015, the number banks EDIS combined with an “EDIC” would declared failing or likely to fail has been be the solution for such problem. As mentioned above – this is only one limited. The number of resolved banks Unfortunately, this seems to be a rather possible way forward. There are several according to the new framework is even long-term solution. Steps in between others. But we should always bear in lower. One possible reason is that for are necessary. mind: losses will not vanish – they have a certain type of banks the resolution to be borne by someone and they have framework is not (fully) suitable. But There are various possible ways forward, to be allocated in the process of winding exiting the market through ordinary all of them with positive aspects and down a failing bank. We should strive insolvency proceeding seems to be not drawbacks. All of them are circling for the most efficient way and aim for suitable either due to the potential mostly around one crucial element – using as less public and mutualized negative impact on financial market funding of winding the failing bank financial means as possible.

interventions by deposit guarantee Evolution rather than schemes (DGS) to finance the sale and market exit of smaller, deposit-based, revolution in crisis banks, the liquidity support from EDIS would mitigate the lack of available management and funding and the risks of shortfalls in the DGS financial means, requiring the deposit insurance recourse to public financing.

The pooling of resources in EDIS Completing the Banking Union would avoid “re-nationalising” the remains a priority for the Commission, Banking Union and could lower bank currently working on the review of contributions while maintaining an the crisis management and deposit appropriate firepower and ensuring MARTIN MERLIN insurance framework, with a public a more sustainable replenishment. Director, Bank, Insurance consultation launched in February, a Synergies with the Single Resolution high-level conference mid-March and Fund could also strengthen the resilience and Financial Crime, legislative proposals scheduled at the of the EU crisis management toolkit and DG for Financial Stability, end of the year. deliver efficiency gains. Financial Services and Capital Markets Union, EDIS is a natural complement of The Banking Union would not be European Commission such a review. Seeking to facilitate complete without its third pillar, EDIS.

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The ongoing health crisis reaffirms generally increases access to funding components, including on mitigating the urgency for robust financial safety for the real economy, lowers the cost of the sovereign-bank nexus, reflecting nets financed by the industry in a crisis capital, contributes to risk diversification upon banks’ exposures to sovereigns, management framework for every bank and stronger resilience to shocks. Banks their financial stability implications whatever its location, size or business in Europe need such a regulatory envi- and the need for safe assets at the EU model. Such a robust framework with ronment to continue contributing to the level. Progress on EDIS should unlock effective and proportionate instruments economic recovery and play their role in some of home-host issues and ring- available for all banks would strengthen other important challenges ahead. fencing practices. depositor confidence and pave the way for further market integration. The work on the so-called hybrid EDIS, At this juncture, one observes only based on the coexistence of national DGSs one resolution case managed by the The priority should be to preserve and a European central fund, continues in SRB and a frequent recourse to public financial stability and level playing field the Council and in the intergovernmental money under national procedures. The in full respect of the diversity in the EU context. The hybrid model would provide current efforts to complete the Banking banking landscape while limiting the use liquidity support as a first step and, is evo- Union provide a momentum, not for of taxpayer money. lutive in nature, allowing for a gradual a revolution of the framework, but for and conditioned transition towards loss targeted changes to improve existing Overall, the Banking Union should en- mutualisation in the steady state. tools, ensure a broader application of sure a solid and stable banking sector in the EU framework and mark the start Europe, taking full advantage of the sin- The process for Banking Union of the gradual establishment of the gle market. Indeed, market integration completion also involves other third pillar.

debt crisis, its core objectives were to grounds, there are now even additional ensure financial stability and to establish considerations going in the same, flawed common principles for adequate banking direction. In particular, this regards supervision. Its three pillars have since plans to further centralise competences been put firmly into place and their at the SRB. added value has been proven as recently as at the onset of the pandemic crisis, Contrary to this, the Commission when regulators and supervisors across should build on the inher- Europe acted swiftly and in unison. ent to the CMDI framework: A clear dis- tinction between systemically important The start of the review of the crisis banks under direct responsibility of EU management and deposit insurance institutions and non-systemically im- (CMDI) framework offers the chance portant banks under national responsi- for measured reforms to address bility. Changing this foundation cannot KARL-PETER shortcomings identified since it be justified – neither economically nor entered into force. The wide scope of politically. It would contradict the idea the European Commission’s respective of a diverse Europe and undermine lo- SCHACKMANN- stakeholder consultation however cal responsibility. suggests a much more fundamental FALLIS overhaul of the entire framework. The European Court of Justice’s recent Executive Member of the Board, ruling in the so-called Banca Tercas Deutscher Sparkassen- und Unfortunately, the underlying concept case has highlighted the validity and Giroverband (DSGV) so far points to an insufficient considera- the importance of preventative and tion of institutional protection schemes alternative measures to support troubled (IPS), which are widely prevalent among members of a guarantee scheme from small and mid-sized regional credit in- within their respective peer group. By Improving the crisis stitutions in Europe, such as the German definition, these measures are required savings and cooperative banks. to be economically more advantageous management and than mere reimbursement of depositors Most notably, the Commission in the event of liquidation. deposit insurance intertwines the CMDI review with its separate proposal for a European Following the reasoning confirmed by framework while Deposit Insurance Scheme (EDIS). This the highest court of the EU, the CMDI is unnecessary and will not lead to any review should seek to strengthen the preserving the results since EDIS has been stuck in the role of existing DGSs and IPSs within legislative process since 2015 for failing crisis management by committing to diversity of the EU to take account of the diversity of the preventive and alternative measures. In EU’s banking sector. Clinging on to addition, national authorities should banking system EDIS is an impediment to finding the be provided with additional tools to best European solution. deal with banks going into national insolvency. This would improve the When the Banking Union – arguably Not only appears there to be little proper functioning of the Banking the biggest EU reform project since the intention of drafting a fresh proposal Union going forward and maintain the introduction of the common currency – which would exclude IPSs from a diversity of the EU banking system at the was set up in response to the sovereign centralised EDIS on subsidiarity same time.

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is a single jurisdiction, such obstacles raising MREL. The first concern can are not justifiable. This underlying flaw be addressed by either harmonising of the BU’s first Pillar also undermines key elements of national insolvency the functioning of the second Pillar, the proceedings for the financial sector and, ability to resolve significant banks and if this is too complex, the alternative liquidate less significant banks in a way is to better frame the Public Interest that preserves value, Shields taxpayers Assessment in a transparent manner and protects depositors. But as long as which would allow for these banks to achieving Banking Union as a single be resolved via SRB action. jurisdiction is not encouraged, most solutions (i.e. sale of business) have to The second concern cannot be taken be found at a national level. This holds at face value. We have not seen any back future sector integration but also evidence that raising MREL is a risks amplifying issues in national problem other than suggesting that an JACQUES banking sectors. inability to issue may not be the bank’s primary problem. Conversely, if some BEYSSADE These dynamics in Pillar 1 and 2 also healthy mid-sized banks truly struggle undermine the acceptability of any in meeting their MREL requirement Secretary General, EDIS-like structure as a Pillar 3 where the solution would be to move forward Groupe BPCE six years after the original proposal we with the Capital Markets Union. are still in the dark on the direction of travel. Therefore, the first part of On this basis, this is not the time to We need to make our response is clear: Improve the introduce another layer of special conditions for using the existing BRRD treatment into a complex framework the full use of tools in the current legislation making just to solve issues that may or may the full use of the Banking Union as a not be incurred by a hazily defined the Banking Union single jurisdiction. group of banks. This means that the establishment of an ad hoc resolution as a single mechanism for medium-sized banks “Same risks, with maintenance of their access to jurisdiction same rules”, the Single Resolution Fund under very regardless of the size favourable conditions, i.e. without of banks having to bail-in at least 8% of the Total The Banking Union (BU) is a great Liabilities and Own Funds should be achievement but remains incomplete radically refused. and below its potential to achieve a The second part of our response is to well-integrated Eurozone banking step back and consider the problem It is inconsistent with the principle sector. Even within the BU, national at hand objectively: according to the “same activity, same risk, same rules” interests still cement fragmentation Commission’s consultation there are and would mean that taxpayers and along national lines and discourage two dimensions to the problem. First, DGSs indirectly subsidize these banks cross-border banking groups. For medium-sized banks that do not pass with insufficient MREL. The challenges example, not even liquidity is allowed to the PIA may be too difficult to handle we are faced with are real enough, move freely within banking groups, not for national insolvency proceedings. we should not exert ourselves in to mention capital. Considering that Second medium sized banks, especially adding new difficulties at national and from a supervision perspective the BU when deposit financed, tend to struggle European level.

up a sizeable cushion of bail-inable Improve the debt for absorption of losses and recapitalization if the situation requires efficiency of the EU so. Although differences remain, we view that amongst the most sizable EU Crisis Management banks there is an overall level-playing- Framework: field in terms of requirements and applications of rules throughout the a key intermediate Eurozone. Fortunately, in the decade after the financial crisis depositor step in achieving protection has not been severely challenged which could be considered Banking Union as a demonstration that banks have become increasingly resilient.

DIEDERIK VAN The EU Crisis Management Framework With respect to the smaller banks has to a large extent contributed to in the EU system the landscape and WASSENAER the initial goals of strengthening framework is more diversified. This Global Head Research the resilience of the banking system. makes the applicable resolution/ and Regulatory & International Affairs, Across the board systemic banks have liquidation rules challenging and ING Group become more resilient and built- diversified. To ensure predictability

112 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net EU BANK CRISIS MANAGEMENT FRAMEWORK we promote more clarity in the BRRD the national triggers to initiate insol- both for compensating depositors as when defining a resolution action in vency procedures; clarification should well as alternative measures and always the public interest or the winding up be made at EU level through the BRRD on a least cost basis. And in any event, of a bank under normal insolvency law and the SRM regulation to establish to prevent an un-level-playing field, when the public interest test is not met. administrative procedures that will be the use of preventive measures by both applicable for all banks and binding for private and public DGSs against the Banks, irrespective of their size, that the national insolvency regimes. background of state aid rules should are in the scope of resolution should be clarified. be subject to MREL requirements Furthermore, we envisage that whereby the size, business model, local more efforts could be undertaken to Throughout the years the Crisis market and rating are duly taken into harmonise existing national insolvency management Framework has also consideration thereby acknowledging procedures and financial means. One significantly contributed to a reduction that the MREL issuing capacity might key element to consider is in our view of the sovereign feedback loop. be vary across countries. We welcome to harmonise the use of DGS to finance However, there is an actual risk that the proposals, currently under way alternative measures in liquidation, dependencies are re-introduced or by the SRB, to harmonize the public such as the transfer of assets and increased – we see this for instance interest test and view that such a test liabilities across the EU. when contributions into the national should be applied by the SRB and no DGS funds are deposited in public longer by national authorities. We note that only in a number of treasury. The DGSD review should Member States DGS can be used a provide for clear rules to avoid this. A key challenge to address is the exist- preventive measure; we believe the Ultimately the European Deposit ing discrepancy between declaring an DGSD should be amended and DGS Guarantee Scheme is the best response institution failing-or-likely-to-fail and funds should only be used in liquidation. to address this sovereign feedback loop.

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SOLVENCY II REVIEW

challenges for insurers, such as the context of a harmonized legal and business interruption issues, to name supervisory framework in the EU. but one. The consequent rise in insurers’ reputational risk has brought Simultaneously, given their business to light the benefit of transparency profile, conducive to long-term and advice to policyholders: they are investments, European insurers have of utmost importance to ensure that a decisive role to play ensuring sound there is no mismatch between expected and sustainable financing conditions and effective insurance coverages. for corporate, especially for small Furthermore, due to the context of the and medium-sized companies, to pandemic and of climate-related risks, foster economic recovery. Long-term the need to address the protection gap investment was already encouraged by issue has hopefully gained traction, subsequent Solvency II revision, and especially when observing the one of the aims of the current review heterogeneity in the level of protection is to go further and detect potential across Europe. unjustified restrictions to economy financing, in particular, long-term Beyond the question of state-owned investment in equities. reinsurance schemes, which benefit to insured people in countries where they Fostering sustainable financing DOMINIQUE exist, it shows that it is important that conditions by insurers is of utmost insurers act more and more on risk importance, as insurers and reinsurers LABOUREIX prevention with clients, via their role are at the frontline of the climate change Secretary General, of advice. Solvency II has met one of challenges, as risks takers and risks Autorité de Contrôle Prudentiel its objectives, namely fostering a fluid carriers. The impact of environmental et de Résolution (ACPR) European market to improve the ability risks should be monitored on their of insurers to offer policyholders all the solvency position as well as on the products they need. It will be essential assets and liabilities quality they carry. to pursue this trend. Insurers must integrate tools and processes in their system of governance to properly identify, assess, manage and Thinking long-term, monitor climate-related risks and their impact on their business model and through short Ensuring suitable, financial exposures. stable regulation and medium-term The upcoming review of Solvency 2 conditions will be one will thus integrate new requirements measures of the main challenges in this regard in pillar 2 of Solvency 2. in the coming months. The pandemic crisis also provided a striking illustration of transition risks, with oil-related asset prices dropping in The first lesson of the Covid-19 crisis 2020. This preview of the still-to-come in the insurance sector is its robustness adjustment to a low-carbon economy and the strength and flexibility of the From this perspective, a simplified should act as a warning: appropriate Solvency II supervisory framework. The Solvency II framework should be an regulatory measures in the pillar 1 to current counter-cyclical mechanisms, important goal to keep in mind, in penalize riskier investments could now including the so-called Volatility order to levy undue barriers to the be considered. Adjustment measure, have proved to supply of innovative and needed be useful to mitigate the impact of products by insurers. Moreover, Once these adjustments are made, it market volatility on the balance sheet supervisory convergence and level will also be important to stabilize the of insurers. It has also enabled to avoid playing field are also essential to ensure regulatory framework to foster long- pro-cyclical behaviors, even if counter- similar policyholders’ protection, term visibility and long-term thinking. cyclical instruments of Solvency II will irrespective of the origin of insurers have to be entirely assessed in light of and the location of the insured person. the whole crisis. In addition, the low- European supervisors are actively for-longer economic environment has working to enhance the quality of to be better taken into consideration in cross-border supervision and the the Solvency II framework, and its risk- protection of policyholders in such based approach, and the EIOPA answer context; in this regard, the development to the Commission consultation has of a harmonized insurance guarantee contributed to this debate. scheme framework throughout the EU would probably help to reduce the For all that, the current crisis has observed heterogeneity. The freedom also highlighted new or growing to provide services only makes sense in

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One unavoidable issue that deserves which is intended to mitigate the effects urgent revision to ensure such of a widening of spreads affecting only recognition is the calibration of interest one or a few national markets, but not rate risk. The existing provisions do the majority of national markets that not capture the risk of falling interest are invested in bonds denominated in rates when market values are already the same currency. This is particularly negative, which is unanimously relevant for the Member State of the regarded as a fatal flaw under the current euro area, especially for those more ultra-low interest rate environment. susceptible to market fragmentation. In fact, such fall has been observed on multiple occasions, including, It has been observed that the activation very recently, following the swift and mechanism does not work as expected, decisive action of the European Central producing a ‘cliff edge effect’ of the Bank in response to the outbreak of the country-specific increase. Notably, in COVID-19 pandemic crisis. periods where the spreads of a single – or few - countries would fluctuate The required amendment will around the trigger point, rather than undoubtedly take its toll on the mitigating market volatility, the solvency position of the European activation of the country component insurance sector. Nonetheless, that translates into a larger volatility of own MARGARIDA should not preclude its inclusion in funds. Hence, the introduction of a the overarching review, under penalty factor to ensure a gradual and smooth CORRÊA that the risk incurred by insurance activation of the country component undertakings remains underestimated, and of a relative threshold calibrated as DE AGUIAR ultimately compromising policyholder to ensure that national specific crises President, Portuguese Insurance protection and financial stability. The are properly recognized is warranted. and Pension Funds Supervisory risk is already there, it is just not being Authority (ASF) adequately measured. The above-mentioned features are just two in a myriad of issues that will A phased-in approach, as proposed by certainly be extensively discussed – and EIOPA, potentially complemented with negotiated – between the European adequate safeguards in Pillar II and legislators following the presentation of Pillar III, such as the consideration in the European Commission’s proposals. Solvency II review: ORSA and the disclosure of the solvency During the discussions, transparency position without the recognition of the and the spirit of commitment must ensuring the phasing-in, appears to be a suitable prevail, in the sight of European unity compromise way forward. and public-good. regime remains Compromise solutions should be fit for purpose sought to solve difficult political negotiations, without jeopardizing the Compromise solutions fundamental principles of the Solvency should be sought II Directive implemented in 2016, which During the third quarter of 2021, the led Europe to the forefront of insurance European Commission is expected without jeopardizing prudential framework worldwide. to unveil its legislative proposals the fundamental for the much-anticipated review principles of Solvency II. of the Solvency II framework. The process for the review, provided for in the text of the Directive, started as early as 2019, with the European Insurance and Occupational Pensions Another feature of the regime Authority (EIOPA) conducting an in- requiring action to ensure efficient depth and wide-ranging technical functioning and reflection of economic analysis at the request of the fundamentals, and for which the European Commission. Portuguese Insurance and Pension Funds Supervisory Authority has been as The package of legislative proposals outspoken advocate, is the enhancement is expected to complete the of the design of the volatility adjustment regulatory toolbox, by introducing (VA). This mechanism was introduced by macroprudential tools, recovery and the Omnibus II Directive to prevent pro- resolution measures and insurance cyclical behaviour on financial markets guarantee schemes. Furthermore, and and to mitigate the effect of exaggerations although it is widely acknowledged of bond spreads. The experience gained that the framework is working well during the first years of application of from a prudential perspective, the Solvency II has, nonetheless, showcased review will also attempt to ensure some shortcomings in its design. that the Solvency II regime remains fit for purpose, recognizing the current One of such deficiencies relate to the macroeconomic context. country-specific component of the VA,

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unfold in parallel with the deterioration will assess the resilience of the sector of the macroeconomic environment in to different recovery scenarios within which a reduction of economic activity the European Union-wide insurance and disposable income is starting to stress test carried out this year. become tangible. In its Opinion on the Review of The outlook for the insurance sector Solvency II, EIOPA proposes to broaden depends critically on the future the prudential regime to incorporate development of the pandemic and on the macroprudential perspective. The the resilience of the economic recovery. tools seek to enhance monitoring and Capital buffers of insurers were solid in add supervisory powers that might the end of 2019 and proved resilient at be useful to address the sources of the time of the virus outbreak. It stands system risk. out that life undertakings are affected JUSTIN the most due to their higher sensitivity Examples are the power to define to risk-free interest rates that reached soft thresholds for action at market WRAY their all-time low levels in the end of level if a certain exposure increases last year. The prolonged period of dramatically and/or reaches a Head of Policy Department, ultra-low yields is further negatively significant level, the expansion of the European Insurance affecting the profitability prospects of prudent person principle and the use of and Occupational Pensions insurers’ investment­ portfolios, due ORSA to include the macroprudential Authority (EIOPA) to reinvestment risk. In addition, the perspective, the request of pre-emptive risk of deterioration of corporates’ plans (such as recovery or resolution ratings could affect the market value of plans) or an enhanced liquidity insurers’ corporate bond holdings. risk monitoring. Maintaining stability In addition, EIOPA also proposes that of the EU insurance The outlook for supervisors should have the power to the insurance sector set a capital surcharge to address one sector in times of depends critically on or more entity, activity- or behaviour- the future development based sources of systemic risk or, in uncertainty exceptional circumstances, additional of the pandemic and measures to reinforce the insurer’s on the resilience of financial position (i.e. the possibility Although financial markets have the economic recovery. of restricting or suspending dividend gradually stabilised after the initial or other payments to shareholders sharp drop in asset prices triggered by and the possibility of restricting the the Covid-19 outbreak, the ongoing Nevertheless, European insurers purchase of the insurer’s own shares). lockdowns in most European countries have been able to withstand the cause uncertainty and medium-term dramatic situation as, in particular, A strong and stable insurance sector risks for the economies. In addition, the Solvency II regime helped them benefits the whole of society. EIOPA potential cliff-edge effects could to better align capital to risk, build- will therefore continue its work to materialise once the fiscal measures up resilience and enhance their risk ensure the early identification of supporting economies will fade out. management practices. While risks risks and vulnerabilities, so that Strains to demand that will reflect surrounding the economic growth the insurance sector can continue into insurers’ underwriting and overall outlook remain high, they appear to to play a vital role in Europe’s post- profitability will take some time to have become less pronounced. EIOPA Covid recovery.

These macro risks result in increased Macro risks are requirements for micro-prudential supervision. For example, the low increasing the interest rates are posing a threat in requirements for particular to the business model of life insurers, because in the past these insurers often promised their customers © Bernd Roselieb BaFin micro-prudential interest rates which they are now finding supervision difficult to generate on the capital market. However, BaFin does not leave it at that, but uses a proactive approach The impact of the coronavirus in its supervision. BaFin ensures that pandemic has reinforced the biggest the guaranteed interest rate for new challenge for insurance undertakings: business remains at a level which life the low interest rate environment. insurers can afford in view of their risk- FRANK GRUND Moreover, this year the crisis could bearing capacity and earnings power. Chief Executive Director of Insurance also have a negative impact on the Anything else would not be sustainable. and Pension Funds Supervision, ratings and quality of corporate loans, Federal Financial Supervisory Authority, and put pressure on commercial From a risk management perspective, Germany (BaFin) property prices. there is no simple analytical procedure

116 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net SOLVENCY II REVIEW for determining the guaranteed interest the lowering of the maximum technical under Solvency II: undertakings need rate. However, setting a guaranteed interest rate by the legislature. to have a solvency ratio of more than interest rate of 0.9% without further 100% in order to remain active on the evaluation is not considered proper market and to write new business. The risk management. In Germany, the BaFin has developed tools ability of undertakings to meet existing guaranteed interest rate refers to the for proactive supervision guarantee obligations is currently less savings portion of the premiums that and is using them in a of a concern to BaFin than their ability remains after the portions that are targeted manner during to write new business. earmarked for the acquisition and the pandemic. administrative costs and for insurance At the European level, Solvency II is the coverage have been deducted from the most important regulatory parameter gross premium. As at 30 September each year, insurance - and this parameter is currently being undertakings must submit a projection adjusted: EIOPA’s proposals for the The level of the guaranteed interest rate to BaFin on the impact of certain review are acceptable to a degree, is limited by the maximum technical capital market scenarios on their future but I still see room for manoeuvre. interest rate for the calculation performance. Our analysis of these For example, the proposed changes of the premium reserve, which is projections is based on a dual approach. to the extrapolation of the risk-free currently set at 0.9%. However, when Firstly, undertakings are required to interest rate term structure: if these determining their guaranteed interest determine, on the basis of local GAAP, changes were to come into force, they rate, insurance undertakings should whether they can continue to fulfil the would result in a significant additional not apply the maximum threshold, but guarantees they have given to their burden for German life insurers. I am should set a rate that is significantly policyholders in the future. Secondly, still hoping that readjustments can be lower than 0.9%. I also fully support BaFin considers the solvency ratios made here.

there is no reason to fundamentally regular stress testing. Supervisors must change a regime that appears to work also be aware that risks, such as those well, even in a crisis situation. However, related to climate change, can have on this does not mean that Solvency II financial stability. By assisting insurers cannot be improved. The regulatory in the identification, monitoring, framework must be strengthened in and assessment of these risks and by order to ensure that the insurance contributing to the mitigation of these industry is capable of meeting future risks, supervisory authorities can help challenges. The pandemic has shown to protect policyholders and to ensure that black swans may well appear on financial stability. the horizon more frequently than predicted in existing models. The Although sustainability is not solvency framework must also reflect specifically part of the Solvency II the changing economic climate. review, as it was not included in GORAZD ČIBEJ the European Commission’s call for evidence, the importance of the Director, The Solvency II sustainability agenda is such that this Insurance Supervision Agency, review must proactively issue must receive proper attention in Slovenia help insurers to the review. reduce the insurance protection gap. Finally, the pandemic has shown that The Solvency II proper customer information is crucial to make the insurance market work review: a “risky” The insurance industry plays a critical efficiently. Policyholders need to know role in the management of risk. In its which risks are covered under insurance business capacity as a risk carrier and investor, it policies and why certain risks are is in a unique position to understand the excluded from coverage. The exclusion pricing of risks. In their risk assessment, from coverage may not be such that Covid-19 has had a huge impact on insurers must be vigilant in an ever- new protection gaps are created or that the insurance industry: financial changing environment of risk and keep already existing gaps are increased, and dislocation across investment classes abreast of new emerging risks. The this should be clarified at the onset. It is increased exposure in certain lines of regulatory framework must support important that the insurance industry business, such as business interruption, insurers in better managing risk by fulfills its socio-economic role by and life and pension products with rewarding good risk management, and reducing the many protection gaps that guarantees. However, the full impact also by avoiding unnecessary and too still remain, in areas such as pandemics, of the pandemic is not yet entirely complex rules and procedures. More natural catastrophes, pensions, health clear, and so far, it can be said that the importance must be attached to risk care, etc. The Solvency II review must EU insurance industry has weathered prevention and risk mitigation. proactively help insurers to reduce the the pandemic storm rather well and insurance protection gap. that most EU insurers and reinsurers Supervisors must assist insurers in remain well-capitalized. their drive for better risk management. If necessary, a public/private partner- They can do so by increasing the ship should be built in order to deal This is an important lesson for the frequency of supervisory reviews, by with risks which the private sector can- Solvency II review: demonstrating that making analyses more granular, and by not bear on its own.

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and reduce the sector’s contribution to ly relevant in a long-term insurance the economy. context and should be removed from the regulatory solvency measurement. The long-term insurance business However, EIOPA’s advice seems to re- model enables insurers to hold illiquid, duce the effectiveness of the volatility long-term investments without the adjustment, while rather, its general risk of forced selling, while using application ratio should be increased, contractual asset cash flows to cover and the risk correction should remain insurance liability payments. The value based on the fundamental spread. of insurance liabilities should thus be based on an interest rate term structure Both, an overly volatile extrapolation that is not subject to unwarranted method and an inefficient volatility volatility, in particular on the long end adjustment have negative impacts on of the curve, where no reliable financial solvency ratios and are likely to force AYLIN markets exist as a benchmark. the industry into countermeasures such as substantial de-risking of asset SOMERSAN The existing Solvency II extrapolation portfolios. This would entail an exit method for risk free interest rates from, rather than increased investment COQUI provides an approach that addresses in real assets and cause higher sovereign the non-liquid part of the yield curve. bond allocations. Chief Risk Officer, EIOPA proposes a new extrapolation Allianz SE method that would add substantial In turn, this tends to prolong the low complexity while increasing volatility interest rate environment, while at and result in materially lower the same time reducing policyholder The Solvency II solvency ratios. returns on long-term savings and pension products. Equally important, Review should better the divestment from real assets would Solvency II has a particularly affect green investments reflect insurer’s long- number of flaws to be like infrastructure thereby challenging addressed, which if left the sector’s support of the real economy term business model unattended cause an in the transition to a carbon-neutral inaccurate reflection future. Solvency II is strongly supported of individual insurer’s In summary, the Solvency II review is by the insurance industry and the solvency position. an opportunity to fix selected flaws framework has proven its value since of Solvency II to better reflect the its implementation in 2016, including Long-term insurance products with long-term business model and related during the ongoing COVID-19 guarantees would become economi- risks in regulation - without reducing crisis. However, the framework is cally unviable - thereby transferring policyholder protection or macro- excessively conservative - if not the market risk for old age provisioning prudential stability. At the same time most conservative globally -and to customers. In addition, the sector such enhancements would foster does not fully reflect the long-term would be forced to increase the use the sector’s contribution to political insurance business model. Solvency II of derivatives in hedging long-term priorities like the Green Deal and has a number of flaws to be addressed, liabilities, thereby increasing the mac- addressing the pension gap in Europe which - if left unattended - cause an ro-prudentially undesired nexus to the – an opportunity that should not inaccurate reflection of the individual banking sector. Similarly, short-term be missed. insurer’s economic solvency position fluctuations in credit spreads are hard-

fair to economic valuations of long Long-term business term business models and their true risk profiles risk exposures. differ from raw The resilience of long-term business models to short term financial market downside movements stems from their stable resources that allow a long-term stance fluctuations, their to investment choices and strategies. The stable resources are not uniquely resilience should be sourced from the duration of insurance products based on the cash flows of their plainly recognized insurance guarantees. As important is the ability to pursue business as a going concern (renewals, future premiums, MIREILLE The Solvency II “2020” review should new clients). Own funds also contributor not be a missed opportunity to to the stability and length of resources. AUBRY improve the framework and regulators Their amount can even exceed the Head of Prudential Regulation should focus on the pressing need to amount of the technical liabilities with Standards & Foresight, Covéa render prudential regulation more a duration potentially infinite.

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Against the backdrop of the stable of investments is fixed income with case of general asset portfolios making resources of long-term business models, regular redemptions forming highly use of cash in-flows derived from assets insurers put in place ALM policies and predictable cash inflows immune to backing own funds. These secured actions that seek performance over changes in market values. Additionally, and immune to short term market time while commanding to all possible a significant share of the liabilities in movements cash inflows show their vulnerabilities, the main one being the the balance sheet is made of own funds excess above cash outflows. forced sale of assets with market losses. of the greatest quality. These own For that, ALM warrants adequate funds have durations far beyond those These features command a review of the coverage of cash outflows with cash of the insurance contracts liabilities Solvency II framework that makes the inflows including buffers to cover and commensurate with the duration entire way towards offsetting spurious possible deviations. This is proved of the undertaking. volatility and appreciating the low risk by the Solvency II quantitative data to short term market movements of reported by insurers. Consequently, risk exposure to short long-term business models. A stronger term movements is on average nil. With focus to going concern is also required. One year of inforce business cash fixed-income average durations across Last, despite the current strong outflows on average typically represent sovereigns and corporate securities of bias towards low for long interest 8% of the total value of technical 8 years, and considering a proportion rates, insurers cannot be left totally liabilities. This shows the limited of fixed income of 70% among the total unprepared in their balance sheet exposure to the total sale of investments investments, a typical average amount against other pathways such as interest of a business model receiving premiums of highly predictable asset inflows rates revivals. The risk-free interest rate before paying any claims. This exposure immune to market fluctuations makes curve needs to be sufficiently stable to is then further reduced due to ALM for almost 9% of the total value of the be reflective of these cases. techniques by which a significant share technical liabilities, and even 12% in the

total balance sheet and market- excessive volatility of solvency ratios is consistent methodology, should not an objective to achieve independently of be questioned. However, the current the occurrence of a crisis. economic environment, characterized by low-for-long interest rates and Second, the classic investment strategy an unprecedented economic crisis, of insurers - and life insurers in particular has further highlighted a number of - is to invest in a portfolio of corporate issues related to the architecture and bonds that is specifically designed to calibration of the Solvency II structure match expected payouts and expenses. that deserve further analysis. This implies that assets are generally held to maturity, to replicate the average First, the recent financial markets duration of the product’s portfolio, and turmoil has resulted in short-term thus short-term fluctuations in the excessive volatility of insurers’ solvency market prices of bonds are irrelevant. GIANLUCA positions. This is an “artificial” volatility Against this structure, the capital as it does not correspond to a real change requirements for corporate bonds are of the insurer’s economic fundamentals, based on the assumption that insurers SANMARTINO but rather to a flawed evaluation of sell all their bonds portfolio at low prices Head of Group Enterprise insurance liabilities. As a matter of in a situation of economic stress. This Risk Management (ERM), fact, insurance liabilities are not traded approach does not reflect the economic Generali and priced on the financial markets but reality of the insurance business and calculated according to a defined model. should be somewhat compensated by taking into account the average holding The challenges and period of the bonds portfolio. The financial the opportunities turmoil has resulted Third, according to the EU legislator, in short-term artificial insurance liabilities should reflect both of the Solvency II volatility of insurers’ the mean expected value of payments solvency positions. to policyholders (Best Estimate) and the 2020 review uncertainty attached to it (Risk Margin), along with the transfer value approach. As a consequence, any market Hence, the Risk Margin should lead The Solvency II regulatory regime turbulence, while immediately reflected to a market value assessment of the is now entering into its 5th year of in the value of listed assets, is not as insurance liabilities by reflecting the application but it has been under correctly replicated on the liability side of “cost” of uncertainty surrounding consideration and development since the balance sheet. This leads to an asset- non-hedgeable risks. However, the the early 2000s. Years of analysis and liability divergence with a consequent Risk Margin prescribed calculation research have led to the creation of a impact on insurance companies’ Own and calibration, first of all the “cost- prudential regime that is now regarded Funds. This problem has been partly of-capital” rate, is questionable and as a global benchmark. mitigated by the Volatility Adjustment its revision is advocated, given the which should definitely be improved disproportionate impact that Risk Therefore, the fundamental pillars by focused corrections against some Margin can have for certain categories of and metric of the regulation, such of its overly conservative and not fully products, which does not seem to reflect as the risk-based approach and the economic aspects. Addressing the their proper market value.

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and the imperative economic recovery • An expected movement of divestments plan beyond the crisis, there are a from risky asset classes matching number of elements of this prudential inforce business to mitigate the framework that are worth examining. lower solvency levels, at a time when Indeed, insurers’ capacity to constitute we need investments in companies the very core of long-term institutional and in infrastructures to fund the investors should be fully mobilized for economic recovery. such objectives cannot be achieved only with public investments. We should acknowledge that the current economic environment as well Insurers’ capacity to invest over the as the ambitions for the green transition long-term is based solely on their call for adjustments to the framework ability to offer long-term products. that, if well-defined and kept to the Long or very long-term reciprocal essential, would enable insurers to fully ALBAN commitments between policyholders play their role without compromising and insurers allow for potentially the framework’s overall balance. To that DE MAILLY extremely long investment horizons, end, we are convinced the following in a wide variety of assets, with buy and should be envisaged: NESLE hold strategies that are specific to the insurance sector. • Adjusting the standard formula to Group Chief Risk & Investment allow for negative interest, for it is the Officer, AXA Group main macroeconomic change since the The Solvency II Solvency II regime’s implementation; review should enable • Reducing capital requirements by Solvency II review: insurers to fully play counterbalancing the introduction of their role without negative rates with a lower risk margin; fostering insurers’ compromising the the vast majority of actors, including EIOPA, find the standing risk margin framework’s overall long-term investment to be too conservative; balance. • Reducing the volatility of the solvency capacity ratios as it leads to a higher capital Nevertheless, while this capacity to charge notably for long-term products offer long-term products ought to be and long-term assets, which ultimately The Solvency 2 regulatory regime is encouraged, some of EIOPA’s technical leads to higher costs for consumers. now entering into its sixth year of proposals to the European Commission application. Up to today, the robustness could make long-term products In conclusion, AXA, like most actors and consistency of this prudential much more costly, with foreseeable in the market, maintains the current regime have enabled European players consequences such as: system works rather well and requires to provide consumers with attractive only a few well-targeted adjustments to products while preserving their financial • Creating a potential protection gap unlock the investment capabilities the strength even in times of crisis. in Europe with a shrinking offer of Public Authorities are calling for, while savings products for pensions or preserving a long-term product offering Yet, to be in a position to respond to protection due to the increasing cost together with a high level of protection the major challenges that lie ahead, of capital, and this, in the European for policyholders. foremost among them the Green Deal context of population ageing.

120 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net We thank the Portuguese EU Council Presidency and the partner institutions for their support to the organisation of the Eurofi April 2021 Seminar BANKING AND INSURANCE REGULATION

INSURANCE SECTOR GLOBAL ISSUES

global Insurance Capital Standard (ICS). Earlier this year we marked an ICS We also maintained momentum on milestone with the completion of the our supervisory guidance on a range of first year of the monitoring period. emerging and accelerating trends, such Despite the operational challenges of as climate change, fintech and cyber risk. 2020, the first year of ICS monitoring saw strong participation and engagement The Roadmap presents a broad range of from insurance groups. Participation planned projects in four thematic areas: in the ICS monitoring period will grow risk assessment and the maintenance in 2021, with additional insurance of financial stability, including ongoing groups participating. assessment of potential vulnerabilities arising from the impact of Covid-19. Importantly, this year allowed for the first ICS discussions amongst group- In 2021, we will undertake our Global wide supervisors in supervisory colleges, Monitoring Exercise (GME), which is which provided valuable input and an assessment of systemic risk at the feedback to further enhance the ICS. sector-wide and individual insurer level and covers more than 90% of the global The ICS will create a common insurance market. language for supervisory discussions of Internationally Active Insurance JONATHAN Groups’ solvency and enhance global convergence among group capital DIXON standards. We are also making good Secretary General, The pandemic progress with assessing implementation International Association of the Holistic Framework and in of Insurance Supervisors (IAIS) highlighted the the coming months will report on importance of implementation across our membership. consistent global Supporting members in addressing the standards and risks and opportunities of key trends, supervisory especially those accelerated by the Navigating cooperation to Covid-19 crisis. Activities include: work to address climate risk and sustainability; uncertainty: the maintain financial supervisory perspectives on the stability. pandemic protection gap; measures importance of a global to increase operational resilience of insurers; supervisory guidance on supervisory response responding to FinTech and cyber risk; supporting activities to implement risk- Last year the IAIS adapted the GME based solvency regimes in emerging to focus on the impact of Covid-19. markets and developing economies; and In February, the IAIS published its This year we will continue to monitor new endeavours in the area of diversity Roadmap which sets out an ambitious the impact of the pandemic on the and inclusion. work programme for the next two years global insurance sector. Running this during a period of continued uncertainty exercise last year provided supervisors Implementation support and assessment, for the insurance sector given the with access to global data so they specifically reinforcing our extensive Covid-19 pandemic. Assessing and could share their experience on any programme of member support to help mitigating risks to the stability of the emerging vulnerabilities. In December, insurance supervisors understand and global insurance sector, while helping we published the results of this analysis implement our standards, through our members to address accelerating in our Global Insurance Market training, peer exchange platforms and risks and opportunities, sits at the heart Report. It concluded that the global implementation assessment exercises. of the IAIS’ Roadmap. insurance sector had demonstrated both operational and financial resilience, Over the next two years, we will The pandemic highlighted the aided by supervisory measures providing continue to work collaboratively with importance of consistent global operational relief and by monetary and our colleagues in the other international standards and supervisory cooperation fiscal support measures in financial standard-setting bodies and with our to maintain financial stability. Despite markets in certain regions. broad range of stakeholders on these the significant challenges during important topics. We will also embed 2020, the IAIS progressed work to Delivering on key post-crisis reforms, emerging lessons learned from the finalise and implement key reforms including further refinement of pandemic to further improve the cross- such as enhanced global standards the ICS during the current five- border coordination and collaboration on macroprudential supervision (the year monitoring period and the we saw between insurance supervisors Holistic Framework for the assessment consistent implementation of the over the last year. and mitigation of systemic risk) and the Holistic Framework.

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already achieved substantial progress While we are open to the arguments in the development of the ICS, with in favour of the Aggregation Method, the agreement of ICS 2.0 in 2019 EIPOA holds the view that discussions representing the culmination of around AM should not distract the IAIS that progress. from work needed to complete the ICS.

In EIOPA’s view, ICS 2.0 represents a The High Level Principles for the significant step in the direction of the comparability assessment between implementation of sound risk-based the AM and the ICS, recently under supervisory frameworks at a global public consultation by the IAIS, already level, enhancing the level playing field provide significant reassurance that for European insurers as well as their the comparability assessment of the competitiveness. AM will be subject to high standards. The assessment will be based on data Even before its expected adoption which should evidence similar results by 2024, the ICS is already shaping between AM and the ICS over time and the development of supervisory under different economic and market frameworks throughout the world. conditions, ensuring that the level of These should be very positive news prudence under the AM is at least the both for large international groups as same as for the ICS. PETER well as for the supervisors in charge of controlling them. Let’s not fool ourselves: the road BRAUMÜLLER towards the finalisation of the ICS is Vice-Chairperson, EIOPA has always supported the still very long and the effort required European Insurance development of an ICS that reflects is still huge. Nonetheless, effort will be and Occupational Pensions the basic sound principles of Solvency worth it as international standards are Authority (EIOPA) II. Such an approach does not mean the best response to fragmentation – that the global standard should mirror particularly relevant in businesses like Solvency II. It is reasonable to expect insurance and reinsurance that heavily that a global standard may need to be rely on scale and diversification. less granular and allow some limited room for jurisdictions to accommodate The information collected during the ICS: the time to national market specificities. monitoring period will by and large determine the final design of the ICS. engage is now! This is why a high level of participation in the ICS development is so critical. If Europe’s IAIGs want to see one single Despite big progress risk-based ICS that reflects the well The development of the Insurance tested principles of Solvency II and Capital Standard (ICS) by the on ICS development, promotes a level playing field between International Association of Insurance strong engagement IAIGs headquartered in different parts Supervisors (IAIS) as part of its on the EU side of the world, then they must take part. comprehensive group-wide Common Indeed, the time to engage is now. Framework (ComFrame) for the remains critical. supervision of Internationally Active Insurance Groups (IAIGs) has been, since its inception, recognized as a key step for the enhancement of EIOPA strongly believes that Solvency global financial stability as well as II should become one of the practical consumer protection. implementations of the international standard. Upon finalization of the ICS, It is thus extremely important that legislators should be open to adjust our EU groups actively engage in the ICS European system if that is needed, with development, enabling the IAIS to the aim that European groups are only collect data from different European subject to a single capital regime. business models in order to ensure a proper calibration and risk sensitiveness The development by the United of the ICS that can match the reality States and other jurisdictions of an in the EU. It’s important for European Aggregation Method (AM) – not part IAIGs not yet participating in the ICS of the ICS – aspires to measure group monitoring period to understand that capital adequacy by leveraging existing it is in their own interest to participate, legal entity requirements through to secure an ICS that continues to simple adjustments and scalars. reflect the sound basic principles of Solvency II and which can truly foster EIOPA still has reservations concern- global convergence and consistency of ing whether reconciling the current supervisory practices. diversity in approaches across jurisdic- tions in such a manner can effectively Working with its membership from ensure sufficient comparability and a all over the world, the IAIS has level playing field compared to the ICS.

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and financial stability. The challenge supervision. As shown by the pandemic, for supervisors is therefore to ensure supervisors should be able to monitor a “healthy” use of technologies. A risks that, in one shot, could affect a proper understanding of these changes large part of the sector and generate and their risk implications is the first, reactions that, in turn, could impact challenging goal for supervisors. the financial system. These types of inward and outward risk call for specific IT innovation could also simplify tools. We need forward-looking tools, the relationship between firms and what-if analysis, effective cross border supervisors. During the emergency, cooperation and proper powers of supervisors took a set of measures intervention. This is key in the context to help insurers ensure business of the potential longer-term effects of continuity. We must now think the current situation. about whether and how we might permanently introduce simplification The expected persistence of low interest in the prudential framework. We should rates, the economic uncertainties avoid unjustified reporting burden and the potential materialization and reduce complexity in supervisory of increased credit risk require a processes. Here I think there is room supervisory focus that goes beyond ALBERTO for improvement in many jurisdictions. the microanalysis. Finally, yet importantly, the crisis has CORINTI highlighted a significant protection Member of the Board of Directors, gap. Households, businesses and Italian Insurance Supervisory In some way, professionals experienced a crisis that Authority (IVASS) was unique in terms of size and extent, the pandemic has and often found themselves without served as a catalyst the necessary protection. We must and has made visible now ask ourselves how the insurance industry can improve its ability to gaps that are not protect the society and contribute to Lessons learned by directly related a new phase of development in the to the crisis. post-COVID economic system. Here, insurance supervisors there is a variety of areas to focus: regulation, solutions for public-private from Covid-19 crisis cooperation, technology, insurance product range, distribution networks, This leads to another important lesson: insurance and financial education. it is essential, now more than ever, that What lessons can insurance supervisors consumers remain at the centre of the This is something that goes beyond draw from the pandemic crisis? At the business. This is not only a principle of supervision, but where supervision outset of the crisis, the main response good market conduct. It is the only way should be part of the solution. from supervisors would most likely have for companies to reinforce and stabilize focussed on the need for emergency their relationship with consumers, and crisis tools. After experiencing which is characterized by a progressive more than one year of ongoing crisis, I reduction of physical contacts, in think the response would mainly focus a context of dynamic markets with on lessons for enhancing supervision multiple players and innovative ways in normal circumstances. In some way, to design and offer products. How the pandemic has served as a catalyst supervisors will promote and enforce and has made visible gaps that are not this principle will be key. directly related to the crisis. For example, the extent of lockdowns The first area to mention is certainly has not only affected consumer’s IT innovation. The crisis has boosted behaviour, but also the “value” of the use of digital tools to design, price some insurance products (i.e. MTPL, and distribute products, with a number travel). In this context, insurers should of implications in terms of collection, assess potential unfair treatment for storage and use of data. These policyholders and take remedial actions. developments can certainly help to In Italy, some companies have lost an better satisfy consumers’ need, promote opportunity to show their attention insurance protection and streamline to consumers’ rights when making contract relationships. At the same this assessment. This is an attitude time, they could expose to risk of market that supervisors have to address, even misconduct, endangering consumer though traditional tools are sometimes protection, or to a number of risks, not effective in this regard. such as cyber, operational, legal and reputational risks, which are relatively Another area where the crisis has new for supervisors, but represent a highlighted the need for improvement potential threat to companies’ solvency is the macro-prudential dimension of

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economic buffers is in a much better help bring about consistency, and position to withstand any external improve the quality, of sustainability shocks that it may face. Resilience to reporting as opposed to developing systemic shocks, such as pandemics, new frameworks which may only lead which do not diversify, requires a to confusion and hinder the progress combined effort between the state and that’s been made. It is only by jointly insurers. Public Private Partnerships developing such frameworks, as well as (PPP) would create preparedness for pooling and sharing data and expertise, such extreme events by pre-funding the that we can move quickly in developing costs. If reinsurers provide their global more resilient economies and building view and expertise on risk, primary new insurance solutions that will close insurers tap into their local network for the protection gap. claims management and states makes use of their logistics and risk bearing The insurance industry continues to capacity, then future extreme events play an important role in society and, can be withstood much better. as such, we must ensure that it remains operationally resilient and trustworthy. The economic stimulus packages It is only by taking a global approach, released around the world play an and by making sure that we apply important role in the global recovery operational resilience frameworks that STEFANIE effort. These packages should also be take the diversity and sizes of different used to address issues such as climate businesses into account, that we can OTT change which are pertinent to the ensure that the industry continues to Head Qualitative insurance industry. For instance, funds be society’s trusted partner in times Risk Management, should go into decarbonising the of need. Swiss Re Management Ltd energy sector, building climate change resilient cities, protecting public health and to the restoration of natural assets and ecosystem services. This will help ensure that extreme weather hazards, such as hurricane related storm After Covid-19 – surges, will no longer materialize into huge property losses if we protect an even more coastal wetlands. resilient insurance sector The insurance industry coped well The ongoing pandemic is not a black with Covid-19 – swan event for insurers and regulators. but there are lessons This is thanks to the fact that the to be learned for insurance industry already considered pandemics in their risk modelling. the future Large systemic events do however unfold in unexpected ways. With Covid-19, we saw unexpected losses in the areas of business interruption The protection gap is another element and, in particular, with respect to Non- that needs to be addressed if we are to physical Damage Business Interruption make our economies more resilient. (NDBI). On the other side of the balance Insurers can take the lead in developing sheet, the uncertainties in the financial solutions and regulators can help by markets, compounded by a low interest providing the regulatory frameworks rate environment, created challenges. needed to facilitate this. Initiatives such as the Financial Stability Board’s Task This unique combination of severe Force on Climate-related Financial effects on both sides of the balance Disclosures (TCFD) complement sheet underscores the systemic impact regulatory efforts as they force of the pandemic. So, what lessons can companies to put a price tag on risks we learn from this pandemic in order that formerly did not appear on their to manage a future systemic shock balance sheet. to the insurance industry, and our economies, better? While it is currently not mandatory, there are over 1000 public and private The Covid-19 pandemic has highlighted sector organisations around the world, the fact that resilient economies need including Swiss Re, that support to be built in order to manage systemic the TCFD giving it global credence. shocks. A society that has internal Expanding the TCFD’s use would

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which requires these regulatory these needs. Firstly, they are a privileged costs to be evaluated in particular channel between the EU economy against the necessity to maintain the and the savers, whose ability to assess competitiveness and risk mitigation risk is limited. In addition, due to the role of the European sector. This is specificity of their business model, they all the more important in a context have the unique ability to invest in of interest rates set at low and even medium to long term horizons, which negative levels to address inflation match with most of the public and issues, which further inflate the private expenses envisaged. longer-term liabilities of insurance undertakings and related provisioning.

Such evaluation should lead to a renewed concertation between the sector and the EU authorities, regarding beyond the technicalities of Solvency II, on an accurate understanding of these new types of risks. JEAN-JACQUES A second and additional problem, which also questions the regulatory framework, will arise as soon as the end BONNAUD of the Covid19 pandemic will allow for EUROFI an economic recovery. In this context, worldwide, the States as well as the private sector are projecting to spend enormous amounts of money, which will raise a financing problem. Preserving social and These expenses are crucial in particular economic roles of the in the EU, to relaunch the economy and address beyond those already planned Insurance sector in before the pandemic, the long-term investment in infrastructures of all the post pandemic kinds, e.g., pharmaceutical, , new materials, digitalisation, world telecoms, … necessary to speed-up to the much-needed green transition and the enhancement of innovation capabilities. The Insurance sector will be confronted with two sorts of challenges in the present and next future.

Firstly, one has to mention the chal- The Insurance sector lenges presented by the immense en- vironmental transformations triggered will be confronted by climate and the sustainability stress- with two sorts of es, which produce a growing magnitude challenges in the and frequency of natural catastrophes such as floods, hurricanes, big urban present and next fires and wildfires, destruction of crops. future. Not mentioning the possible costs of covering the negative consequences of the sanitary constraints imposed by States on the earnings of firms, when- Should there not be any increase of ever they are not entirely addressed interest rates, it would be even more by state subsidies, these sustainability essential to provide the insurance stresses will imply massive and unex- sector with a regulatory framework pected expense increases within the enabling it to further channel the insurance and reinsurance sectors. It individual’s savings towards long-term is clear that regulatory costs will also equity investments of listed or non- be faced by the European insurance listed companies, well beyond the mere sector. They are due to the unexpected sovereigns and corporate borrowings, increase of these risks and will come in the financing of which will be further addition to the rising burden of oper- indirectly supported by ECB non- ating costs. conventional monetary policy.

This is no doubt that cost efficiency Indeed, insurance companies are is thus essential for the sector, essential for addressing the financing of

126 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net FOLLOWING EUROFI EVENT

THE EUROFI HIGH LEVEL SEMINAR 2022

PARIS – FRANCE 23, 24 & 25 FEBRUARY 2022 5

FUTURE STEPS OF THE CMU

ISSUES AT STAKE

CMU is crucial for the EU with the increased funding needed for supporting the post-Covid recovery, the EU Green Deal and digital transformation The new CMU action plan published in September 2020 completes the previous ones with additional actions for making capital market financing more accessible to EU companies in particular SMEs and a stronger focus than previous plans on increasing retail participation and further integrating EU capital markets.

The Ecofin council has since prioritized these objectives, emphasizing in particular the first one, for which legislative proposals – concerning notably the simplification of listing rules, the setting up of a European Single Access Point for corporate information and the review of the ELTIF and securitisation frameworks and of prudential requirements – are due to be delivered by the Commission by the end of 2021.

The CMU project however faces two types of challenges. Firstly, implementation challenges, due to the breadth of the project and the urgency of its implementation, which are not easily compatible with the usual timing of European legislative processes. Secondly, challenges related to the post-Covid macro-economic and monetary context that tends to favour debt financing and liquidity hoarding. NEW CMU ACTION PLAN...... 130

Rodrigo Buenaventura - Spanish Securities and Exchange Commission / João Nuno Mendes - Ministry of Finance, Portugal / Laura Van Geest - Dutch Authority for the Financial Markets / Thomas Book - Deutsche Börse Group / Bernard Spalt - Erste Group Bank AG / Rimantas Šadžius - European Court of Auditors / - European Parliament

AIFMD AND ELTIF REVIEWS...... 138

Gabriela Figueiredo Dias - Portuguese Securities Market Commission / Ugo Bassi - European Commission / Natasha Cazenave - Autorité des Marchés Financiers / Laurent Van Burik - Commission de Surveillance du Secteur Financier / Verena Ross - European Securities and Markets Authority / Thomas Schindler - Allianz Global Investors GmbH / Christian Edelmann - Oliver Wyman (UK)

RETAIL INVESTMENT...... 144

Maria Luis Albuquerque / Guillaume Prache - Better Finance / Ante Žigman - Croatian Financial Services Supervisory Agency / Stéphanie Yon-Courtin - European Parliament / Christian Staub - Fidelity International / Fausto Parente - European Insurance and Occupational Pensions Authority / Simon Janin - Amundi

EQUITY FUNDING...... 150

Mario Nava - European Commission / Elke Kallenbach - Federal Ministry of Finance, Germany / Sebastien Raspiller - Ministry of the Economy, Finance and the Recovery Plan, France / Jesús González Nieto-Márquez - BME

SECURITIES AND DERIVATIVES CLEARING...... 154

Klaus Löber - European Securities and Markets Authority / Jochen Metzger - / Nathalie Aufauvre - Banque de France / Daniel Maguire - LCH Group and LSEG / Haroun Boucheta - BNP Paribas Securities Services

SECURITIES POST-TRADING...... 158

Jochen Metzger - Deutsche Bundesbank / Niels Brab - Deutsche Börse Group / Guillaume Eliet - Euroclear S.A. / Swen Werner - State Street Bank and Trust / Alex Dockx - JPMorgan / Francisco Béjar - Iberclear / Hélder Rosalino - Banco de Portugal

CONSOLIDATED TAPE AND SINGLE ACCESS POINT...... 164

Hanzo van Beuzekom - Dutch Authority for the Financial Markets / Verena Ross - European Securities and Markets Authority / Natasha Cazenave - Autorité des Marchés Financiers / Stephen Berger - Citadel / Nicholas Bean - Bloomberg / Daniel Mayston - BlackRock / Nicolas Rivard - Euronext

RELAUNCHING SECURITIZATION...... 170

Dominique Laboureix - Autorité de Contrôle Prudentiel et de Résolution / Fausto Parente - European Insurance and Occupational Pensions Authority / Paulina Dejmek Hack - European Commission / Nathalie Esnault - Crédit Agricole CIB / Alexander Batchvarov - Bank of America FUTURE STEPS OF THE CMU

NEW CMU ACTION PLAN

we should be extremely careful when and keep confidence in primary and combining them, especially if at the secondary markets. same time we promote a lowering of disclosure requirements by issuers. Capital markets have withstood the Those three ingredients could be COVID crisis remarkably well and a dangerous combination for the the extreme volatility we observed following reasons. Firstly, the retail end in March-April 2020. Although IPOs of the spectrum may lack the training were quite scarce in 2020, we have and experience needed to assess SMEs. seen a clear surge in 2021. But even Secondly, research coverage is very thin during the direst times, companies that for the SME part of the listed companies. were already listed and that required Thirdly, SMEs are frequently subject financing found relevant demand at fair to higher volatility and default rates, prices in EU equity and fixed income making them the riskiest part (also markets. Some Spanish companies, the most promising sometimes) of the for instance, led the biggest secondary investment spectrum. The ingredients equity offerings in 2020 and being for mis-selling, losses and possibly a already listed made a real difference for withdrawal of confidence in equity them compared to what would have markets from retail investors would be been the case as a non-listed company. served if we stimulated both processes The depth shown by EU capital markets RODRIGO at the same time. was truly remarkable in that sense.

BUENAVENTURA It is obvious that we need to bring more Chair, Spanish Securities and companies to the listed world, from Exchange Commission (CNMV) all sides of the spectrum: large and small, traditional and innovative. To Collective do that, lowering costs and reducing the time required to access the market investment key is appropriate, but when doing so we Towards CMU: for diversification should not lower investor protection. and risk reduction The key for strong and stable capital how to incorporate markets is long-term trust from in a retail-oriented investors as well as the development, safely a more CMU. improvement and refinement of an appropriate financial education retail-oriented market that allows, to all investors, a better understanding of risk in the investment decision making. I genuinely think that the only CMU is an essential component intelligent way of promoting at the to achieve deeper markets, better same time the new flow of SMEs and an investment choices and healthier increased retailisation of the buy side financing by companies. It acquires is to promote retail investors accessing even more relevance in pandemic this new market through collective times, as we have seen how important investment. Collective investment for companies is to have enough equity schemes run by professional managers and for investors to have diversified provides both diversification, which portfolios across different Member is key when we talk about SMEs, and States. But we have also seen, thanks research capabilities that are absent in to Brexit, how relevant is to have that niche, hence reducing risks and diversification on financial centers. A increasing return for retail investors. polycentric financial marketplace is Actually, these types of vehicles could not only more competitive but also even be incentivised from a policy more robust. This is compatible with perspective vis-a-vis direct investment a polycentric financial supervision, in single SME stocks. bound together by tighter coordination mechanisms and a stronger ESMA. Collective investment schemes could also professionalise SMEs through their One aspect that merits attention is the role of stewardship, which is becoming coincidence of new entrants into the more popular in the area of sustainable markets in the SME spectrum and the finance. Nevertheless, the role of Asset increased participation of the retail managers in SMEs markets should investors. While these two trends, taken be closely monitored by supervisors individually, are worth supporting, to avoid any market abuse situation

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Financial institutions played a crucial conjunction with the work in other role, and although the European areas, such as the implementation of the financial sector has entered the Next Generation EU Recovery Fund, crisis better prepared, the risk of the Banking Union, the Digital Finance contagion from the real economy to Strategy and Sustainable Finance. the financial system, namely through non-performing loans, must be For example, the Portuguese Presidency acknowledged and addressed. is committed to making progress on the Regulation of Markets in Crypto- Financing the recovery is a pivotal assets (MiCA) and the comprehensive challenge going forward and a “true framework on digital operational Capital Markets Union is key to an resilience for EU financial entities efficient and robust European financial (DORA), which also contribute to the architecture”1. Moreover, the CMU is CMU. The implementation of the also key for a stronger international Capital Requirements Regulation/ role of the euro. Directives review, allowing to phase- in the reforms in such a way that the Capital markets have an increasing role critical role of banks in supporting the to play in accelerating the recovery and recovery is not hampered and, also, the green and digital transformation, encouraging more long term and equity JOÃO NUNO complementing bank financing, and financing to SMEs. mobilizing additional capital for MENDES investment and recapitalisation of The Commission’s proposal on the EU State Secretary, EU corporates. Green Bond Standard should contribute Ministry of Finance, Portugal to promote the development of the The Portuguese Presidency welcomes market and consolidate the role of the the European Commission´s new EU in green financing. We see great Capital Markets Union (CMU) Action opportunity to expand the existing Plan and the Council Conclusions capital markets products toolkit to Capital Markets adopted in December, which we better suit the recapitalisation needs consider to be very comprehensive. In of European corporates which have Union: supporting this regard, the awaited KPI on CMU seen their equity base eroded due to the will be important to measure progress COVID-crisis. recovery and the in implementation. We have mentioned the role of green and digital securitization, but we also see with great promise the progress in the transitions development of hybrid solutions Capital markets have in some EU countries and see the potential to share knowledge and best a growing role to practices in this regard. The motto of the Portuguese play in the recovery Presidency - “This is the time to deliver: and green and digital a fair, green and digital recovery” - encapsulates the unique challenges at transition, mobilizing this juncture in time: i) the absolute additional funds to priority to relaunch the economy and recapitalise EU firms. the recovery; ii) the sense of urgency, at EU-level, of the implementation of the Recovery and Resilience Facility (and the approval of national recovery and resilience plans) and iii) the unique We have been supportive of advancing opportunity to ensure a green and actions that improve market access digital transition. conditions for smaller firms, supporting them in recovering from the aftermath The response to the Covid-19 pandemic of the Covid-19 crisis and diversifying saw an unprecedented scale of public their funding sources. In this regard, support to businesses and employment, we would highlight the importance of a combination of liquidity measures strengthening the role of securitisation and working capital support that has in providing additional financing to the helped European businesses weather real economy. the crisis. We also look forward to the Commis- Financial stability and resilience must sion´s proposal on the Single Access be monitored closely. The phasing out Point which, in our view, has great poten- of public loan guarantee schemes and tial in improving accessibility of relevant moratoria on loan obligations must be information on European companies. timed carefully, mitigating the short- term risks for the economy and the The progress in the implementation banking sector. of the CMU must also be seen in 1. Euro Summit meeting (11 December 2020) – Statement

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investors in EU capital markets. not always able and in the position EU investors’ overall participation to effectively supervise individually. in capital markets is relatively low. Therefore, for a well-integrated and However, the demographic changes functioning CMU it is key that ESMA (ageing population) across the Union and the national authorities further require larger retail participation. At build on the work currently undertaken the same time, retail participation in their efforts to collectively address increases the opportunities for SME cross-border risks. funding. The AFM believes that efforts should be made to further increase the However, convergence also has level of investor protection. In order to its limitations, it will not make enable the retail investor to enter into full use of the potential efficiency cross-border transactions, they should and effectiveness gains, nor does be able to expect similar high quality it eliminate the risk of regulatory supervisory outcomes across the EU. arbitrage. The ultimate convergence is centralization of direct supervision. We Larger retail participation must go believe there is a strong case to be made hand in hand with improved investor to centralize supervision on markets protection. We hope that the upcoming that are cross-border by nature, where Retail Investment Strategy by the EC the risks are cross-border related, rules LAURA acknowledges this need and aspires to are harmonized, and we see a risk of raise the bar for investor protection. As regulatory arbitrage. This would in our VAN GEEST a market conduct supervisor, we will view logically lead to centralization Chair of the Board, also look with a bit more caution to of certain supervisory tasks at the Dutch Authority for proposals that might even jeopardize wholesale side of the capital markets. the Financial Markets (AFM) investor protection, such as introducing a new category of qualified investors, To sum up: For EU markets to function or to proposals to soften for instance effectively, high quality supervisory listing requirements for SMEs. outcomes are required. Regardless as to whether the supervised entity (firm/business) is primarly offering Working towards high services on a local or cross-border basis. Supervision should therefore be quality supervisory For EU markets to organised accordingly. outcomes across the EU function properly, For EU markets to function properly, the geometry of the geometry of supervision should supervision should follow the geometry of the business. The AFM fully supports the objectives follow the geometry of of the CMU and encourages the EC the business. in its efforts to further strengthen the CMU by striving for liquid, transparent and accessible EU capital markets. A healthy financial system breathes with two lungs: 1. a robust banking system, In order to effectively supervise cross- and 2. resilient and diversified capital border retail financial services, we markets. It is key for the EU to keep believe that specific attention must be working on stronger integrated capital paid to issues related to the current markets in order to avoid over-reliance passporting regimes. The AFM on the banking system. The AFM encourages the EC to analyse both encourages the regulatory efforts taken the positive and negative aspects of so far. However, Europe’s financial the current passporting system and system is still very much dependent the supervisory challenges thereof in on banks and the strong home-bias in order to look for solutions that will bond and equity markets indicate that empower NCAs to effectively protect markets are not yet fully integrated. investors domestically. While being a cornerstone of the single market, the Overall, we believe that the current system – with ‘home’ and ‘host’ Commission is focusing on the right responsibilities - imperils the effective topics in its current CMU action plan. protection of investors that are engaged We especially endorse proposals that in cross-border transactions. lead to central solutions for EU wide problems. Such as proposals concerning We can also fully support any further a European Single Access Point or a work to strengthen supervisory consolidated tape. convergence, or even further centralization of certain supervisory Furthermore, there is still a significant tasks. We believe that cross-border need as well as high potential for problems require cross-border increased participation of retail solutions. Individual supervisors are

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make the EU a key player in the global 2. To support long-term and sustaina- financial arena by building synergies ble growth, it is essential to contin- between existing areas of reform and ue strengthening the EU’s resilience taking leadership in new strategic and financial stability and reducing growth areas. our overreliance on offshore mar- kets. Achieving our “Euroclearing” This includes redefining our financial objectives must be a priority, as well services landscape by linking the as securing the Euro Area’s well-func- eurozone and CMU reforms to the tioning and liquid exchange-traded strategic objectives of the international derivatives (ETDs) market. The man- role of the euro initiative. To this end, datory “open access” rules for ETDs we need a fit for purpose regulatory run counter to these objectives, put framework that supports our markets financial stability at risk and should and strengthens the resilience and be revisited, also in light of the fact competitiveness of the EU’s financial that no other jurisdiction is apply- market infrastructures (FMIs). As ing them. And we need to consist- Executive Vice-President Dombrovskis ently and systematically build up eu- and Commissioner McGuinness ro-denominated markets to reduce put it: We need to “reinforce the EU the dependencies and reliance on THOMAS infrastructure that underpins our third countries. financial system”. 3. Finally, the EU should continue to take global leadership in new strategic BOOK Against this background, the European growth areas such as sustainability. Member of the Executive Board, Commission’s strategy to promote the The EU can be the global leader Deutsche Börse Group “openness, strength and resilience” of in this sphere, set the standards, EU financial markets is a vital step in the be competitive while having a role right direction to complete the CMU model function and defending our agenda. It highlights the importance core values. Other jurisdictions start of EU FMIs, as well as key EU markets, following us on this path, we can be The EU as a key to strengthen our financing capacity bold and ambitious. and stability. player in financial Let’s embrace this broader perspective of openness, strength and resilience markets – not the across the board – bring a balance into the relationship of the size of our real playing field The time has come economy and our population with our financial industry – and make the EU to strategically and its capital markets global leaders make the EU a key that deliver in the societal interest to This year’s Eurofi Forum in Lisbon player in the global provide for a sustainable outlook for comes at a historical moment for our future generations! financial markets. The EU is facing a financial arena. critical juncture: we urgently need to finance our recovery plans from the Covid-19 crisis, as well as drive the green and digital transformation at full In this sense, three aspects are speed. The unprecedented pressure on paramount: public finances and bank balance sheets makes it indispensable to foster deep 1. You cannot have a CMU, deal with the and thriving capital markets to finance impact of Brexit and ensure a sustainable these ambitions. recovery from the COVID-19 crisis without functioning, deep and liquid However, key metrics show that EU secondary capital markets that allow capital markets are still significantly for a robust price discovery process less developed than in other leading and efficient capital allocation. ESMA’s jurisdictions. In 2020, looking at recent market structure report reveals primary markets, there were 1,415 IPOs, very high fragmentation (more than of which 60% happened in the US and 250 venues; versus 60 in the US) and China. Only 7% took place in the EU. overall low levels of transparency since Similarly, if we look at the ratio of the introduction of MiFID II. More market capitalization to GDP, the US than 50% of the volume is still traded is at 148% while the EU lags behind off regulated exchanges.1 Paired with at 53%. recent developments, such as the significant rise of payment for order The EU has sent a strong signal of unity flow schemes, it is therefore critical with the EU Recovery Package. And the to simplify the EU equity market rapid implementation of the new CMU structures and effectively limit “dark Action Plan is critical to support the trading” to increase transparency EU’s efforts going forward. However, and general measurability for 1. ESMA, Annual Statistical Report on Securities Markets the time has come to strategically end-investors. 2019, November 2020.

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to economic recovery. In our initial regulation, the promotion of referrals assessment we found that the CMU for SME to market-based financing action plan covers four areas that are options as well as the review of the of strategic importance for the further securitization framework. integration and development of EU capital markets. These are measures: Apart from these initiatives there is also a lot the private sector can do. • to incentivize retail investment (e.g. Erste Group has for instance started an through adjustments of MiFID rules equity initiative for SMEs more than on advice); 10 years ago and we recently further • to promote equity investments (e.g. increased our efforts in this area. From through reduced capital requirements); a practical point of view, creating a legal • to foster financial literacy and, framework throughout the EU, which • to improve protection of intra-EU enables such initiatives even further investments. and also strengthens retail investments is of key importance. Here we see a need Without a doubt, all of those measures on the EU level to spread best practices are important as they will contribute across member states. to an overall strengthening of Europe’s BERNARD capital markets. While the CMU The situation is even more pressing action plan is a comprehensive plan as the pandemic has triggered a large addressing both short-term and mid- increase of private savings, which could SPALT term targets, we must realize that the partially be used by retail investors to Chief Executive Officer, economic pressure stemming from the contribute to and participate in the Erste Group Bank AG pandemic is tremendous and that there economic recovery within the EU. is an obvious need to prioritize. Generating growth for Europe’s post-Covid-19 economy depends on substantially stronger market financing Capital markets and higher levels of equity, especially Generating growth for for our SMEs. The CMU action plan and the pandemic: Europe’s post-Covid-19 is an adequate tool to contribute to achieve this but needs to be followed by economy depends on the new CMU action bold political decisions on all levels. higher levels of equity, plan in light of the especially for Ultimately, better capitalized SMEs and a more integrated capital market post-Covid recovery our SMEs will help to advance what Europe really needs to become more crisis- proof: ambitious digitalization and sustainability agendas. As we try to grasp the massive economic We consider measures to improve effects of the Covid-19 pandemic, we the equity base of SMEs particularly must realize that a crisis is not only a important – not without reason are destructive force, but also a chance they often referred to as the “backbone” to reconstruct. Developing the EU’s of the EU economy. Almost 60 percent capital markets, and ensuring access of the continent’s GDP and 70 percent to market financing, will be essential of the jobs depend on this sector. In in this respect. We are convinced that smaller countries these ratios can be better-capitalized companies and a even higher. Most of the SMEs are vibrant capital market are two of the not publicly listed and heavily rely on most essential ingredients to rebuild bank financing. Just as during past Europe’s economy. crises, slumping revenues during the pandemic have eaten into these The second CMU action plan has its companies’ capital, limiting their focus on three pillars: ability to borrow and take risks, which ultimately hampers investment in new 1) support of green, digital, inclusive business areas such as green technology. and resilient economic recovery by making financing more accessible to Having the post-COVID business European companies; environment in mind, we must think 2) make the EU a safer place for of possibilities to strengthen the equity individuals to save and invest long- base of SME. Such possibilities are term; partly reflected in the points mentioned 3) to integrate national capital markets above, but also in other areas of the into a genuine single market. action plan such as the idea of a European Single Access Point (ESAP), With all of these angles Erste Group simplified access to public markets can highly associate and we do believe for SME, the review of European they cover key elements of the path Long Term Investment Fund (ELTIF)

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We observed that large discrepancies regional capital markets and businesses between Member States persist in the seeking market financing. size of the SMEs’ financing gap and the availability of funding sources. Access We recommend that the Commission to capital markets remains expensive use more actively all available tools, and burdensome, especially for SMEs. such as technical support and The so-called ‘debt-equity bias’ is a country-specific recommendations, disincentive for the development and to incentivize and help build financial integration of capital markets. Other ecosystems across Europe, not relying issues, such as a lack of harmonized solely on national initiatives or demand. insolvency proceedings and the general The coordinated creation recently of diversity of company law across the the legal framework for covered bonds EU, are well known. The Commission’s simultaneously in three Baltic States is new 2020 action plan strives to address one example. many of the issues identified. Another necessary action to address Certain actions, such as simplification key cross-border barriers to investment of listing rules for public markets, is the reinforcement of financial can contribute to more market literacy specifically among SMEs, funding and private risk sharing, if primarily start-ups that are looking RIMANTAS implemented well. A simplified system for ways to fund their not always of providing relief from withholding “bankable” ideas. Although this mainly ŠADŽIUS tax, as recommended by the ECA, could falls under the remit of Member States, Member, European Court of Auditors also bring significant improvements. the Commission can still play a critical However, without political dedication supporting role via existing European in building a truly European capital programmes and by promoting market and further measures to tackle best practices. key cross-border barriers, it will be A way forward for difficult to deliver added value for The ECA will continue to report on the EU businesses and investors. Hence, EU’s progress towards a single market EU capital markets – support and joint decisions by Member for capital. We have recently started States is required, which so far have an audit to assess whether EU actions the auditors’ view proved to be problematic. helped to develop an effective single market for investment funds to benefit consumers and businesses, while ensuring financial stability. As the Union’s independent external auditor, the European Court of Fostering efficient Auditors (ECA), not only assesses implementation of the EU budget, but local capital also the performance of EU institutions markets will be and bodies in reaching their objectives. key for building a Among others, we evaluate actions of the European Commission, the genuine CMU. European Supervisory Authorities, the European Central Bank as a banking supervisor and the Single Resolution Board. The ECA has been publishing Fostering efficient local capital markets reports on the EU’s financial and will be key for building a genuine economic governance since 2014. One CMU. Indeed, capital markets in of our recent reports deals with the Europe remain highly concentrated Commission’s work on the development and strikingly heterogeneous among of EU capital markets and building the Member States. Thus, the first step Capital Markets Union (CMU). would be to render local capital markets deeper, more liquid and better aligned In this report, titled “CMU – Slow with regional counterparts. This will start towards an ambitious goal”, we require willingness, comprehension, concluded that the Commission has substantive efforts and delivering real indeed pursued a number of legislative structural reforms. initiatives and other measures to implement its 2015 CMU action plan, To tackle the needs of Member States, yet no catalytic effect was observed. in particular with less developed capital Many of the measures that the markets, action at both, national and Commission was able to take within EU-level, is required. We recommend its remit only addressed narrow areas to establish a comprehensive EU-wide in the pursuit of the CMU objectives. strategy bringing together all relevant So far, they did not lead to the highly public sector actors, such as EU and anticipated structural shift from bank Member State authorities as well as to more market funding for businesses promotional banks, in order to identify in general, and SMEs in particular. and address the needs of local and

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capital market in Europe, leaving pragmatic approach might finally take the EU has dealt another blow to shape. The upcoming reviews of MiFID the EU’s attractiveness as a financial II and Solvency II as well as the Basel centre. In the absence of equivalence III implementation package can be the decisions, the European Union has cut first litmus test if the Council actually itself and its businesses off from an means business in relation to a more attractive financing hub - at least for ambitious approach to the CMU. It the foreseeable future. In this sense, would definitely be time. Brexit highlights that the Capital Markets Union project is needed more than ever.

The general recipe is clear and the most recent Capital Markets Union action plan presented by the European Commission in September 2020 contains many of the right ingredients. Improving cross-border access to company information, facilitating access to public markets for small MARKUS and medium sized companies and retail investors alike, making long- FERBER term investments more attractive and MEP, Committee on Economic reducing uncertainty in relation to and Monetary Affairs, cross-border investments through tax European Parliament and insolvency harmonisation are no- brainers in theory.

Capital Markets What is more Union: needed than ever is not yet another fewer action plans, rehash of the same more action! ideas in a new action plan, but meaningful execution. Improving European capital markets has been a long-standing goal of the European Commission and the European legislator. Even before this However, a lack of progress on the CMU policy objective has been officially is not attributable to a lack of good christened “Capital Markets Union”, ideas, but to a lack of execution. Many the idea was very much part of the EU’s of the core ideas in the most recent financial services agenda. Capital Markets Union action plan are old friends from previous iterations. Yet, progress has been frustratingly slow. If you look at metrics such as stock What is more needed than ever is not market capitalisation as percentage yet another rehash of the same ideas of GDP, the European Union lacks far in a new action plan, but meaningful behind countries such as the US and the execution of those ideas. Unfortunately, UK and even many Asian jurisdictions many of the sensible ideas, the such as Japan, Hong Kong or Singapore. Commission and the European Parliament have been consistently At the same time, the European Union’s calling for have been frustratingly hard corporate financing model remains to implement in practice, often due to heavily skewed towards bank financing fundamental resistance by the Council while many European retail investors that stubbornly refuses to touch keep having fundamental reservations delicate subjects such as insolvency law against equity investments despite and taxation. fewer and fewer attractive investment alternatives in times of ultra-low Brexit can be the wake-up call that interest rates and bond yields. is needed. The Council’s “Next CMU” working group that came up The United Kingdom, arguably the with a few very sensible proposals most liquid and most highly developed is an encouraging sign that a more

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EUROFI POLICY NOTES

PUBLIC AND PRIVATE SECTOR VIEWS FUTURE STEPS OF THE CMU

AIFMD AND ELTIF REVIEWS

Brexit, digitalization and ESG, togeth- investors’ perspectives, particularly in er with the CMU Action Plan, impose the areas of reporting, delegation, risk policy and regulatory updated respons- management, supervision coordination es making the right tools available to and convergence and proportionality. achieve the intended results and re- The new framework must make AIFs quiring measures and contributions of resilient to other crises and avoid varied nature, sectors and wills. them spreading or amplifying risks throughout the financial system. The asset management sector surely plays a critical role in this process. But above all, we need an efficient and coordinated supervisory response, The new CMU plan includes an in order to ensure proper risk innovative proposal that could evolve management and avoid future crises to banks directing SMEs to providers of that would be detrimental to investors’ alternative funding. Although posing interests, for the funds’ industry and relevant challenges, bridging banking the society in general. This concern is and non-banking financing should be also extensive to UCITs and particularly incentivized, as it creates awareness and to MMFs. Regulatory changes need to opportunities to a wider financing market, be complemented by harmonised and with benefits for all parties. For countries effective supervision to foster more GABRIELA with lower levels of financial literacy and investment and sustainable growth. high levels of corporate indebtedness this This also requires asset managers, FIGUEIREDO could be particularly beneficial, allowing investment advisers and distributors smaller companies to get more visibility understanding investors’ needs and DIAS on alternative equity funding. risk profiles and offering transparent, President, Portuguese Securities comparable and suitably designed Market Commission (CMVM) and marketed products, that offer the expected returns.

Funds need Taken together, the envisaged enhancements should indeed increase flexible solutions, investment, return and trust in the asset ELTIF and AIFMD while granting proper management sector, offering a relevant protection to investors contribution to our desired Union. reviews: the challenge Building the CMU is an ambitious, yet and financial stability. not an easy goal to achieve. But capital to meet investors’ markets and asset management cannot ignore the call to participate in the needs European economic recovery. The European long-term investment funds (ELTIFs) and Alternative A consistent, persistent and cohesive Investment Fund Managers Directive contribution from EU 27 asset The 2015 Action Plan on Building a (AIFMD) reviews, among other management to the new CMU is Capital Markets Union was aimed at measures, should become important critical to returning to long-term strengthening the link between savings pieces of this project. But in both cases, growth, to finance the green and digital and growth, with the ultimate goal of the major challenge is to ensure that transition and to a more inclusive and promoting a truly single capital market the revised frameworks provide flexible resilient society. across the EU. The results, however, fell solutions for investors and businesses, short of expectations, making it crucial while ensuring adequate protection for that we get the new CMU action plan retail investors and financial stability. on track, decisively focusing on a “CMU for people and businesses”. The revised ELTIFs regime should de- sign these funds as a true alternative for Efficient, stable and participated capital both retail and professional investors, markets provide more options and to accelerate their uptake by investors better returns for savers and investors and channel long-term financing to and offer businesses additional funding companies and infrastructure projects, choices. This will be decisive for the in particular those contributing to the competitiveness of the EU 27 block and objective of smart, sustainable and in- our strategic global agenda. clusive growth.

But the context and the market itself Despite a strong consensus around its have been through rapid and deep success, the AIFMD requires reflection transformations. The pandemic crisis, both on the macroprudential and the

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generally functioning as intended but to the marketing and distribution that it could benefit from some targeted of ELTIFs to retail investors while improvements and clarifications to improving the attractiveness and improve its implementation and usability of the ELTIF regime for efficiency of operation. the professional investors. These potential amendments need to be In terms of the feedback to the public assessed in the broader context of the consultation some early issues have risk-benefit analysis of increased retail been identified that will be subject to investor participation, higher uptake further analysis including the lack of in ELTIFs and applicable investor- a depositary passport, the availability protection safeguards; and use of liquidity management tools, • Broadening the scope of eligible reviewing data reporting requirements, investment assets and strategies to the differential treatment of custodians include structures such as fund of of AIF assets and the fragmented funds or other indirect investments market for loan originating funds. that support the ELTIF label and its objective of long-term sustainable At the same time, we must bear in mind growth; that the AIFMD is still a relatively new • Reviewing the portfolio composition, framework, particularly compared to diversification requirements and the UGO BASSI UCITS. While ensuring adequate levels concentration limits in a manner that Director, Financial Markets, of investor protection will remain our would introduce more flexibility for DG for Financial Stability, key priority, we must also support the managers and provide appropriate Financial Services and Capital further development of the EU AIF diversification; Markets Union, market and provide investors with • Amending the redemption policies European Commission access to a wide range of investment and the frequency, liquidity opportunities while ensuring a level management tools and life cycle of playing field for EU managers and their ELTIFs in a manner that does not overall competitiveness. compromise the integrity of the funds, protects the interests of the investors and facilitates the execution Asset Management: of the investment strategies pursued by the managers. a year of review 2021 is a These policy considerations mainly significant year pursue the twofold objective of for the EU asset promoting the ELTIF market by The year 2021 is a significant year for management sector. broadening access to these investments the EU asset management sector as and facilitating a broader range of the European Commission prepares its investment strategies while ensuring proposals on the reviews of the AIFMD the necessary levels of investor and the ELTIF frameworks. While protection. this work is still ongoing, a number The ELTIF Review of policy areas have been identified The Commission is aiming for Q4 from the public consultations aimed Since the introduction of the ELTIF 2021 to submit its AIFMD and ELTIF at further facilitating EU AIF market framework, the uptake of the ELTIFs proposals to the co-legislators. integration and enhancing prudential has remained relatively modest. Only tools where necessary while supporting four Member States have domestic the overall achievement of the Capital ELTIFs with only 28 funds launched to Markets Union. date and the total asset base remains below EUR 2 billion. The AIFMD Review Based on the High-Level Forum Since its adoption almost a decade on the CMU report of 2020 and ago, the AIFMD has contributed to stakeholder feedback to the ELTIF the development of the Single Market public consultation the Commission for Alternative Investment Funds, services have undertaken a focused established an effective supervisory review of the ELTIF framework. regime, improved transparency for The aim is to introduce targeted investors and regulators, the monitoring improvements to the ELTIF regime of market developments and has set out given its potential to play an important new tools for market oversight. role in providing capital investment to the real economy and supporting In June 2020, the Commission long-term sustainable economic published a report for the EU co- development. While the review is still legislators on the functioning of the ongoing, the following policy themes AIFMD, providing an assessment of the are particularly noteworthy: experience of industry and regulators in applying the AIFMD. The report • Reducing barriers to investments concluded that the framework was and finding a balanced approach

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framework is in place. Yet, striking policy – which need to be carefully a balance between retail access and assessed and calibrated. retail protection is not an easy task. Alternative investment funds (AIFs) According to IOSCO’s 2018 differ considerably in nature, risk profile, recommendations on liquidity and authorisation and regulatory management, funds should offer a requirements, thus making the creation redemption policy consistent with the of an EU one-size-fits-all regime for liquidity profile of their underlying retail AIFs hazardous. Instead, the AMF assets to avoid the so-called liquidity considers that the ELTIF is the right mismatch. Another challenge to vehicle to foster retail participation consider is the difficulty of valuing in AIFs. non-listed assets in the absence of a secondary market that supports the The forthcoming review is the price discovery process. NATASHA opportunity to consider broadening the scope of the eligible portfolio assets for In order to address such risks and CAZENAVE such funds and recalibrating some of adequately protect investors, the AMF the features of the current framework advocates for ELTIFs to offer certain Managing Director, in order to make it more attractive and features and safeguards when they Head of Policy and facilitate the access of retail investors to target retail investors. Importantly, International Affairs, private markets. their closed-ended nature should be Autorité des Marchés Financiers maintained. Nevertheless, to take into (AMF) account the fact that retail investors AMF advocates may need to access their savings before for ELTIFs to offer an ELTIF reaches maturity, liquidity certain features and could be organised through the Revamp ELTIF to safeguards when they development of a secondary market target retail investors. for example. Another possibility would direct more long-term be to foresee occasional and limited liquidity windows. In any event, financing towards At a time of an unprecedented pandemic the distribution of ELTIFs to retail crisis, the ELTIF review may bring many investors should be conditional on the European companies? benefits to the overall EU economy: performance of suitability assessments investors would gain from a more and the provision of investment advice. diversified pool of assets with potentially The persistence of low interest rates higher returns and savings could be Investing in non-liquid assets demands and the necessity to finance a quick channelled more efficiently towards the a long-term investment horizon, certain economic recovery has reignited the financing of non-listed companies and risk tolerance and capacity to bear losses debate around the ability for retail small and medium enterprises. that not all retail investors are able to investors to access riskier investments withstand. This is a major difference than those currently offered through Nevertheless, apart from the inherent with most UCITS funds available to UCITS funds. investment risk from investing in retail investors. It is essential that retail non-listed or small businesses, ELTIFs investors understand this distinction The AMF supports the democratisation display certain characteristics – namely in order to adjust their investment of investments in private markets, the intrinsic illiquidity of their portfolio expectations, accordingly. provided that a sufficiently protective assets and their restricted redemption

primary purpose is hence to introduce Delegation rules legislative proposals designed to tackle hurdles for completing the Single under the AIFMD: Market for AIFs, with an emphasis on the experience acquired in applying the need for clarification, AIFM, its impact on investors, AIFs and adjustment or AIFMs. complete revamp The AIFMD seeks to achieve a coherent approach of supervisory authorities based on the to the risks of the financial system, to provide a high-level investor protection supervisory experience and also to facilitate AIFM market integration. The current AIFMD of national regulators? provides for rules on delegation, LAURENT further specified by Article 82 of its Delegated Regulation 2013/231. This VAN BURIK The review of the AIFMD, enshrined article includes a series of parameters Head of Division of Legal and in the Directive itself aims to complete for the delegation of AIFM functions to International, Commission de the work of the CMU, of which the third-parties, including provisions on Surveillance du Secteur Financier (CSSF) AIFMD is one of the founding pillars. Its when the AIFM would be considered to

140 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net AIFMD AND ELTIF REVIEWS be a “letter-box” entity. This regime was functions or to the current delegation the AIFMD rules rather than problems further complemented by a July 2017 regime. Further, an ESMA “Supervisory in relation to the AIFMD delegation non-binding ESMA Brexit Opinion in Coordination Network” has operated regime itself. the area of investment management. between 2017-20 where all EU NCAs had been requested to present Brexit If nevertheless the view is taken that This opinion focuses on technical related cases of fund managers and substance should be given to the aspects of delegation arrangements MiFID firms, focusing on delegation existing AIFMD delegation rules, those such as the due diligence to be applied and substance aspects. could cover specific aspects of the by an IFM (e.g. operational risk existing framework such as provisions management policies and procedures), on the control of the delegates, the a focus on supervisory aspects as well Experience of NCAs requirement for a specific delegation as clarifications on the substance in applying the policy addressing specifically initial and requirements (human and technical AIFMD has not on-going controls (e.g. on the basis of resources) as well as expertise on the evidenced specific the EBA guidelines on outsourcing). selection of potential delegates and the deficiencies in the effective monitoring of those. Further controlling measures could current rules that would include an ongoing review of the Considering the purpose of the AIFMD require or justify a organizational set-up of the delegate as and the aim of the review of the AIFMD, complete revamp. well as other aspects in accordance with the experience of NCAs in applying the a risk-based approach and potentially AIFMD has not evidenced any specific more specific provisions on exchanges deficiencies relating to the delegation The SCN discussions have shown between NCAs directly involved in the framework that would need to be that delegation rules work effectively, delegation of AIFM core functions. addressed. To the contrary, experience and only a very small number of cases has not evidenced any issues linked to revealed issues which were usually delegation of investment management related to an inadequate application of

Since its creation in 2011, ESMA and complexity and risk of regulatory the national competent authorities arbitrage for investors, market have exchanged practical experiences participants and authorities. in supervising firms in accordance with the AIFMD rules. One area that we believe deserves specific attention is that of delegation We have noticed many areas of the and substance. These rules deserve framework that should evolve in to be updated, both in the area of the the current review. In addition, the AIFMD and UCITS. recent COVID-19 related stresses highlighted some areas that could be In many cases, AIFMs and UCITS further improved. management companies delegate to a large extent the collective portfolio The current AIFMD framework management functions to third VERENA requires changes covering areas such parties and only perform some control as reporting, availability of liquidity functions internally (notably risk management tools and leverage. There management functions). In particular, ROSS is also merit in greater harmonisation portfolio management functions are Executive Director, of the UCITS and AIFMD frameworks often largely, or even entirely, delegated European Securities and in many areas. to third parties within or outside Markets Authority (ESMA) of the group of the AIFM or UCITS management company. The current AIFMD framework requires We recognise that such extensive Enhancing the changes covering areas use of delegation arrangements can such as reporting, increase efficiencies and ensure access AIFMD framework availability of liquidity to external expertise, taking into account the global nature of financial in the forthcoming management tools markets. However, we also see that and leverage. they may increase operational and review supervisory risks. More broadly, it is time to create a true Single Rulebook for investment Therefore, ESMA believes the extent The AIFMD has provided a solid management by making greater use of of delegation should be clarified to framework for alternative investment directly applicable regulations rather avoid the risk of letterbox entities. funds in Europe. It gave a basis for than directives which need to be Consideration should be given to consistent supervision of alternative individually transposed by the different specifying and complementing the managers in the EU, thus reassuring Member States. Many key regulatory existing broad qualitative criteria investors in Europe and the world that matters covered by the AIFM and to clarify which core functions alternative investment funds are grounded UCITS Directives are left to national should always be retained by the in a credible regulatory framework. discretion which adds to regulatory licensed entity.

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Long-Term Investment Funds not need liquidity should consider (ELTIFs), provide retail investors with investing in such funds. Some AIFs access to investments unavailable maintain a portion of more liquid in UCITS funds? What sets such assets, often reducing potential alternative funds apart from UCITS performance of the fund. Moreover, and what would make AIFs and the liquid assets portion may not ELTIFs suitable and attractive to retail suffice to cover an extreme situation investors? Since AIFMD governs fund in which all investors seek to redeem. managers and not the funds, there are many different types of AIFs and a In practice, many AIFs and most broad spectrum of fund characteristics. ELTIFs are set up for professional Therefore, a differentiated approach to investors only. The combination of this question is needed. large unit sizes and initial investment requirements, capital calls and THOMAS A number of AIFs have been set up restrictive redemption make such and function very much like UCITS, investment funds less suitable for retail SCHINDLER geared towards the specific needs investors. Adaptation of such AIFs for of retail investors. Their investment investment by retail investors would Global General Counsel, strategies usually permit investment not make sense as retail interests Allianz Global Investors GmbH in certain assets or a portfolio would inevitably and irreconcilably weighting just outside the scope of collide with those features offered to the UCITS requirements, creating professional investors. Should retail the opportunity for retail investors to broaden their investment exposure For a well-informed decision to invest investors consider whilst maintaining liquidity as well in AIFs and ELTIFs, retail investors as the subscription and redemption need additional information from investing in AIFs features UCITS are known for. distributors on all features typical to AIFs but not present in UCITS. Retail and ELTIFs? investment in less liquid strategies The many different will require more extensive customer types of AIFs and due diligence, appropriateness The success of the UCITS brand and the broad spectrum of and suitability testing, and a clear establishment of UCITS as the default fund characteristics understanding of the target market. investment fund for retail investors in require a differentiated Europe has created a strong focus on More affluent and financially literate the most liquid assets classes. approach. retail investors may then find investments in AIFs and ELTIFs an Despite the continuing low interest Investing in less liquid assets, the interesting and attractive investment rate environment prompting investors purpose of many AIFs and ELTIFs proposition, allowing them to to explore new avenues, retail investors (which provide long-term financing access asset types and investment continue to invest through UCITS and for infrastructure projects, SMEs and strategies that enhance and are the limited range of strategies available unlisted companies), means that early complementary to more traditional in this structure. redemption is usually unavailable, UCITS investments. restricted, or only possible at a Could EU Alternative Investment significant cost for the investor. As Funds (AIFs), including European such, only retail investors who do

Still more is needed to fund innovation How blockchain and infrastructure to achieve a broad- based recovery and deliver on the technology can climate agenda European governments have promised. At the same time, low kickstart ELTIF interest rates and much easier access to investing public markets have pushed investors further out on the risk curve.

The European Long-Term Investment Yet retail investors have been reluctant Fund was supposed to throw open the so far to dive into ELTIF portfolios. doors of the cloistered kingdom of At the end of 2020 assets under unlisted companies and real assets to management of ELTIF funds across the ordinary investors. Six years later, the EU stood at just €1.5 billion. rush hasn’t happened. CHRISTIAN What’s the holdup? A lot has been written This should be a golden era of ELTIF about fairly technical details such as EDELMANN investing for institutional and retail the authorisation process, prospectuses Co-Head EMEA Financial Services, investors alike. The pandemic has and disclosures, and specific details on Oliver Wyman (UK) prompted governments to tap taxpayer portfolio composition. Yet in our view, money to keep the economy afloat. the biggest stumbling block is liquidity.

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ELTIF assets are long-term in nature Blockchain technology can help. It A blockchain-driven platform for but the lack of modern technology and would allow for real-time distribution secondary trading might also attract standardisation increases the liquidity of everything from the most current a new cadre of retail investors challenges in several ways. First, selling asset valuations to legal information concerned about liquidity. Private assets requires material legal resources; needed for an asset transfer. assets are often viewed as an insular it can take months for contracts to be world of asymmetric information, and finalized, and cross-border transactions blockchain could help lift the veil. present still more challenges. Blockchain technology can help democratize That would help democratize markets Likewise, the registration process typ- markets that have that have traditionally been dominated ically costs €300,000 in legal expens- by the largest firms and wealthiest es, compared with roughly €30,000 to traditionally been investors. For retail investors, €40,000 for a typical European mutu- dominated by the it could provide access to true al fund. largest firms and alternative investments. For advisors wealthiest investors. and distributors, it could provide a What’s more, each private debt loan differentiated value proposition. is a bilateral contract often spanning 100 or more pages, requiring manual Hours and days could turn into Blockchain technology won’t turn intervention in administration. And fractions of a second. It would also help ELTIFs into the hottest retail ELTIF funds also suffer from a lack of the EU create and distribute the lingua investments overnight. But it could a standardised template for regulatory franca needed to standardise these help to create buzz for an investment reporting and communication between products and underlying investments product that, so far, hasn’t lived up to manufacturers and distributors. across firms and borders. its potential.

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RETAIL INVESTMENT

Looking at retail investment as a through capital markets, including that source of funding for economic provided by retail investors. activities, there’s no dispute that these resources could, and should, The post-Covid recovery challenge adds be channelled to investments that to the urgency and relevance of what match the longer-term nature of was already recognised as the necessary household’s savings. Developing the way forward. The Commission’s new funds industry, promoting an equity action plan, appropriately called “A culture, generalising auto-enrolment Capital Markets Union for people occupational pension systems, and, and businesses”, sets an ambitious most of all, rebuilding people’s trust roadmap with targeted and specific in the financial system, are critical measures, taking on board many of the if the EU wants to deliver on its recommendations put forward by the ambitious goals of becoming more High-Level Forum on CMU. competitive and sustainable, while taking full advantage of the benefits of The actions in the new CMU plan digitalisation. All available resources directed at increasing retail investor will have to be pooled to cope with the participation in capital markets, if tremendous investment effort required. delivered as intended, do address many of the relevant problems identified, but MARIA LUÍS they are no silver bullet, because there is no such thing in such a complex ALBUQUERQUE reality. Culture, namely the lack of a risk The need to provide culture as seen in other geographies, also plays an important role, and our citizens with that will take longer to change. Also, the tools to build powerful instruments in influencing Retail investors better financial people’s decisions, like taxation, are not under the Commission’s remit, and and capital markets futures for therefore could not be considered in themselves. the action plan. need each other For the agreed actions to produce to succeed the desired impact, however, more needs to be done. All actors need to In the crisis spurred by the Covid-19 take ownership of the plan and do pandemic, the immediate response their share. That means swift decision European households have on average of support to the economy, though processes through the Council and high savings rates, and yet too little of much needed, led to a sharp increase European Parliament, but also in those savings produce the best outcomes in indebtedness, both for sovereigns Member States. Decision makers must for both savers and the economy at large. and corporates. The banking sector, recognise the importance of developing Therefore, the first compelling reason to backed by regulators’ flexibility and integrated and efficient capital markets, change the current situation is the need the monetary policy stance, has and act to put our common goals above to ensure that savings generate fitting contributed significantly to stabilise the protectionist temptations and vested returns to each person’s objectives, be economy in this first phase. However, if interests. It will not be easy, but it will it an adequate retirement income or we are to avoid the risk of an extensive definitely be worth it. children’s education. Long term savings, destruction of productive capacity as in these two examples, should not be across the EU, debt, and in particular put in bank deposits. There, nominal bank debt, is not the answer. returns are getting ever lower, and real returns are actually negative. Companies, including small and medium size companies, must have So, the imperative to change comes first increased access to equity through and foremost from the need to provide the capital markets if they are to be our citizens with the tools to build effectively supported over the long better financial futures for themselves. recovery process ahead. Developing the instruments which promote retail That implies not only designing investment engagement, while assuring or adapting legal and regulatory the necessary investor protection, may frameworks, but also increasing actually prove decisive for the survival the level of financial literacy so that of many viable businesses. Innovative each individual is better equipped to businesses, growing businesses, in understand financial products and order to be successful in Europe, also make the right choices. depend critically on available funding

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services providers and those of their PFOF impairs the retail broker’s individual, non-professional clients. duty to act in the best interest of its Perhaps the most detrimental practice clients and to obtain the best possible in this field is that allowed by “non- execution result. A CFA Institute independent” advice. report demonstrated that a ban on PFOF in the UK by the Financial Paying commissions or non-monetary Supervisory Authority led to “an benefits to investment advisors for increase in the proportion of retail-sized their “advice” (actually for their sales) trades executing at best quoted prices to “retail” clients has gradually and from 65% top 90% between 2010-2014” significantly steered EU households and also narrowed down price spreads away from direct ownership of the for large cap equities. In addition to EU economy to packaged, fee-laden poorer execution, PFOF can hinder financial products, as there are no competition among market makers and commissions on listed securities and securities markets themselves and hurt low-cost index funds (ETFs) – only price formation. on more “packaged” retail investment products. Therefore, BETTER FINANCE recom- mends to policy makers to urgently ban GUILLAUME BETTER FINANCE demonstrated how inducements for all retail investment heavily fees weigh on long-term real products (i.e. all “PRIIPs” and pension (after inflation) net returns. Moreover, saving products such as PEPP) as the PRACHE research by the European Securities main source of conflicts of interests in Managing Director, and Markets Authority (ESMA), and retail financial services, at the very least BETTER FINANCE other research reports, consistently for independent advice, for portfolio found that – on average - cheaper, management and for “execution only” passively managed products (e.g., index transactions. The High Level Forum for ETFs) largely outperform the more the Capital Markets Union has made expensive, actively managed products the same recommendations to the Eu- Addressing conflicts in net terms. ropean Commission last year. of interest for a CMU that really “works A “CMU that works for people” for people” must uphold high standards of retail investor The recent Capital Markets Union (CMU) Action Plan, sparked by the protection. Covid-19 crisis, aims to put equities back at the heart of the EU economy funding and reduce the reliance on bank funding. In the aftermath of This high level of fees can largely be the global health pandemic, the EU blamed on “inducements” because the economy will be in dire need of new commission for a non-independent capital financing in order to stimulate “advisor” (actually a sales person) will a swift recovery as well as innovation, eventually be borne by the retail client sustainable investments and growth. through the fees paid for the product .More problematic, , receiving remu- As the main source of long-term capital, neration or non-monetary benefits for EU households have a key role to play. particular products, creates an inherent But inviting EU savers to participate conflict of interest between the provid- more directly in capital markets comes er and the client: according to MiFID II, with a certain responsibility: investing investment firms must “act honestly, fair- in the EU’s CMU must be safe, fair, ly and professionally in accordance with and trustworthy. the best interests of its clients” (Art. 24).

To achieve this, the EU must first Besides the conflicts of interest effectively address conflicts ofgenerated by non-independent advice, interest in “retail” financial services a recent scandal involving retail equity (distribution and execution) and trading revealed an additional source create a bias-free environment which of conflicts of interest affecting retail stimulates competition and upholds investors: the payment for order clients’ best interests. flows (PFOF). The stand-off between professional and retail investors BETTER FINANCE has long voiced its following the GameStop case shone the concerns regarding the misalignment spotlight on the issues with PFOF, that between the interests of financial were largely ignored before.

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to an abundance of information becoming progressively larger, which under various sectoral rules (MiFID, in turn, may well be one of reasons UCITS KID, PRIIPs, IDD), but the the average investor or SME still turns way this information is presented to the banking system, because of the is often anything but simple and comforting simplicity of a banking loan. understandable to the average person. Increasing financial literacy, especially The combined effect of high volumes of for citizens of less established capital cryptic information is likely to produce markets, will play a major part, but this one of two possible reactions of average still does not mean that the average retail investor: 1) treat the information person will be interested or has the document as an annoying and verbose time to go through pages of complex user agreement, scroll down and click information. “agree”, or 2) try to read it, give up and opt-out of the capital market entirely. Furthermore, information on some ANTE products simply cannot be simplified Both supervisors and legislators are enough for retail clients without it being ŽIGMAN stuck between on the one hand needing misleading in some way, not without the informed consent of the retail someone sitting in the retail investor’s President, Croatian Financial investor with regards to the full extent corner and filling in the financial Services Supervisory Agency of the risks and rewards involved, knowledge gaps, having at heart the (HANFA-CFSSA) and on the other hand keeping the interest of the client, not distributor or information simple enough for it to be manufacturer. digestible by non-professionals. Are we failing This is where a network of financial advisors can play a vital part. Promoting retail investors? We risk turning independent advised sales could go the information a long way to secure a buy-in from presented to retail the retail market. Instead of trying to One of the cornerstones of the new investors to protect them educate everyone, why not provide CMU is to increase retail participation into a liability shield for those that need it with additional in capital markets. The consensus on support? the how to deliver these objectives the benefit of financial has historically been the following: service providers. How the actions from the CMU action a) increase transparency (more plan will be implemented remains information), b) increase the quality In some cases, this balancing act is just to be seen, but key will be to ensure (better information), c) streamline not achievable, and we risk turning the consistency between the different and simplify the information (more information presented to retail investors legislative proposals, requiring accessible information for the average to protect them into a liability shield for close coordination both within the retail investor). While we have come a the benefit of financial service providers. Commission and within the co- long way on transparency and quality, However, opting for simple may get us legislators, which has sometimes been work still needs to be done on the back to misleading, which then prompts difficult to achieve. However, it should simplicity front. us to incessantly review and improve be clear that transparent and simple the information at investors disposal. does not mean risk free, and that capital Thanks to regulatory efforts, the So far, this has historically led to the markets will always have their ups retail investor has now easy access scope of the information requirements and downs.

The recent GameStop events in the Empowering US are a cautionary tale on direct re- tail investment in financial markets all citizens to without appropriate consumer pro- tection safeguards. In the EU, such become active safeguards are seemingly in place and consumers in should remain. Our ultimate goal is to empower citizens financial products to become active consumers in financial products, just as they are more and more active in scrutinising products in shops. Mobilising savings for a green and digital There is still much to do to promote economic recovery is not just one of the safe retail investment, with increased objectives of the Capital Markets Union. awareness, tailored information and STÉPHANIE It is a unique opportunity to unlock renewed trust. new funding for SMEs and corporates. YON-COURTIN It is a political imperative as citizens are Firstly, we need to raise awareness that MEP, Vice-Chair of demanding closer alignment between financial products are part of citizens’ the ECON Committee, economic decisions and long-term daily life, whether they are offered European Parliament sustainability goals. insurance when renting a car or buying

146 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net RETAIL INVESTMENT appliances, they request a mortgage investment landscape after ten years Ultimately, consumers will actively to buy their new home, or they save of debate. invest and use their financial power if for retirement thanks to life insurance and only if they regain trust in financial contracts or other financial products. So close to the finish line, better is the intermediaries. enemy of good: we will further improve Increase consumers’ attention to saving the PRIIPs KID in the medium term. Consumers need to know and see that for longer-term goals is crucial to unlock Most importantly, the PRIIPs Regulation their financial interlocutors are their financing potential in the EU’s economy. has focused all distributors and providers partners, and not just vendors. This Financial education is not only a matter on the value provided to end consumers, renewed trust will come from a change for school and university courses, but rather than the value they could derive of culture by financial intermediaries. rather as a life-long learning project. from selling products. Work place trainings and regular Co-building saving strategies together financial checks are two concrete A holistic review of the EU rulebook on with consumers rather than offering suggestions to tackle financial literacy distribution should aim at empowering ready-made packages and products; in the EU. retail investors with relevant information actively looking for the best investment to make informed decisions every step solutions, tailored to each consumer’s Secondly, consumers should have access of their financial way. Integrating all needs, rather only presenting in- to information on all financial products, dimensions of costs, performance, house products; fostering regular tailored to their needs and their sustainability and rights for consumers, dialogue with each other rather than understanding of financial markets. in an interactive digital format tailored relying on passive disclosure: all these The EU has made a quantum leap with for each consumer’s needs, is an inspiring changes can be implemented in the the PRIIPs Regulation, on the verge of horizon for the next generation of short-term. being finally applicable across the whole consumer protection rules.

bounced between 8 and 9 percent during We therefore welcome the CMU’s am- the same period. This is a range that has bition to stimulate retail participation held firm since 2012, and one that is yet in markets through programmes such to recover from the effects of the 2008 as PEPP, a pensions dashboard and a financial crisis, when the rate was above clean-up of product disclosure stand- 11 percent. ards. We also welcome the upcoming MiFID (and IDD) distribution reviews. These numbers tell multiple stories, but one that immediately stands out is But our post-Covid world requires both about opportunity costs. A euro earning a rapid response and one that builds next to zero interest in a bank is one on Covid consumer behaviours in their that doesn’t contribute to an economic more positive aspect - a continent- recovery or grow over time in a pension. wide shift online. We believe that online financial health and planning CHRISTIAN This adds up quickly over many house- tools, built on Open Finance standards holds and many years. The European and situated within the wider Fund and Asset Management Association financial inclusion agenda, should be STAUB estimates that the wealth of European a fundamental cornerstone of policy Managing Director Europe, households would be around 1.2 trillion going forward. Fidelity International euros higher had they reduced their bank deposits between 2008 and 2019 and in- Stimulating financial health vested in stocks and bonds instead. Restoring retail Financial planning tools have a Policy dilemma double benefit when it comes to ‘retail financial balance in participation’: they both bring long term And so, policymakers surveying a post retail market participants and support the post-pandemic era Covid-19 landscape face a difficult strategic investment over event-driven challenge. Businesses, and to some speculation. extent national treasuries, will be keen A natural human response to times of for these savings to flow back into the This is particularly important in an era uncertainty is to save resources. And few economy via consumption. where gamified access to speculative years have been as uncertain as the one market trading is becoming ever easier. just past. European households reacted But to only focus on short-term con- The instinct to save can very easily turn to the Covid 19 crisis by increasing their sumption as a route to economic recov- into a desire to take increased risk when savings rate to more than 17 percent in ery would be to miss a great opportunity periods of uncertainty lift. the third quarter of 2020; the second to revive retail participation in the EU’s highest level since records began in 1999, capital markets, and channel those sav- So, we must do what we can, as soon as we according to Eurostat. ings into the type of long-term prosper- can, to engage potential retail investors, ity that was foregone in the past decade. restore public trust in capital markets However, savers have been reticent about and stimulate participation. Or risk moving this money from bank accounts We need an investment-led recovery as another lost decade of low investment. into investment accounts. Eurostat data much - if not more than - a consumer- also shows that the investment rate led recovery.

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First, there is a need for clear and them to take action if they see shortfalls transparent information. in their pensions adequacy.

The pensions landscape varies consid- Second, there is a need for pension erably across Europe, but better infor- products that meet the needs of today’s mation on gaps in sustainability and workers. This means designing long- adequacy will help countries identify term savings products for people who the emerging gaps in theirs system. This change jobs frequently, or work on a type of information will not just help freelance or casual basis. governments in their decision-making. With the right information, people will Products like the pan-European also be able to make better decisions on pension product, or PEPP. how to save for retirement. The PEPP is a portable, transparent, FAUSTO cost-effective personal pension product. Simple, scalable, Savers will be able to take their PEPP PARENTE digital-first products with them when they move jobs or countries and the Basic PEPP will Executive Director, will demonstrate offer an affordable and capped default European Insurance and the benefits of CMU to European consumers. investment option. In addition, savers Occupational Pensions will receive clear and comparable Authority (EIOPA) information about performance and will This year, EIOPA will be supporting be able to switch providers if they would the implementation of the Action Plan like but also with costs being capped. on the Capital Markets Union (CMU) Closing the pensions with the provision of advice on the PEPP also paves the way for more development of pensions dashboards long-term investment in equity-like savings gap with that will help strengthen the instruments, in order to increase the monitoring of pension developments potential for better long-term returns simple, scalable in Member States. for investors and foster sustainable economic growth. Simple, scalable, products like PEPP With the help of a network of experts, digital-first products will be key in and making use of existing best practice, demonstrating the benefits and the EIOPA will also map the functional value of a Capital Markets Union to Estimates put close to 20% of EU feature of a tracking tool, including European consumers. citizens at risk of poverty or social how best to present information. We exclusion in older age. This makes will also provide advice on how to Improving pensions adequacy and pensions adequacy and coverage communicate and launch the service. coverage are difficult – but not becomes a priority for governments. impossible – challenges. Focusing on The goal is to create an attractive, the demand side and engaging savers Yet, for many people pensions are a easy-to-use tracking system that in their retirement planning with clear complex and confusing, and this makes provides people with comprehensive and transparent information will help people reluctant to invest in long- information – in other words, a system not only to close the pensions gap, term savings products. The challenge that meets the needs of savers – so that but also provide a source of valuable is to overcome these barriers and to it is easier to engage people with their funding to strengthen the Capital stimulate interest and action. retirement planning and encourage Markets Union.

For France only, 220 billion euros were Preserving access to saved in 2020, 60 billion higher than qualified financial last year1. advice for retail Still, nothing guarantees that this idle money will be invested in the economy, investors is key for notably in a context where citizens are mostly (64%) pessimistic about the success of CMU ! the European post-covid-19 recovery2. Recent ESMA’s analysis3 showed that while equity UCITS have delivered Covid-19 crisis has led to an a nearly 9% net performance during unprecedented increase in European the last decade, only 10% of European households’ savings, especially in cash households invest in mutual funds. and deposits. According to estimates SIMON made by the European Central Bank, Therefore, initiatives that aimed the total of Eurozone household at increasing retail investors’ JANIN financial assets flows was more than participation in financial markets are Head of Group Public Affairs, 700 billion euros at the end of 2020, key. And one can only fully support Amundi against 570 billion euros a year before. the new action plan of the European

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Commission on Capital Markets Union goes towards more transparency particularly challenging. As provided in published in September 2020 which should be welcomed, it is nevertheless a study dedicated to the Dutch market4, sets out the objective “to make the EU essential to avoid adopting radical “some groups of consumers are struggling an even safer place for individuals to measures that would in the end go to pay directly for financial advice”. save and invest long-term”. Among the against the interests of retail investors, And as regards the UK, recent figures new measures which are supposed to and their ability to access to qualified published by the FCA (2020) show that support these objectives - the review financial advice, whatever their the global cost of ownership for the of ELTIF Regulation together with the investment capacity. investors (including the cost of advice) promotion of long-term investment, remains high – leading to exclude the in particular trough the promotion of less worthy part of retail investors (with employee share ownership - should be It is essential to financial assets below 200 000 £). engaged in priority. avoid radical measures that would in the end However, these measures will prove go against the interests to be effective only if there are not of retail investors. counterbalanced by others. Indeed, 1. Stat BdF: https://www.banque-france.fr/presentation- among the 16 actions of the new action trimestrielle-de-lepargne-des-menages plan, one that could potentially have In this respect, retrocessions of https://www.banque-france.fr/statistiques/epargne- unintended consequences pertain management fees play a key role in des-menages-2020t2 2. https://ec.europa.eu/commission/presscorner/detail/ to the announced assessment of remunerating the cost of advice. fr/ip_20_1975 rules applicable to the remuneration Conversely, in countries where a ban of 3. https://www.esma.europa.eu/sites/default/files/library/ of distributors, with possible these so-called ‘inducements’ has been esma50-165-1106-asr-performance_and_costs.pdf 4. A commission ban for financial advice : Lessons learned amendments of the related provisions adopted (UK, NL), access to financial from the Netherlands, Fred de Jong, University of in MiFID II. While any initiative that advice has since then revealed to be Amsterdam, 2017

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EQUITY FUNDING

honours his promise to pay back. The did by developing the EU taxonomy evidence seems to suggest that we for sustainable activities. Another have fixed our trust-issues over the last measure is to actively support reforms decade: the banking sector is stable, in Member States to carry out reforms reinforced by better EU level regulation to develop green finance ecosystems or and strengthened pan-European green bond markets. The Commission supervision. Governments agreed to does that through the Technical have the European Commission issue Support Instrument. debt for the first time in history to fund a recovery program macroeconomic Second, equity is most important for significance. start-ups and innovative companies and difficult to access especially for SMEs. Unlike debt, equity is about future Therefore, the European Commission perspective: when you buy a share, has launched several initiatives to foster MARIO NAVA contrary to debt, there is no promise access to equity: the Capital Markets that you get your money back, there Union to unlock more investments, also Director General, DG for Structural is only a (hopefully well-grounded) for SMEs. Reform Support, European Commission perspective that the company succeeds. Looking at the current stock-market, The Single EU Equity Financial Instru- future perspectives do not seem to be ment to support European businesses’ Equity or debt? Last the issue. Here of course the low interest growth, research and innovation. Ven- environment helps. But the stock- ture EU, the Pan-European Venture time we needed trust, market is not the economy, and while Capital (VC) Fund-of-Funds programme companies associated with the digital to further address Europe’s equity gap now we need future economy may have profited, many brick- by investing in VC Funds-of-Funds. The and-mortar business have suffered and European Innovation Council Fund perspective! piled on debt. Should we help them to which just provided a first equity in- convert their debt into equity? vestment of EUR 178 million in break- through innovation. The financial crisis of 2008 was a crisis As you will read in any economist’s of debt – triggered by debt handed out article at some point: It depends. Third, if the economic outlook brightens, by banks as loans, fuelled by repackaged First, what is clear is that the future equity becomes more attractive, debt debt, wreaking havoc on interbank will be green and digital. Therefore, more sustainable. This is the real debt markets and culminating in the subsidising carbon-heavy businesses solution for which we have to work, sovereign debt crisis. 2008 and the of the past will not help. Investors and the European Commission does: following years we also experienced a know that and are seeking green The Recovery and Resilience Facility, crisis of trust: banks, supervisors, even investment opportunities. Therefore, making €672.5 billion in loans and grants governments did not trust each other. one important measure is to help available, gives perspectives that the EU So, one might say debt is very much investors identify green investments, will emerge stronger and more resilient about trust – the trust that someone as the European Commission recently from the current crisis.

capital and of making Germany more Boosting attractive to venture capital.

the German VC In recent years, Germany’s venture capital market has advanced Ecosystem significantly. In particular, Germany is doing comparatively well in the area of early-stage financing for start- Start-ups are a key driver of structural ups, thanks in part to the many public change. They put new, innovative ideas funding programmes in place at the into practice, create jobs and safeguard federal and state (Bundesländer) levels. the foundations for future prosperity and growth in Germany and Europe. However, despite the international People who start new businesses can attention directed towards Germany’s be valuable innovators, and they play start-up scene, the venture capital ELKE a tremendously important role in the market in Germany remains too development of the German economy. small, especially when compared KALLENBACH internationally or when viewed in Deputy Director for International The Federal Government has therefore relation to the size of the German Financial Market Policy, Federal set itself the objective of improving economy. In some countries, venture Ministry of Finance, Germany legislation and tax rules for venture capital investment is many times higher

150 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net EQUITY FUNDING than in Germany. Start-ups in Germany ups during the coronavirus pandemic. portunities during the capital-intensive have inadequate access to capital For regulatory reasons, and to ensure scale-up stage. To this end the German especially when it comes to second- consistency with EU competition government is currently setting up stage and third-stage financing. and state aid law, funding from these an €10 billion equity fund for emerg- instruments is typically contingent ing technologies (Beteiligungsfonds für For this reason, the German government upon significant contributions from Zukunftstechnologien, or Zukunfts- has already adopted a number of private investors. In this way, such fonds (“Future Fund”) for short), which instruments to promote financing for funding expands the amount of will be set up at KfW. With this Future innovative start-ups. financing available on the German Fund the German government will mul- venture capital market. tiply its existing funding structure both This support is provided both (a) quantitatively and qualitatively. indirectly via funds such as the ERP/ EIF Fund of Funds and KfW Capital’s Germany is committed Moreover, the German government ERP Venture Capital Fund Investment to improve financing proposed several regulatory and tax- programme, which invest in private opportunities during related measures to increase Germany’s venture capital funds and (b) directly the capital-intensive attractiveness for investment funds via public funds such as the High-Tech scale-up stage. (VAT exclusion to management fees Gründerfonds (HTGF) and coparion, of VC funds, new tax regulations for which invest directly in start-ups. In employee investment schemes, less red addition, the German government set Closing remaining gaps: Germany is tape and more flexibility for investment up a €2 billion programme to help start- committed to improve financing op- fund managers).

liquidity to companies, through direct private sector. The aim is to use the subsidies, furlough schemes, tax and resources, information and incentives loans moratoria and state guaranteed of the private actors to ensure a good loans. An unavoidable side effect has use of taxpayers’ money. been an increase in corporate debt. In France, it has risen by €217bn in 2020. The situation calls for a comprehensive Cash holdings by companies have strategy. This is what France is trying also increased dramatically (€200bn). to do, with a mix of horizontal policies This big picture hides very different (such as cuts in production and corporate situations across companies, some income taxes), and specific measures faring fairly well, and others emerging addressing different situations. For badly bruised from the crisis. instance, the recently announced “prêts participatifs et obligations Relance” A severe economic downturn automat- scheme targets companies affected by SEBASTIEN ically decreases the levels of equity cap- the crisis but with manageable levels of ital in the economy, via reduced profits, debt and investment plans to finance. higher debt and the use of cash holdings RASPILLER to meet payment deadlines. These equi- The scheme rests on up to €20bn of Director, French Treasury, ty losses act as shock absorbers and help “equity loans” (subordinated long- Ministry of the Economy, businesses go through crises. However, term debt) and subordinated bonds, Finance and the Recovery Plan, a sustained lack of equity is damaging with a public guarantee of up to 30% France to the economy, by increasing the risk of first losses at the portfolio level. For of viable companies going bankrupt and viable firms struggling to meet their of debt overhang situations, in which debt repayment deadlines, a clear debt companies prioritize debt reduction restructuring plan is needed. France Developing equity strategies over investment and employ- has reinforced public restructuring ment plans. committees that help devise solutions funding is much with all stakeholders of struggling companies and is reforming bankruptcy needed and should Boosting equity procedures to make them more financing is critical effective. rely on a result-driven now, with government intervention if necessary, The European Commission’s decision strategy especially for SMEs which to prolong and expand the scope of the Temporary Framework has freed do not have access to up some policy space to implement As the world slowly emerges from a capital markets. new instruments to help companies challenging year, the outlines of the rebound from the crisis. The post-Covid era begin to take shape, Boosting equity financing is therefore involvement of financial actors will be calling for new ways to repair the critical now, with government critical in ensuring that these schemes damage done by the crisis to the intervention if necessary, especially for are a success. Beyond public support corporate sector. SMEs that do not have access to capital to the financing of our economy, we markets or professional investors. This should lift the barriers to investments Most of the emergency support schemes support should come with terms and in equity by the private sector: the have focused, and rightly so, on keeping conditions: assistance has to be targeted Solvency II review is a not-to-be missed the economy afloat by providing towards viable firms and to involve the opportunity in this regard.

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SMEs are at the core of growth to consider these investments an option generation: they increase the productive when drafting their portfolios. fabric, allow for larger investor participation, and provide for solutions At the same time, companies need to be to demands in new fields, such as ESG. able to raise capital without having to In certain ways, the recovery measures deal with excessive burdens that drive put in place in the second half of 2020 investment away from their projects. have alleviated some of the most Policy makers need to understand and acuciating concerns for SMEs, but we assess carefully the impact that current need to consider a change in paradigm regulation may have in discouraging to fully unleash their potential. investments. The EU is rightly proud of taking investor protection with the Equity funding is based on investor trust relevance it merits, but there is still room and capability to invest, their access to for allowing companies to approach JESÚS equity issuing procedures is paramount a wider and more diversified base of to create value. Investors must be given investors while preserving their rights. GONZÁLEZ the tools to access the financial system in effective ways: they must be able to Easing the requirements for SMEs to be NIETO-MÁRQUEZ understand and decide amongst the listed, to open secondary issuances and different investment options available, to be rightly covered in research, as well Managing Director BME Growth, and that stems, inevitably, from a more as a carefully dimensioned tax regime, Bolsas y Mercados Españoles (BME) comprehensive financial culture and paired with tax incentives, need to be education. Investors with a deeper assessed to level the playing field for knowledge will better understand their SMEs vis-à-vis the rest of companies. Equity financing in risk profile and widen the investment base, to fund SMEs. Finding the balance on these measures the post-Covid reality should be considered as a means to grant SMEs access to financing in aims of Investor participation continuing towards the funding chain: A year after the pandemic hit our at the heart of allowing for growth and for moving on systems we are still speaking about SME funding. the next step of the regulated markets. recovery and rebuilding from a crisis that is still peaking. Measures have been We cannot ignore the opportunity established to counter the devastating Capital raising can certainly stem from window offered by the review of effects of the Covid-19, but we must different sources and making use of MiFID II, and furthermore, we need not forget the overarching goal of already established channels needs to be to understand it as a chance to make building a resilient and robust financial taken a starting point to give visibility our financial system more dynamic system capable of absorbing shocks and to SMEs while providing investors (and and inclusive, taking one decisive step generating growth. their intermediaries) for a trampoline forward in the completion of the CMU.

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Policy notes written by the Eurofi Secretariat on recent regulatory developments and macroeconomic trends impacting the EU financial sector, including implications of the Covid-19 crisis

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EUROFI REGULATORY UPDATE APRIL 2021

INSIDE

RESPONSES TO THE COVID CRISIS EU BANKING AND CAPITAL MARKET FRAMEWORK ENHANCEMENTS ESG AND DIGITAL FINANCE POLICY DEVELOPMENTS FUTURE STEPS OF THE CMU

SECURITIES AND DERIVATIVES CLEARING

As concerns EU CCPs, further enhancing sition period in September 2020, ESMA supervisory convergence is a key priority adopted temporary recognition decisions of the CCPSC. Building on regular (following the Commission’s temporary exchanges of views and discussions equivalence decision), which expire on 30 amongst national competent authorities June 2022. This enabled a smooth transi- (NCAs) and relevant supervisory decisions tion for UK CCPs from the EU CCP to the and opinions on EU CCPs’ initiatives (such third country CCP regime under EMIR, as the validation of significant risk model with two UK CCPs having been recog- changes), the CCPSC has two primary nised as Tier 2 CCPs: ICE Clear Europe instruments to further promote common and LCH Limited. In respect of TC CCPs, supervisory practices and culture: the CCPSC will face three major priorities:

- CCP stress tests: Annual CCP stress - Direct supervision of Tier 2 CCPs: An tests measure the level of resilience of efficient direct supervision framework KLAUS LÖBER CCPs against common stress scenarios will ensure that Tier 2 CCPs comply with and identify issues for follow up via EMIR requirements on an ongoing basis, Chair, CCP Supervisory Committee, regulation or supervisory actions. The as the case may be under comparable European Securities and Markets CCPSC is about to embark on the next compliance still to be decided. Authority (ESMA) round of CCPs stress tests, building on - Review of the Tier 2 CCPs’ recognition: experience gained and having regard to The CCPSC is mandated to assess new or emerging stress scenarios (such whether the services provided by Tier 2 The priorities as cyber resilience). CCPs, or some of them, are of a systemic - Peer Reviews: Peer reviews of NCAs’ nature that is too substantial to be safely of ESMA’s CCP supervisory activities towards CCPs provided from outside the Union. The have been successful in defining CCPSC will carefully analyse potential Supervisory best practices and identifying, where risks, dependencies and stability relevant, inconsistencies or divergencies implications that result from the current Committee in the application of EU regulatory situation and potential evolutions. It requirements. The CCPSC has recently will also look at costs and benefits of a completed the 2020 peer review and will potential relocation of clearing services. 2020 has seen the establishment of the soon launch the 2021 exercise. - Other TC CCPs’ recognitions: The new supervisory regime for CCPs under CCPSC also has to review the TC EMIR 2.2, a key part of which is the new Looking at third country (TC) CCPs, the CCPs that were recognised before CCP Supervisory Committee (CCPSC). review of EMIR introduced a two-tier the entry into force of EMIR 2.2, in The appointment of the Chair and the recognition regime, whereby those third order to determine if any of them two Independent Members completed country CCPs qualifying as systemically would qualify as Tier 2 CCP. Finally, in the establishment of the CCPSC and, with important for the financial stability of the 2021, the CCPSC will process pending it, the implementation of the enhanced Union or of one or more of its Member applications for recognition of the regimes for the recognition of third States (so-called Tier 2 CCPs) are subject SEC-regulated US CCPs, following up country CCPs as well as for supervisory to EMIR requirements on an ongoing ba- to the recent Commission equivalence convergence for EU CCPs. sis. Ahead of the end of the Brexit tran- decision adopted under EMIR.

services both internally and externally, All for one and thus increasing its importance and its resilience at the European and one for all international levels.

With the adoption of the Capital In particular, with increasing cross- Markets Union Action Plan 2020 a border trading of shares, bonds and few months ago, the EU Commission derivatives, the economic opportunities started a new and important chapter in of a united capital market will soon the achievement of a single EU capital present themselves to the member market. It was Alexandre Dumas who states and lead to sustainable growth. once wrote “all for one and one for all”: Against this backdrop, the continued The same sentiment could be applied removal of cross-border impediments to the capital markets union. and increased transparency are essential for a level playing field. JOCHEN In the belief that 27 economies together can achieve more than each one CCPs have always played a key METZGER individually, the intention is that the EU role in this respect as they reduce Director General, Payments and Settlement will unleash enhanced economic power counterparty and settlement risks, thus Systems, Deutsche Bundesbank by providing cross-border financial contributing to secure and continuous

154 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net SECURITIES AND DERIVATIVES CLEARING economic growth. The new supervisory In the area of CCPs, ESMA supports because it allows the local specialisa- framework EMIR 2.2 enhances the the Member States’ authorities in the tions of the CCPs to be optimally taken resilience of these important players. coordinated supervision of EU CCPs by into account by the respective nation- issuing peer reviews and stress tests and al authorities. This is crucial since not The recently enacted CCP Recovery by participating in CCP colleges and in all CCPs clear the same products, and and Resolution Regulation augments the CCP Supervisory Committee, and, many have different risk profiles and the regulatory framework with a in future, in CCP resolution colleges. varying legal systems, but it also en- powerful recovery and resolution ables a consistent methodology to be regime and completes the picture and reinforced, best practices to be defined the mission initiated at the Pittsburgh ESMA performs and thus the goal of achieving a single summit in 2009. Binding recovery and an important capital market to be fostered. resolution plans in conjunction with function through adequate tools to deal with crises will its supervisory However, this will not be the end: with generate more predictability, safety convergence work. the advance of digitalisation, a changing and confidence in the European capital clearing landscape will emerge. New market and ultimately increase trust in market players will bring with them the EU’s financial system. Outside of the EU, ESMA’s supervision new opportunities, but also new risk. of systemically important third- In that context, ESMA performs country CCPs ensures that the high EU Questions are arising concerning, in an important function through its standards are not being eroded. particular, how to integrate these new supervisory convergence work by players into the single capital market. promoting the standardisation of This European approach has fully prov- The answer for that can only be “same supervision practices and compiling a en its worth in terms of coordinated activity, same risks, same rules”. single rulebook for EU financial markets. and harmonised supervision, precisely

financial and operational resilience. troughs. More specifically, authorities Margin collection continued smoothly, should deal in priority with fluctuations without any member default and EU of initial margin models and monitor CCPs deployed business continuity discretional changes. While EMIR al- plans to carry out their activities on a ready requires CCPs to implement an- fully remote basis. ti-procyclicality tools in their IM mod- els (e.g. floors, buffers) they could be While this crisis has showed that post- subject to further guidance, including 2008 reforms were useful, including possible steering power from author- clearing mandates and CCP regulations, ities and transparency. More general- some events at global level have raised ly, CCPs could disclose more granular, questions on the preparedness of actors, frequent data on margin breaches and especially the liquidity capacity of some increases. EU authorities could devel- non-banks to meet higher margin calls. op enriched disclosure standards in NATHALIE this regard. EMIR is a robust framework for CCP resilience that involves close cooperation Beyond CCPs, and to better consider AUFAUVRE and supervisory convergence and has liquidity strains at ecosystem level Director General Financial just been complemented by a regulation stemming from margin requirements, Stability and Operations, on recovery and resolution. Yet, EU transparency should be improved Banque de France authorities pay close attention to the on uncleared markets and vis-à-vis above-mentioned vulnerabilities, and client clearing practices. End-users have therefore undertaken policy work might be subject to liquidity pressures at ESMA and ESRB level to enhance the through collateral restrictions or add- Adding predictability stability of the clearing chain. ons set by clearing agents or bilateral counterparties. In June 2020, the to resiliency: Financial actors need more predictable ESRB issued recommendations on this margin practices, without weakening issue that national authorities are now the post-Covid CCPs’ first defense lines. In this respect, implementing. the clearing membership of EU CCPs challenges of should remain subject to high liquidity While the EU should not wait to and operational standards. Similarly, take action, international standard- margining collateral eligibility should remain setting bodies will have a key role to limited to highly liquid assets, and any play too. While CCPs are a sizeable broadening should be closely monitored part of the question and the CPMI- The Covid outbreak in spring 2020 to ensure this does not create additional IOSCO Quantitative Disclosures could triggered extreme market moves in some liquidity risk for CCPs. be refined, we welcome the holistic financial sectors like equity markets. In approach on assessing margin practices addition, the global financial system had Predictability should help limiting in the financial sector that FSB, CPMI- to adapt quickly to lockdown measures margin procyclicality. Margins should IOSCO and BCBS have together that were imposed in all jurisdictions. In be calibrated so that their level would embraced. We think this ambitious work this unprecedented context, EU CCPs remain adapted through the econom- will result in substantial supervisory and their members proved remarkable ic cycle, while smoothening peaks and outcomes and proposals.

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ensured that margin increases were This further enhances cross-border highly predictable with limited supervision of third country CCPs (TC impact on our members’ liquidity CCPs) and ensures EU firms remain requirements. For e.g. the largest daily competitive by accessing to global increase in total margin called during markets and CCPs supporting these. March 2020 was only at 3.5% despite the volatility observed on markets. Accessing global markets is key for EU firms, as the Euro market is LCH’s SwapClear serves customers in predominantly traded outside EU 62 different jurisdictions, has registered borders (75%) but also because EU services in 11 jurisdictions and clears firms’ clear more non-Euro currencies products in 27 different currencies. than Euros. EMIR ensures that EU Internationally integrated businesses Firms’ hedging activities are supported bring material benefits to users across by a strong supervisory framework. DANIEL jurisdictions, especially in the case of It enables them to access global OTC derivatives markets which are pools of liquidity and compete with MAGUIRE truly global. They should be supported their international peers on a level by consistent global and supervisory playing field. Chief Executive Officer, oversight based on cooperation and LCH Group and Group Head, proportionate deference mechanisms. Unfettered access to global markets by Post Trade, LSEG EU participants and financial stability are the principles for a successful ...”the Euro market economic recovery and EMIR provides The need for a is predominantly the foundations upon which market traded outside EU participants and CCPs can operate diversified clearing borders (75%)”… on a cross-border basis in an open ”EU firms’ clear more manner leading to economic growth ecosystem non-Euro currencies and prosperity. than Euros” Market fragmentation would only CCPs are an integral part of the increase financial stability risk and costs. financial ecosystem. They support Jurisdictions approach to supervision The EU could draw inspiration from its financial stability through robust and varies from direct registration peers and some of the requirements of resilient risk management frameworks requirements to full deference. Some EMIR. For example, it could require TC and diversified memberships spanning impose the use of local settlement CCPs of systemic importance to the multiple jurisdictions, forming deep systems and require CCPs to deposit EU to use local settlement systems and pools of liquidity. CCP membership is a collateral in their local currency on deposit local currency cash at the local key feature that contributes to making local central banks deposit accounts, Central Banks. a CCP resilient to market shocks giving them visibility on all flows in and defaults. the currency they manage. EMIR 2.2 This would further improve financial introduces the direct supervision of stability through increased oversight This has been illustrated during systemically important CCPs and direct capabilities over international Euro the Covid-19 associated market application of EMIR requirements. flows, ensuring continuous monitoring stress, where CCPs have successfully of market activity but also an additional preserved financial stability. The anti- As such, a Tier 2 CCPs (such as LCH liquidity tool to be used in case of procyclicality measures enshrined in Limited) is subject to requirements market stress. LCH’s risk management framework at least as demanding as EMIR.

ing CCPs’ risks through the adoption of EU and third-country EMIR 2.2 but also with the recent adop- tion of the CCP Recovery and Resolu- CCPs: the risk of tion regulation (which includes a second fragmentation? tranche of skin in the game). In particular for third-country CCPs, EMIR 2.2 has al- lowed the enhancement of third-country The end of the Brexit transition CCPs supervision by ESMA through the period marks the start of a new revised recognition mechanism. regulatory paradigm between the European Union and United Kingdom EMIR 2.2 has also introduced a especially with regard to UK central reinforcement of the application of counterparties (CCPs). EMIR key provisions for third-country tier 2 CCPs, considered as creating a In the EU, two important regulatory systemic risk to the EU. However, with HAROUN trends have emerged during the past regard to euro-denominated OTC few months. derivatives, EU authorities still consider BOUCHETA Europe is too dependent to UK CCPs Head of Public Affairs, First, the European Commission has and does not benefit from sufficient BNP Paribas Securities Services reinforced the framework for manag- supervisory powers.

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Second, the European Commission has risk could be to further fragment the EU and UK financial markets. The granted the UK a temporary equivalence derivatives markets and not control the lack of coordination in the application decision for CCP clearing services in potential risks or outcomes. of the derivatives trading obligation order to preserve financial stability, (DTO) has generated a significant with the grace period running until the shift of the dealing volumes on US 30th of June 2022. In the meantime, the A relocation policy venues and penalized both EU and UK European Commission is encouraging of euro clearing that market volumes. EU-27 market participants to migrate would only involve their risk exposures from UK CCPs. EU-based clearers To avoid the risk of fragmentation, Through a recent communication, the will damage those authorities should take into account Commission reiterated the expectation political, risk and competition that EU clearing members and market firms and would not considerations. Maximising liquidity is participants reduce excessive exposures meet the expected key to CCP efficiency, providing clearing to systemically important UK CCPs, political goal of EU members with cross-margining benefits in particular their euro-denominated institutions. and clients with larger liquidity pools. OTC derivatives exposures. A relocation policy of euro clearing that There are clearly more questions than The end of the transition period has would only involve EU-based clearers safe bets here and It is also important evidenced the necessity to adequately and market players will damage those to understand the point of view of anticipate and coordinate the impacts firms and would not meet the expected non-EU clearing members clearing on financial markets of structural political goal of EU institutions. Indeed, euro transactions and the strategies regulatory changes. While the trading to achieve this goal while maintaining they will follow. Could the European of shares has not undergone any major CCP efficiency and financial stability, Commission take a strong stance and issues, due mostly to an effective EU authorities will have to work closely impose through regulation to non-EU anticipation by the industry, the trading with the industry to define the relevant clearers to clear euro-denominated of OTC derivatives – IRS and CDS - measures to be implemented within a instruments in the EU? If not, the has suffered negative effects for both reasonable timeframe.

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SECURITIES POST-TRADING

tools to customers, and distributed ledger in mind. First, when we enable this pilot technology (DLT) looks set to play a to gain speed and take off, we need to much more important role in securities be able to call it back and force a safe settlement in the future. landing at any time if its objectives are not met. There are, of course, reasonable A crucial factor for all new technologies limits incorporated into the pilot regime, is the regulatory environment – without concerning both the duration and certain a stable and predictable set of rules, value thresholds to limit the size and risk innovations face strong headwinds that of the regulatory sandbox. Nevertheless, may prevent them from taking off. At we need to communicate to the market the same time, regulators need to ensure that winding down the regime will be that consumers do not board vessels that a viable option if significant risks are are too risky for them and the market identified that cannot be addressed in any as a whole. In other words, regulating other way. JOCHEN emerging technologies is about striking a balance between potential and challenges. The second key issue is that we need to METZGER The EU has developed a pilot regime to prevent fragmentation of the European steer and stabilise the development of settlement landscape. New solutions Director General, Payments DLT for trading and securities settlement. based on DLT promise to increase the and Settlement Systems, efficiency of securities settlement, but Deutsche Bundesbank In essence, the initiative is about creating this depends on the specific design and a kind of “regulatory sandbox” in the EU development of the market. Creating for the development and operation of many different non-interoperable DLT How to steer the market infrastructures based on DLT. sandbanks or islands each with its own Having a ring-fenced sandbox means settlement asset will not enhance overall DLT pilot regime? that newcomers are able to play and settlement efficiency in Europe. The experiment in a safe and supervised sandbox concept is good but there would Navigating between environment. The regulation takes the have to be a common one without major form of a pilot regime and has four main barriers to transactions, meaning that potential and objectives: first, to create legal certainty DLT infrastructure providers would need for DLT market infrastructures within the to ensure a high level of interoperability challenges EU; second, to support innovation in the with existing legacy systems. EU by removing barriers to the application of new technologies in the financial DLT offers significant efficiency gains Technological change is the driving force sector; third, to safeguard consumer and for the European settlement landscape. of our times – and Covid-19 has further investor protection and market integrity; However, we can only achieve these accelerated the pace of change. Digital and fourth, to guarantee financial stability. gains if we find the right balance between technologies are advancing in all segments enabling potential and mitigating of finance: contactless payments have Creating a pilot regime for DLT market challenges. Avoiding fragmentation boomed during the pandemic, robo- infrastructures is the right approach. will be key to reaping the benefits of the advisors offer fully automated investment However, we need to keep two key issues pilot regime.

But in all this misery, there are also some DLT is good, good news: The G20 reforms have paid off! Despite all the turmoil and volatility except when over the past year, markets remained stable. Let us not forget that the post- it’s not trading sphere is playing a key role in this context as the backbone of security, (regulated) stability and reliability in the financial system – fundamentals that should never be compromised. Yes, the EU finds itself at a crossroads. With unprecedented public debt levels This is where the CSDR comes in – and and pressure on the monetary policy as it is fair to say that we have come a long well as the banking system, the untapped way: Shorter settlement periods or growth potential by boosting the EU’s significantly enhanced organisational NIELS BRAB capital markets becomes critical now. and prudential requirements for Head of Group Regulatory Strategy, With the Brexit being a reality, the time CSDs are only some of the key fields Government Relations & Political has come to act – and the reflections of progress. While it is good to ensure Affairs, Chief Regulatory Officer, around sovereignty and a stronger Euro the functioning of the framework, a Deutsche Börse Group are the right way ahead. full sweep review occurs misplaced

158 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net SECURITIES POST-TRADING given that certain requirements have the post-trading integration and safeguarding its fundamental stability never been phased in, such as the making the internal market more and integrity prerogatives. The DLT settlement discipline regime. And after efficient, resilient and competitive. Pilot Regime proposals should therefore all the impact assessments and years of These include, for example, the need still find the right balance between preparations, it would occur premature to boost cross-border competition by innovation and security, respecting to simply change or delete certain enhancing the passporting regime and the principle of “same business, same requirements at this stage. streamlining the approaches by NCAs, risk, same rules”, avoiding conflicts the ability of CSDs to service intra- of interests and ensuring technology- This holds in particular true for the group, or the ability to provide ancillary neutral legislation. buy-in regime, notably considering that banking services. the Eurosystem still faces significantly When Deutsche Börse Group made the higher settlement fails than other markets electronic in the 90s, we did not leading jurisdictions. Enforcing …ensure the CSDR see any regulatory relief for our business discipline is needed – as it means that remains future-proof case. History illustrated that we were market participants need to stand in while safeguarding nevertheless successful. Today, Deutsche for what they promised and cannot its fundamental Börse Group has a number of DLT based simply get away with misbehaviour to stability and integrity offerings on the market – again, without the detriment of the integrity of the prerogatives. receiving regulatory relief. EU’s markets, such as non-delivery of securities. If new technology is claimed to be Let us not forget to highlight the incompatible with fundamental By contrast, it makes sense to review importance of technology in this principles of financial regulation, some aspects that require adaptations context. With the next big digitalisation we should carefully reflect if it is our to bring the EU’s endeavour on the wave in full swing, it will be key to ensure fundamentals or the technology that is CMU front forward by strengthening the CSDR remains future-proof while not fit for purpose.

to reshape in some ways the securities and investors. While the current markets, by introducing new services proposal aims to test very innovative and new players. concepts such as the combination of trading and post-trading within one This reshaping has the potential to single legal entity, questions remain bring benefits in terms of efficiency on whether it would be in line with and transparency, but market the necessity to offer issuers and authorities need to be careful on how investors more open, interoperable and this transformation takes place. EU competitive markets. regulators have a crucial role to play in setting the fundamental objectives of The introduction of DLT may lead to the DLT pilot regime. We believe that exemptions justified by some feature of the reform should be based on two main the technology, to the extent however drivers: (i) bring benefits to the EU and that they do not result in increased GUILLAUME its CMU (ii) do not compromise on financial stability and systemic risks. the safety and stability of the financial The legislative framework must, in this system. The EU will achieve the digital respect, remain technology neutral. ELIET finance agenda’s ambitious targets only To ensure a certain level of security, a Head of Regulatory, if it successfully manages to combine common feature of most analysis was Compliance and Public Affairs, these two elements. to highlight the importance of having Euroclear S.A. a market infrastructure dedicated to operating the DLT platform and The objective must performing key roles such as ensuring be to develop DLT the integrity of the issuance, managing Making the DLT technology, not the governance, performing the due for itself, but as a diligence, etc. We believe this role of pilot regime a catalyst for a more gatekeeper, which was also supported by the High Level Forum on CMU, success for the EU integrated and could bring additional safety and thus safer CMU. confidence in the new regime.

As a financial market infrastructure, Indeed, creating a space for DLT into the Euroclear is supportive towards the Euroclear has always been supportive regulatory landscape should not only project of setting up a pan-European of the development of new technologies serve the mere objective of developing experimentation zone for DLT, which that could make the financial markets a new technology. It should also bring can indeed be a great additional tool safer and more efficient. On DLT, we benefits for the CMU, contribute to to bring the EU forward in the digital already highlighted the potential of better market integration and help the age. The objective must be to develop this technology in several strategy and development of more cross-border flows DLT technology, not for itself, but as a legal publications, and we are involved of funding. In this respect, the DLT pilot catalyst for a more integrated and safer in different initiatives to explore and regime should be designed in a way that CMU. The political discussions at the leverage its benefits. Like many market avoids creating market fragmentation, European Parliament and European players, we believe DLT has the potential which would be detrimental to issuers Council shall keep firmly this objective.

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countries which have implemented and public sector and the transparency comparable ‘sandboxes’ that allow around such engagement. Nevertheless, for temporary relief from certain the scope of the pilot regime is regulatory obligations in order to limited, i.e. restricted to illiquid promote experimentation particularly securities, subject to a sunset clause in the field of emerging technologies. and participation is only foreseen for CSDs and MTFs (multilateral Previous consultations from the trading facilities). This could create EU Commission concerning new unintended outcomes: technologies showed that many respondents, aside from some of the • Participation is limited to central in- current infrastructure providers, frastructures only: DLT-based net- believe that the existing EU framework works are decentralised networks by is insufficiently technology neutral. design. This implies the redistribution SWEN This could undermine the successful of roles and activities that currently deployment of new technologies such reside across existing market infra- WERNER as DLT. The pilot regime is a way to structure and their users. The pilot re- address this issue: gime does not fully allow for this level Managing Director, Digital Product of experimentation to happen. Development and Innovation, • it recognises the potential need for • There is continued uncertainty about State Street Bank and Trust regulatory change in light of new the exit strategy: there is insufficient technologies, clarity on how a successful business • identifies areas that may be model, developed as part of the The DLT pilot regime insufficiently innovation friendly, pilot, can achieve a general stay once • requires those seeking to create a DLT the pilot regime expires. This may – a path to Europe’s market infrastructures to prove that increase the risk for investors to existing EU rules are incompatible engage in building such models. ‘next-gen’ market with DLT. • National regulators are creating po- tentially more attractive alternatives: infrastructures? various Member States are in the pro- The real success is the cess of amending their national se- engagement model curities law to allow for the creation Distributed ledger technology (DLT) is a created between of securities that are issued in digital foundational technological innovation the private and form using DLT.This may be more at- that could bring long-term benefits public sector and the tractive than the pilot regime to create more efficient markets. The European Commission’s proposed DLT transparency around The pilot regime is a welcomed pilot regime aims to support the digital such engagement. example of how EU regulators can transformation of financial markets. If flank technological innovation with adopted, it would allow the operation of Consequently, the barometer of success regulatory flexibility. However, market infrastructures based on DLT. for the pilot regime is not necessarily additional effort will be needed to its widespread adoption, since the allow for greater levels of decentralised The pilot regime adopts a sandbox regime should only be used if existing market structures to evolve, which will approach to creates certain exemptions regulation would not allow for it. be beneficial to financial markets in from specific requirements embedded Europe and contribute to the efforts of in EU legislation such as MiFID or The real success is the engagement creating a deep and innovative capital CSDR. At present, there are over 50 model created between the private markets union.

between trading and post-trade Improving CSDR processes, with efficiencies passing settlement discipline through from one to the other. to support CMU In that context, the objective of the CSDR Settlement Discipline Regime objectives (SDR) – to increase settlement efficiency in the market and decrease settlement fails – is the right one. We commend The creation of an integrated and the European Commission for recently efficient European capital market – the consulting on the details of the regime goal of the CMU project – is among the to make sure they are fit for purpose. most important goals currently being For example, we believe that a targeted, pursued in the EU. appropriately calibrated cash penalty regime – as currently envisioned in the ALEX DOCKX A crucial element of this framework SDR – will have a positive impact on set- Executive Director, Securities Services is the safety and efficiency of the tlement efficiency on a standalone basis, Industry Development, JP Morgan arrangements required to finalise sufficiently penalising sellers while com- securities transactions. There is a clear pensating buyers for late delivery, ulti- flow in operations and interdependency mately leading to lower settlement fails.

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However, we believe one particular they want on behalf of investors, and volatile, and bid-offers and settlement provision of the SDR – the mandatory thus may have to make sub-optimal failures increase. Furthermore, buy-in regime – risks reducing the investment decisions or may have to pay while negatively impacting all asset efficiency and liquidity of European a liquidity premium. Issuers could also classes, these effects are likely to be capital markets, leading to greater be negatively affected, with issuance disproportionately detrimental to less costs to investing in European ability and pricing related to the actively traded or illiquid securities, securities, contrary to CMU aims. The expected liquidity of the instrument. including instruments issued by SMEs, issue is with the mandatory nature and high yield and emerging markets of the buy-in regime for non-CCP securities, which already suffer from cleared transactions, which makes A mandatory buy-in lower liquidity and higher costs it insufficiently flexible by removing regime for non-CCP of trading. investors’ choices and ignoring cleared transactions the particular liquidity profile of could negatively The result is that a measure which was the securities. impact market meant to improve settlement efficiency and stimulate European capital markets liquidity and increase This is likely to fundamentally impact is likely to come at a high cost. We liquidity providers’ ability to make costs to end-investors. would therefore suggest replacing the markets. To adjust for the expected cost mandatory buy-in regime for non-CCP of being bought-in, market makers may Ultimately, a mandatory buy-in regime cleared transactions with a discretionary have to add a premium to their prices – for non-CCP cleared transactions could one, while keeping a strong and robust widening the bid-offer spread – or they negatively impact market liquidity and penalty regime. Such an approach may simply not make an offer price on increase costs to end-investors. This would significantly improve settlement an enquiry. Asset managers, in turn, could be especially the case in times efficiency in the EU and serve the may not be able to obtain the securities of stress when markets become more ultimate goals of the CMU.

In September 2020, the European Regime, which is a crucial part of the Commission published its Action Plan CSDR and needs further improvement to boost the CMU by tackling some of regarding the buy-ins regime, rules the remaining barrier to a single market on penalties and on the reporting for capital. One of the barriers, which of settlement fails. Rules on buy- hinders the cross-border investments ins should be differentiated by the and transactions, is the fragmented post- markets, instruments and transaction trade landscape or the lack of common types. Also, cleared and non-cleared CSD ecosystem. transactions should have same buy- ins regime to avoid de-incentivising To create a common CSD ecosystem, we central clearing. As for rules on need more simplified and harmonized penalties, negative interest rates should rules such as Central Securities be taken into account and some types Depository Regulation (CSDR), of transactions should be exempted FRANCISCO Settlement Finality Directive (SFD) from the scope. and Financial Collateral Directive just to name a few. For this, we need (i) to Digitalisation, the global trend which BÉJAR clarify and harmonise the passporting is evolving very fast and further Deputy Chief Executive Officer, procedures and enhance cross-border accelerated by the pandemic, is one Iberclear (BME) provision of services, (ii) facilitate the of the European Commission’s six servicing of domestic issuance in non- priorities. Therefore, the European national currencies, and (iii) strengthen Commission’s Digital Finance Package EU securities post- the supervisory convergence among the is very timely and highly welcomed. national competent authorities. trading priorities However, it is important to ensure the level playing field, clarity, and EU needs common proportionality of the new legislations, We are living in an unprecedented time, CSD ecosystem to Markets in crypto-assets (MiCA), socially distanced and heavily relied complete the CMU Digital operational resilience act on digitalization and innovation. Here (DORA), DLT Pilot Regime, and their we are, yet again hit by another crisis interaction with existing legislations. but by health crisis this time which has Indeed, the consultations issued by the paralyzed economies around the globe. European Commission on CSDR and Trading volumes have soared during The world economic and geopolitical SFD are in line with the recommenda- the beginning of the pandemic and the orders will most probably change tions of the High-Level Forum on CMU volatility has gone wild. Yet, financial depending on the policies and strategies and are on the right direction. However, markets infrastructures proved to be countries will and are employing not only to achieve even better results, it is also resilient and functioned smoothly. in order to recover from the pandemic- important to resolve tax-related matters, However, we have to take another led crisis and mitigate the risks but also simplify the CSD links framework and step forward to better CSD legislations to achieve the goals they have set for the employ technological innovations. to create common CSD ecosystem, future. Therefore, we need to complete complete the CMU and thus, contribute the Capital Markets Union (CMU) now In the meantime, we have to to the well being of people in the more than ever, or the stakes are too high. implement the Settlement Discipline European Union.

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assets and digital resilience. Some of markets in the euro area. It has to the proposals are directly targeted to be highlighted all the work done by facilitate innovation and make Europe the Eurosystem in the development a more integrated and innovative of the infrastructure for large-value market while addressing the emerging payments, for post-trading services for risks, namely the “Legislative proposals financial instruments and for instant on crypto-assets to draw on the retail payments and, still to come, possibilities offered by crypto-assets, the provision of a central liquidity while mitigating risks for investors and management system, the development financial stability” and the “Legislative of a single collateral management proposal for an EU regulatory system and the improvement of framework on digital operational the efficiency and safety in cross- resilience – Prevent and mitigate borderpayments. cyber threats”. Despite the relevance of the This package also includes a “Retail abovementioned initiatives, it has Payments Strategy for the EU”, by to be acknowledged that a more which the Commission points out integrated and energetic European that the development of efficient financial market depends also on the international payments, including capacity of the European players to HÉLDER remittances, as well as the issuance compete internationally, to innovate of a Central Bank Digital Currency by and to mitigate the risks arising from ROSALINO the Eurosystem, could enhance the their activity. Board Member, international role of the euro and the Banco de Portugal EU’s ‘open strategic autonomy’.

Third, a communication entitled “The European economic and financial system: fostering openness, strength Are the actions being and resilience” was disclosed on January 2021. Two of its pillars relate taken enough to to strengthen the international role of the euro and to develop further EU support the CMU and financial market infrastructures and increase their operational resilience. to strengthen the This communication includes as a international role key action the promotion of euro- denominated investments, the of the euro? facilitation of the use of the euro as an invoicing and denomination currency and a better understanding of the obstacles for its wider use. At the The European institutions, as well as same time, it also establishes that the national authorities, are taking actions Commission and the ECB will jointly towards a more integrated, harmonized review a broad range of policy, legal and and efficient financial markets in the technical questions emerging from a euro area, and in this way to enhance possible introduction of a digital euro. the international role of the euro. Last, the European Commission The European Commission has announced the revision of both recently launched some important the Central Securities Depositories initiatives. First, in December 2018, Regulation (CSDR) and the Directive the Commission communicated on on settlement finality in payment the need to move “Towards a stronger and securities settlement systems international role of the euro”. In that (SFD). The proposals embedded in the communication, the Commission CSDR and SFD reviews are moving in concludes that “strengthening the the right direction, towards a more international role of the euro will competitive and levelled playing field require the further strengthening of European market. All efforts put on the structures of the Economic and the harmonization of definitions, Monetary Union, including through interpretations and implementation the adoption of all pending proposals issues, as well as streamlining reporting, for completion of the Banking Union are very much welcomed. and decisive progress on the CMU”. The ECB and NCBs are also taking Second, a digital finance package important actions in the market was adopted on 24 September 2020, infrastructure and payments field to comprising a digital finance strategy consistently concur to the increased and legislative proposals on crypto- efficiency and integration of financial

162 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net The Eurofi High Level Seminar is organised in association with the Portuguese Presidency of the EU Council FUTURE STEPS OF THE CMU

CONSOLIDATED TAPE AND SINGLE ACCESS POINT

this article, I would like to highlight two mandatory contribution, sharing of actions of the Commission’s action plan revenue with contributors, appropriate which can stimulate the development funding by users, full coverage and of transparent capital markets: IT-aspects to face the challenge to make it operational in a short time 1) Post-trade consolidated tape for frame. Whilst the AFM is supportive equity and equity-like instruments; of establishing a CTP, we also note 2) and the building of a European Single the practical constraints that should Access Point (ESAP). temper expectations. The operational preparation will take a few years, but if In the AFM’s view, a real-time post-trade the preconditions mentioned above are Consolidated Tape Provider (CTP) is an taken into account, we are confident essential part of the CMU. A CTP would a CTP should have added value for allow consolidation of market data at market participants even without the HANZO VAN low cost, enabling market participants UK participating. to get a comprehensive and accurate BEUZEKOM view of the market and facilitating Another essential part of the CMU is price discovery. the building of a European Single Access Board Member point for companies’ information. Dutch Authority for A CTP is needed to address the negative Therefore, the AFM supports the the Financial Markets (AFM) effects of fragmentation of markets Commission’s initiative in the creation and to counteract the market power of of a European Single Access Point trading venues in selling market data. (ESAP), as financial information is Towards a transparent It would contribute to the CMU and a currently fragmented across different single market in the EU while it would databases in different member states Capital Markets Union supplement best execution policies and difficult to access. for retail investors by improving the availability of common reference A central access point will enhance In September 2020 the European price information resulting from a the accessibility of financial and non- Commission adopted a New Capital fragmented market. Current barriers to financial information. In order to make Markets Action Plan. An important the emergence of an equity CTP are the the establishment of ESAP successful in goal of the action plan is to stimulate limited commercial rewards, the strict the AFM’s view the Commission should market-based finance to sustain the regulatory requirements, competition adopt a phased approach. Whereby in recovery and the long-term growth to by data vendors and problems with the first stage ESAP serves as a platform finance the green and digital transition data quality. to access all public information of of the economy. In order to make companies with securities listed on sound investment decisions, investors We recognize there are some EU Regulated Markets. When this in capital markets must have access preconditions for the establishment is successful, the Commission could to a broad range of information about of an equity CTP like sufficient consider to enlarge the scope of ESAP companies and financial products. In data quality to make it meaningful, to for example non-listed companies.

ESMA fully supports the creation of Increasing CMU’s a single access point to financial and non-financial regulated information, transparency and including sustainability information, fairness – Insights on based on a harmonised digital format. The ESAP is expected to enable cross- the ESAP and the EU CT border investments and enhance the visibility of less known entities, including SMEs. A well-functioning and integrated market for capital across the EU To achieve this aim, the ESAP needs requires a high level of transparency to (i) be implemented in a progressive and the accessibility of comprehensive way (to avoid the risk of building an and reliable information. As outlined overly complex and thus inefficient in its CMU action plan, the European architecture), (ii) cover comparable VERENA Commission intends to cope with this information rendered in machine challenge by establishing a European readable format (giving cross-border ROSS Single Access Point (ESAP) for corporate investors access to easily consumable Executive Director, European Securities disclosure and an EU Consolidated data), and (iii) be underpinned by a and Markets Authority (ESMA) Tape (CT) for market data. clear data governance accompanied

164 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net CONSOLIDATED TAPE AND SINGLE ACCESS POINT by data checks (to ensure the highest providers but left the creation of a CT need to be met, notably the mandatory quality of the data and the protection open to a market-led initiative, which contribution of high-quality data of investors). did not materialise. It appears that by trading venues and Approved the lack of commercial and regulatory Publication Arrangements (APAs), the Given its expertise and its extensive incentives for potential providers, sharing of revenues with contributing experience in designing and managing the competition of unregulated data entities, the operation of the CT on an large scale EU-wide public IT and data vendors as well as shortcomings in exclusive basis, and the definition of a systems, ESMA is in an ideal position the quality of OTC data prevented strong governance framework. to setup and run the ESAP. Of course, its emergence. the project needs to be matched with The Commission is expected to soon adequate resources. clarify its proposals on both projects. ESMA stands Regardless of the approach taken, ESMA Together with the ESAP, ESMA views ready to assist the stands ready to assist the Commission a CT for equity as a must-have feature Commission with its with its expertise to create the ESAP of the CMU, to enable investors to expertise to create and the EU CT that will move the EU access meaningful information at pan- the ESAP and the EU closer to a fully-fledged CMU. European level. The creation of a real- time post-trade EU CT for equities will CT that will move the In a wider perspective, this commit- give a reliable view of liquidity across the EU closer to a fully- ment is in line with ESMA’s objectives Union and mitigate the fragmentation fledged CMU. and priorities, including the support of markets. of the sustainable finance and digital- isation agenda, as well as the need for Looking back, MiFID II laid out Now, looking ahead, to reap the full transparency and data quality in securi- the requirements applicable for CT benefit of an EU CT certain conditions ties markets.

is yet to emerge, notably due to a lack of to outweigh the costs that would be business incentives and the existence of incurred to make it viable operationally. several barriers such as data quality. Instead, the first building block could However, this consolidated tape could be to first set up a real-time post-trade provide much needed transparency transparency tape consolidating relevant on where and how trades happened. It data from trading venues, systematic could not only ensure market players are internalisers, and approved publication able to determine where liquidity lies, arrangements reaching a significant to monitor trades appropriately and to market share in the relevant asset classes. perform transaction cost analysis, but it could also help them manage risks or Similarly, in order to ensure an efficient document their best execution policy. mechanism from its inception, it could cover equity instruments first, and once NATASHA The upcoming review of the MiFID operational, be broadened to cover II framework and in particular MiFIR bonds and derivatives. transparency rules, is an opportunity CAZENAVE to remove the existing obstacles An appropriate framework bringing Managing Director, (whether these come from MiFID or together all providers and users of Head of Policy and International not) and provide the right framework the consolidated tape (CT) data could Affairs, Autorité des Marchés for the emergence of a European help ensure maximum support for Financiers (AMF) consolidated tape. the project. In particular contributing participants could be entitled to a share of the CT revenues, for example through The first building an appropriate redistribution fee It’s time for a post- block could be to determined based on their contribution. first set up a real- Furthermore, transactions that do not trade data tape time post-trade contribute to price formation, such as transparency tape. transactions benefiting from a pre-trade transparency waiver (e.g. technical In light of the implementation of MiFID trades), might not provide entitlement II and amid a highly fragmented trading What type of consolidated tape could be to any remuneration. environment in Europe, the need for a contemplated? consolidated view of trade data remains Importantly, the CT’s governance and unaddressed. Some have advocated for a pre- financing structure could also take into trade consolidated tape enabling account the current lack of data quality. Such a consolidated view of trade real-time order routing and offering As an example, any entity reporting transparency, the so-called consolidated a live European best bid and offer. poor quality data could be penalised. tape (CT), is to date the missing part of However, given the competitive trading European financial markets. Despite environment and the high volume of Let us hope the Commission will put MiFID II setting a dedicated framework orders, at this stage the advantages forward an ambitious proposal in the for such a tape to operate, the tape itself of such a pre-trade tape do not seem coming months.

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identified the core benefits of a Numerous academic studies demon- consolidated tape (CT) in equity strate that increased post-trade trans- markets, including improved price parency, in the form of real-time pub- transparency, greater competition, and lic reporting of transaction prices and enhanced information for investors. sizes, narrows bid-ask spreads and en- A CT would also increase resiliency by hances liquidity. providing reliable reference prices to support uninterrupted trading even First, this transparency empowers in the event of an outage at a primary investors to accurately assess execution trading venue. quality, demand accountability from liquidity providers, and obtain Likewise, in its January 2021 roadmap best execution. Second, it removes to foster the openness, strength and information asymmetries and allows resilience of Europe’s economic and all liquidity providers to better manage STEPHEN financial system, the Commission risk, and in turn, more confidently quote highlighted how a CT in the non-equity prices, commit capital, and warehouse BERGER markets would encourage trading risk across all market conditions. to take place on transparent trading Finally, real-time public reporting Managing Director, platforms, increase market depth, and makes markets more resilient, especially Global Head of Government & make EU markets more attractive for in times of stress, by ensuring that new Regulatory Policy, Citadel both issuers and investors. information is efficiently assimilated and reflected in current price levels. The myriad benefits of CTs for Consolidated tapes each of the equity, bond, and OTC In parallel, the Commission and ESMA derivatives markets far outweigh the should remain committed to resolving for equities, bonds implementation costs. Further, the the current deficiencies they have wisely diverse beneficiaries far outnumber identified with respect to the scarcity, and OTC derivatives the limited cadre of trading venues and quality, timeliness, and accessibility intermediaries who, despite casting of MiFID II post-trade transparency are key to enhancing doubt on CTs, remain well equipped data for bonds and OTC derivatives. to compete in a more transparent For example, the vast majority of off- the efficiency, marketplace. venue OTC derivative transactions with systematic internalisers are competitiveness Experience in North America with currently entirely exempt from MiFID CTs that are appropriately tailored to II transparency requirements. and resiliency of EU their respective asset classes provides overwhelming evidence of their value Policymakers and market participants capital markets and viability. To begin with, EU real-time have repeatedly highlighted the critical post-trade CTs should be developed for role of CTs in achieving truly integrated equities, bonds and OTC derivatives. EU capital markets. The MiFID II The European Commission has They should be comprehensive, require review provides a crucial opportunity correctly concluded that a “true single mandatory contribution of both on- and to finally realize the benefits of CTs market cannot exist without a more off-venue transaction data, disseminate while also addressing underlying integrated view of EU trading”. In its information immediately upon receipt, shortcomings in the transparency September 2020 Capital Markets Union and allow only targeted and limited regimes for the equity, bond and OTC (CMU) action plan, the Commission deferrals for larger sized trades. derivative markets.

MiFID II anticipated a commercial entity A principled producing a Consolidated Tape (CT) and being authorised as a Consolidated compromise, not Tape Provider (CTP). Yet, as everyone is painfully aware, no commercial compromised entity has taken up this ‘opportunity’. Understanding why this is the case principles, can is critical to ensuring the upcoming revision of MiFID reflects the lessons to deliver a CTP be learned from this experience.

In my last EUROFI article of Despite being the legislation’s objective, September 2020 I discussed the value of a reasonably large part of the community transparency data in Fixed Income (FI) understands that commercial entities markets where I concluded that solving will not seek to be CTPs as there is no NICHOLAS the ongoing issues around post-trade commercial rationale for them to do so. data would provide the most meaningful Far fewer people understand why. BEAN return. In this article I would like to Head of Electronic Trading Solutions, highlight the challenges of MiFID II in Running a CTP presents five key Bloomberg bringing such FI data to the market. challenges to commerciality: product

166 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net CONSOLIDATED TAPE AND SINGLE ACCESS POINT quality, product latency, product scope, Product scope: The vast majority of public domain material. Therefore, you product value and competition from Government Bonds do not produce can pay for data at 40 320 minutes or Approved Publication Arrangements per trade prints. Corporate Bonds do receive it at no cost from 40 335 minutes. (APAs) and Trading Venues (TVs). have per trade prints but only circa 3% of transactions do so immediately. The Competition from APAs and TVs: Product quality: Data sources (APAs and remaining 97% do so approximately ‘Cost+’ is shorthand for the ‘cost of TVs) publish information of variable four weeks after execution via the producing and disseminating data and quality and conformance. However, deferral’s regime. may include a reasonable margin’. Per the market expects a CTP to provide the current rules, an APA or TV would uniform aggregated data. Thus, to meet have to sell data to a CTP at cost+. Thus, this expectation a CTP would have to Would you pay at when a CTP resells the data it would do expend significant cost to clean and 4 weeks or take it so at cost++ which may outweigh the standardise the data. for free at 4 weeks expense of collecting the data directly and 15 minutes? from a short list of key APAs/TVs. Product latency: A Systematic Internal- iser sends data to an APA, which pub- In closing, while these challenges explain lishes it to the market. A TV publishes Product value: A CTP can only monetise why a CTP has not emerged under the its own transparency data to the market. trade-prints in the first 15 minutes of current regime, it is still possible for publication. Considering the Corporate a commercial entity to provide a CT CTPs will always publish data after both Bonds and deferrals issue set out above, to the market. We just need to work an APA and a TV as it goes through the this means that from 0 minutes to 40 with the likely commercial candidates technical steps of collection, cleansing 320 minutes the majority of meaningful - as well as users - to find a principled and republication. Thus, any latency trade prints are deferred, from 40 320 compromise, without compromised sensitive customer will go directly to to 40 335 minutes the CTP can sell the principles, within a revised regulatory the ‘source’. data, and from then onwards the data is framework.

to date, Europe still does not have an Realising the consolidated tape should authoritative, comprehensive solution therefore be an important priority for any asset class. for EU policymakers and financial market participants, and an integral Its continued absence represents part of CMU. In line with the impetus a market failure and a hurdle to of the CMU Action Plan, we believe a achieving the Capital Markets Union. single consolidated tape provider per Delivering it would bring many benefits asset class should be mandated and to Europe’s evolving capital market, overseen by ESMA, with clear delivery market participants and, crucially, guidelines and technical specifications. end-investors such as retail savers and Inconsistencies in market data reporting pension funds: investors would have and distribution arrangements must be a full picture of the market when they fixed, and fair commercial arrangements make trading and investment decisions; overseen by robust governance processes DANIEL risk managers the ability to assess put in place. liquidity faster and more transparently – particularly important during We see the delivery of a consolidated MAYSTON stress events like last year’s; and retail tape following a three-stage process, Head of Market Structure investors transparency into fair prices with a real-time post trade tape and Electronic Trading, on all venues, with more visibility of for equities and ETFs coming first; BlackRock the ‘value for money’ which they receive followed by an extension to bonds from their service providers. and other instruments; and – in time – the development of a pre-trade European Best Bid and Offer metric. Now is the time to The ongoing A pre-condition of achieving this will review of MiFID II be to facilitate high quality source deliver the European provides an excellent data through pre-defined standards; a opportunity to make regulatory framework that mandates consolidated tape the EU consolidated contributions to the tape and shares its revenue equitably; and the underpinning tape a reality, rather of strong governance arrangements. The past two decades have seen than an ambition. successive pushes to make European The ongoing review of MiFID II capital markets more transparent. It would deliver ecosystem-wide benefits provides an excellent opportunity The first iteration of MiFID in 2004 by addressing the current challenge to make the EU consolidated tape a significantly increased post-trade data of increasingly costly and complex reality, rather than an ambition – and in availability. The introduction of MIFID licensing requirements for market data; doing so improve savers’ and investors’ II and MiFIR gave a second push towards by making regulatory initiatives more confidence and outcomes; allow a full standardisation with the ultimate aim of data-driven; and by reinforcing trading view of the single market for capital; ‘setting the conditions’ for the emergence resilience and continuity in the event of and drive its competitiveness at the of consolidated tape providers. But exchange or venue outages. international level.

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the basis of which it recommended the a solution based around an end-of-day establishment of a real-time post trade execution analysis file would satisfy CT in the first instance, followed later these requirements. by a real-time pre-trade CT. However, the overwhelming majority of the An end-of-day execution analysis file use-cases identified, which are already containing post-trade data enhanced serviced today by existing vendor or with trade sides and available volume in-house solutions, do not require a at execution time would represent the real-time CT and could be met by the most appropriate solution to address creation of an end-of-day tape. the need for consolidation. Such a file would cover 100% of data sources and carry post-trade data together with An end-of-day execution information on liquidity available at analysis file would execution. It would enable market NICOLAS represent the most participants to assess fragmentation appropriate solution. and available liquidity across venues, RIVARD as well as to support execution analysis allowing investors to validate the Head of Advanced Data Services, It is important to underline that there execution provided by their brokers. It Euronext are a myriad of issues one must consider would constitute a distinct offering and when looking at a real-time CT: (i) a would not burden market participants real-time pre-trade CT would, given the with duplicative costs. An end-of-day number of venues in Europe, advertise a misleading sense of liquidity, which, In any event, a number of principles must execution analysis were it to be used for best execution underpin any CT, notably it should: (i) purposes, would create a flawed and cover 100% of data sources (venue and file – an effective easily gameable benchmark to the OTC) to maximize transparency, (ii) be detriment of investors, especially retail; underpinned by improved data quality, solution to the and, (ii) a real-time post-trade CT would, and (iii) be based on the principle of while not raising the same level of mandatory contribution and mandatory identified use-cases policy concerns as real-time pre-trade, use by all market participants, including be costly to set up and manage but also mandatory payment. divert precious time and resources from Given the current trading landscape, key initiatives that would strengthen As a pre-requisite to any form of it is imperative to consider the added the EU’s capital markets. consolidation, it is essential to radically value of a mandated consolidated tape improve practices in terms of data (CT) for equities compared to existing Instead, it is our view that policymakers completeness, accuracy and timeliness solutions. The question of use-cases is should focus on a scope design of reporting, as well as establishing the critical starting point. which balances meeting as many of standardised practices in the flagging of the identified use-cases as possible, trades and granularity of time stamps A study produced for the European against avoiding potential problematic across all data sources. It is paramount Commission by Niki Beattie and policy evolutions in respect of best that this type of work be headed by an Market Structure Partners identified execution and achieving a cost effective independent and neutral body, such and analysed 14 use-cases for the CT on outcome for the industry. Fortunately, as ESMA.

168 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net NEXT EUROFI EVENTS

THE EUROFI FINANCIAL FORUM 2021 8, 9 & 10 SEPTEMBER 2021 LJUBJANA – SLOVENIA

THE EUROFI HIGH LEVEL SEMINAR 2022 23, 24 & 25 FEBRUARY 2022 PARIS – FRANCE

THE EUROFI FINANCIAL FORUM 2022 7, 8 & 9 SEPTEMBER 2022 PRAGUE – CZECH REPUBLIC FUTURE STEPS OF THE CMU

RELAUNCHING SECURITISATION

and liquidity upgrade, can help deepen term considerations, wehave to admit the Capital Markets Union. Banks that the securitisation framework has that outsell or protect assets through not reached all its promises yet and still securitisation may benefit from liquidity needs some fine-tuning to help support and/or preferential risk weights and get its revival. more flexibility to provide funding to the real economy. However, securitisation is Refining the securitisation regulatory a complex product that can endanger the framework remains a priority. Securi- financial stability when inappropriately tisation, in its well-designed form, may used and hence deserves a robust be part of the solutions to face post framework. Covid-19 crisis challenges, such as: ac- companying NPL off-loading, capital To this end, increased attention has freeing, through an efficient significant been paid to the regulation of the risk transfer (SRT) assessment, and fur- DOMINIQUE EU securitisation market in the wake ther expansion of the ABCP segment of the Great Financial Crisis. A new in order to support the European real LABOUREIX simple, transparent and standardised economies and meet their financing (STS) framework has been adopted to needs. Developing green securitisation Secretary General, Autorité de Contrôle fix the weaknesses identified during is also a promising tool. Accordingly, EU Prudentiel et de Résolution (ACPR) this crisis. This framework has been regulators should continue improving crucial in strengthening the investors’ the framework by implementing a risk- confidence. EU legislators also intend to based approach, consistently with finan- Deepening the EU improve further the framework in 2021 cial products subject to similar credit, by introducing (i) a more risk sensitive liquidity and agency risks. This would securitisation market: approach to deal with the securitisation facilitate origination and investment of non-performing loans and (ii) a in a wider range of operations. Areas of a key step for the differentiated regulatory treatment of improvements may include: (i) develop- STS synthetic securitisations. ing a EU label for sustainable securitisa- Capital Markets Union tions; (ii) removing remaining barriers, However, the market has not yet fulfilled through a careful risk sensitivity eval- its potential. In 2020, primary public uation, by reassessing the calibration Securitisation can play a decisive role ABS issues in Euro fell by ca 40% from of capital and liquidity requirements to support the objectives of the Capital 2019 (from €39 bn to €22 bn). The low to encourage investments by banks Markets Union but needs to be properly level of holdings by insurers is also and insurers. regulated to address financial stability a striking feature. Although the new considerations. The EU financing framework entered into force in January The upcoming reviews of Solvency II and market still relies heavily on banks. 2019, the market is far from mature. the securitisation framework provide Securitisation, through diversification The Covid-19 crisis has played a role in the ideal opportunity to progress on of funding sources, risk diversification this regard. However, apart from short- these questions.

them. Insurers and pension funds Securitisation: an should have the opportunity to invest in securitisations. Indeed, where appropriate treatment justified Solvency II makes a risk-based distinction in its treatment of spread to ensure policyholder risk between asset classes.

protection EIOPA provided advice on the recali- bration of spread risk charges for the What is special about securitisations identification and calibration of infra- is that they should not be special. In structure investments in September other words, the prudential framework 2015 and infrastructure corporate in- for insurers, including capital vestments in June 2016; on reducing charges, should reflect the riskiness reliance on external credit ratings and of the securitisation. Only through the treatment of exposures to regional FAUSTO such treatment can the principal governments and local authorities in aim of protecting policyholders be October 2017; and on the treatment of PARENTE best realised. unrated debt in February 2018. Executive Director, European Insurance and Occupational Not treating securitisations does EIOPA provided advice on more Pensions Authority (EIOPA) not mean discriminating against favourable but still prudent treatment of

170 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net RELAUNCHING SECURITISATION securitisations as long ago as 2013. EIOPA What is special All these measures reflect that proposed a category of securitisations securitisations are likely to be a with lower capital requirements as about securitisations relatively small – 2.4 per cent of overall there is clear evidence that many is that they should investments by insurers at end-2019 – securitisations displayed lower spread not be special. but material area for insurers. volatility and performed well from a fundamental credit risk perspective. Ensuring a well-functioning and stable EIOPA’s most recent review of the EU’s insurance sector is part of a robust This advice was subsequently imple- prudential framework for insurance did financial services sector in Europe. A mented. These qualifying securitisa- not recommend disturbing the current risk-based regulatory framework is tions have to meet a number of crite- treatment of securitisations nor indeed fundamental to achieving this and to ria on their structure, the quality of the treatment of spread risk more ensuring, both policyholder protection the underlying assets, underwriting generally. Nonetheless, securitisations and policyholder trust in the sector. processes, and on transparency. In the will benefit from some broader meantime, insurers among others have changes being proposed. For example, EIOPA’s advice and activity on the areas benefitted from the introduction of one recommendation is to simplify of securitisation will always follow simple, transparent and standardised the calculation of the risk mitigating these considerations so that Europe’s (STS) securitisations, though use has impact of a number of techniques insurance sector works for the benefit not yet been significant. including securitisations. of people, business and society.

expansion of the market to the benefit As markets and policy makers gain of companies and the economy as experience with the framework, we also a whole. note that the appetite for its reviewis growing. The Council Conclusions As one of the priorities of the CMU on the renewed CMU Action Plan project, the EU aimed to do just that mentioned a review of the securitisation with the securitisation framework framework as one of the important and that became applicable on 1 January urgent deliverables for 2021. This was 2019. The new framework is meant to echoed also by the European Parliament promote the revival of the EU market, in its own initiative report on the CMU in particular through the creation of from September 2020. the STS (Simple-Transparent-Standard) quality label and the prudential benefits In any event, the legislation in force attached to it, while also drawing the requires the Commission to review PAULINA lessons from the financial crisis by the functioning of the securitisation adequately protecting investors and framework and deliver a report to the managing potential systemic risks. legislators by 1 January 2022. Like the DEJMEK HACK CMRP, the upcoming review – and any Director for General Affairs, legislative proposals that may follow DG for Financial Stability, Financial Regulation and – will have to be based on thorough Services and Capital Markets Union, supervision need to preparatory work by and input from European Commission walk the fine line the European Supervisory Authorities. of ensuring that we Further technical work should draw the lessons identify areas where the rules could be improved in order to foster the market, from the crisis while What is next for EU without compromising on investor and supporting expansion consumer protection. securitisation? of the market. While we are still gaining experience with the framework and its practical When structured in a sound way, Last December’s agreement on the effects, the review will be the next securitisation provides a tool for Capital Markets Recovery Package important stepping-stone for the efficient risk and capital management, (CMRP) amplifies the potential market after the CMRP. The review diversifies funding sources for banks benefits that securitisation can bring will also look at the important issue and companies and enables a broader for the economy by extending the STS of green securitisations, to see what range of investors to fund the economy. label to on-balance-sheet (synthetic) can be done to encourage this market However, as the Global Financial securitisations and removing regulatory segment to grow further and support Crisis demonstrated, poorly regulated obstacles to the securitisation of non- the green transition. securitisation can be a source of risk for performing loans. the financial system. The Commission stands ready and is The swift conclusion of the political looking forward to the work with the Therefore, regulation and supervision trilogues shows that the legislators European Supervisory Authorities and of securitisation need to walk the fine share the Commission’s ambition to all relevant stakeholders to continue to line of ensuring that we continue to revive this important market, provided develop EU’s securitisation framework draw the lessons from the crisis so that legislative proposals are based in the context of the CMU and beyond. that risks do not re-emerge while, at on a solid analysis and thorough the same time, supporting a beneficial preparatory work.

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comparability in structures and reporting. Finally, securitisation is growingly used Since its entry into force in 2019, STS has in sustainable green finance. Social been largely adopted for asset classes by securitisation is also emerging as a way design eligible to STS. Significant effort to support disadvantaged borrowers or has been made in reporting for public projects with social utility. and private transactions and ABCP. Which priorities to improve Public volumes falling short the situation of expectations While securitisation is well equipped In 2020, publicly placed issuance was to support the CMU, its development €81.4bn after €116.8bn in 2019 and is hindered by significant obstacles. In €135.8bn in 2018 (record year post crisis). order to make it attractive to banks, it Overall, €194.7bn of public securitisation must remain economic and manageable. NATHALIE was issued in 2020, a decrease of 10.4% Therefore, measures should focus on from 2019. 2019 was a transition year for ESNAULT adapting to the new framework. 2020 • Reducing punitive capital charges: has been clearly hit by the pandemic, measures should focus on reducing the Managing Director Securitisation, especially placed issuance. non-neutrality of the capital regime Crédit Agricole CIB and lowering capital floors for senior More fundamentally, bank-led securiti- tranches. Solvency 2 should also be sation issuance is impacted by the avail- recalibrated, in particular for STS; Securitisation at ability of cheaper alternatives like the TL- • Facilitating significant risk transfer TRO scheme of the ECB, which has been (SRT): the process for SRT should the service of the loosened again and extended until 2024. be improved to ensure consistency and better predictability. Visibility is European economy also needed on key features such as Banks need well- synthetic excess spread; functioning securitisation • Improving liquidity treatment (LCR): While significant progress has been made in their toolbox to securitisation should be treated to restore the place of securitisation in contribute to recovery equally to covered bonds – e.g., senior Europe, securitisation issuance fell under and assist in the strategic STS qualified as Level 1 for most €200bn in 2020, its lowest level since liquid assets; 2013. This is explained by conjectural redeployment of their • Revisiting disclosure requirements: reasons like the pandemic but there are balance sheet. full disclosure templates should apply fundamental reasons at work. only to public issues in line with the Strong latent potential proportionality principle. Tremendous effort to restart the market Public volumes do not reflect the Generally, measures should ensure EU securitisation has been significantly entire market. Banks often use private level playing field with other products reshaped after the financial crisis and the securitisation for managing their and sustainability of the operating subsequent adoption of new regulations, balance sheet. Private securitisation also environment over time. EU banks need providing notably for a new label for accommodates diverse non-bank issuers well-functioning securitisation in their “simple transparent and standard” (STS) and asset classes (transport assets, trade toolbox to contribute to recovery and securitisation. New regulation was also receivables etc.), with banks providing assist in the strategic redeployment of needed to overcome deficiencies, in critical funding to this market, directly or their balance sheets. particular a lack of risk alignment and through ABCP.

RMBS supply declined to reach €45bn EU securitisation in 2020 (down almost 40% in the last 5 years), while annual mortgage covered revival requires CMU bond supply varied between €412bn level-playing field and €612bn in the last decade. Other ABS volume has been volatile around the €50bn mark from one year to the Re-launching the securitisation market next. The potential introduction of ESN has been a long-standing objective in (e.g. auto loan covered bonds) will likely the context of the deepening of the EU replicate the negative experience of CMU. Measures adopted in recent years prime RMBS issuance in auto ABS space. with much fanfare have not delivered the desired results. The market data We must note the increase in direct informs us that 2020 recorded a third- loan portfolio investments by year-in-a-row decline in both placed insurance companies and pensions ALEXANDER and retained securitisation volume. fund, eschewing the more protected STS framework has been in operation and liquid structured finance bond BATCHVAROV for about 2 years now, but we are yet to format. We are also observing a shift Managing Director, Global Research, see a pick-up in its use by new issuers. away from use of securitisation to Bank of America Over the years total prime Euro area use of credit claims pools as general

172 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net RELAUNCHING SECURITISATION collateral since the changes that ECB charging the post-pandemic recovery, must reflect the strong credit, price introduced in April 2020. We observe transitioning to a sustainable economic and liquidity performance of EU a declining use of prime quality asset model and in response to Basel 3 roll- securitisation bonds without much cash securitisations with the increase of out. Last year the High Level Forum on external support when compared synthetic balance sheet securitisations, CMU prioritised the steps necessary to with instruments that were subject including that of SME loans thanks to achieve that goal. to very favourable - in every respect - the support of EIB/EIF. That contrasts regulatory treatments. The systemic with the pick-up in NPL and in non- risk consideration of the use of conforming (non-prime) mortgage Undeniable need for such other instruments should not loan securitisations, along with higher- a level playing field be overlooked. yielding leveraged and commercial real across capital markets estate loans. instruments on the EU In short, the revival of the securitisation capital markets. market in the EU requires as a minimum The decline of broadly available a realignment of its regulatory, securitisation market expertise and political and monetary treatment with its concentration in a small group Without enumerating them here, we that of other fixed income markets. of investors is underway; a smaller emphasise that they are only partly Additional targeted support for investor base is a challenge to the EU addressing the undeniable need for a certain securitisation market sectors securitisation market revival. level playing field across capital market (SME, project finance, green and instruments on the EU capital markets social finance) is necessary to help EU In many EU quarters there is a support in terms of their political, capital, securitisation achieve its full potential for securitisation market re-launch as liquidity and monetary treatment. The for the benefit of the EU economy and part of the deepening the CMU, turbo- regulatory treatment of securitisation the long-term objectives of EU CMU.

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DIGITALISATION AND PAYMENTS

ISSUES AT STAKE

Digitalisation, electronic payments and new technologies such as DLT, crypto-assets, AI and cloud services are key drivers of innovation, agility and efficiency in the EU financial sector and may also facilitate its integration. These innovations also bring many changes in the financial ecosystem that raise new questions in terms of level playing field, consumer protection and sharing of responsibilities between regulated financial players and third- parties. They also face regulatory and non-regulatory barriers that may hinder their development at the domestic and cross-border levels.

The Digital Finance Strategy (DFS) proposed by the Commission aims to support this transformation by adapting the financial framework to this increasing digitalisation, identifying measures that may support a further digitalisation of the sector and also addressing possible new risks and level playing field issues related to digitalisation. The DFS is part of a broader Digital Finance Package that includes measures targeting crypto-assets (MiCA), DLT market infrastructures (the DLT pilot regime) and instant retail payments (the retail payments strategy), as well as a framework for digital operational resilience (DORA).

Establishing a common European financial data space that may facilitate an appropriate access to and sharing of financial information among market stakeholders is a further objective for promoting data-driven innovation in the financial sector. DIGITAL FINANCE STRATEGY...... 176

Marcel Haag - European Commission / Harald Waiglein - Federal Ministry of Finance, Austria / Isabel Guerreiro - Banco Santander / Bjørn Sibbern – Nasdaq / Märten Ross - Ministry of Finance, / Sebastien Raspiller - Ministry of the Economy, Finance and the Recovery Plan, France

FINANCIAL DATA SPACE AND CLOUD INFRASTRUCTURE...... 182

Joachim Wuermeling - Deutsche Bundesbank / Tsvetelina Penkova - European Parliament / Christopher Buttigieg - Financial Services Authority / Ksenia Duxfield-Karyakina - Cloud / Daniel Kapffer - DekaBank

ADAPTING THE FINANCIAL FRAMEWORK TO DIGITALIZATION...... 186

Fernando Restoy - Financial Stability Institute / Rui Peres Jorge - Portuguese Securities Market Commission / Stephane Janin - AXA Investment Managers / Francesco Ceccato - Europe

CRYPTO-ASSETS AND STABLECOINS...... 190

Benoît Cœuré - Bank for International Settlements / - Deutsche Bundesbank / Marcel Haag - European Commission / Roeland Van der Stappen - VISA Europe

CROSS-BORDER PAYMENTS GLOBAL ROADMAP...... 194

Denis Beau - Banque de France / Tara Rice - Bank for International Settlements / Giuseppe Grande - Banca d’Italia / Marc Bayle de Jessé - CLS Group / Peter Bucher - Western Union International Bank GmbH / Ulrich Bindseil - European Central Bank

EU RETAIL PAYMENT INITIATIVES...... 198

Burkhard Balz - Deutsche Bundesbank / Juan Ayuso - Banco de España / Maria Velentza - European Commission / Stéphanie Yon-Courtin - European Parliament / Fiona van Echelpoel - European Central Bank / Marcel Haag - European Commission / Joachim Schmalzl - Deutscher Sparkassen- und Giroverband / Juan Orti - American Express / Martina Weimert - EPI Interim Company SE / David Watson - SWIFT / Charlotte Hogg - VISA Europe DIGITALISATION AND PAYMENTS

DIGITAL FINANCE STRATEGY

authorisation and passport system and a help European financial firms’ scale unified set of rules, the EU is in a unique up their digital operations; position to encourage innovation and development in this sector. 2. ensuring that the EU regulatory framework facilitates digital innova- Digital finance offers significant tion in the interest of consumers and benefits to consumers and society. It market efficiency; can promote inclusion, increase digital 3. creating a European financial data and financial literacy and empower space to promote data-driven consumers by increasing choice and innovation, in order to encourage the maximising control over their data. creation of innovative products for Financial technology has the potential consumers and businesses; and to turn Europe into a global leader in digital finance, allowing us to shape 4. addressing new challenges and the values that underpin developing risks associated with the digital technologies. transformation.

The Covid-19 pandemic has emphasised The Digital Finance Strategy is the importance of digital finance. accompanied by legislative proposals Online identity verification has enabled on crypto-assets and digital operational MARCEL consumers to open accounts and use resilience, as well as a Retail multiple financial services at a distance, Payments Strategy. HAAG while growing numbers of consumers Director, Horizontal Policies, use digital in-store payments and make The Commission’s data-driven agenda DG for Financial Stability, Financial online purchases. The pandemic has connects the Digital Finance Strategy Services and Capital Markets Union, demonstrated that consumers and with the European Data Strategy. A European Commission businesses alike are ready to embrace common financial data space will digital financial services. unlock the opportunities of data sharing in finance. Our priorities are to introduce standard formats for the disclosure of company and financial data, to support the uptake of innovative Promoting the digital Europe must seize tools to facilitate supervisory reporting by regulated entities and to boost data transformation of the benefits of Digital sharing in the financial sector and finance for European beyond by expanding the Open Finance Europe’s financial consumers and framework currently limited to the Payment Services Directive. services sector: companies, while monitoring its risks. This will build on the crosscutting data harnessing framework to remove barriers across economic sectors, consisting of the opportunities and 2020 legislative proposals on a Data Governance Act and a Digital Services/ managing risks In September 2020 the European Markets Act, and the proposals for a Commission published its Digital Data Act coming up for 2021. Finance Strategy. The Strategy takes into account the recommendations Across the four priorities of the The European Union is set to fully of the Expert Group on Regulatory Digital Finance Strategy, alongside embrace digitisation in financial Obstacles to Financial Innovation the proposals of the Digital Finance services. We are well-positioned to reap (a public consultation among 400 Package, the Commission will the benefits that the digital revolution stakeholders) and a series of 30 online promote digital finance and harness offers to consumers, service providers webinars gathering 6,000 people from its opportunities for consumers and and the wider EU economy, while across Member States that took place the financial sector alike. At the same at the same time ensuring that the during the course of 2020. time, we will ensure that consumers increasingly digital financial system are protected and that the increasingly works safely. The Strategy sets out four priorities for digitised financial system functions promoting digital transformation of safely for the European economy as The adoption of financial technologies the financial sector up to 2024: a whole. is a major economic opportunity that stands to boost Europe’s 1. tackling fragmentation in the Digital competitiveness and growth. With a Single Market for financial services, single market of 27 countries and 450 in order to help European consumers million customers, along with a single to access cross-border services and

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sector is paramount. This will appropriate tools in order to execute facilitate the upscaling of Europe’s them in a proportionate manner vibrant FinTechs and promote data treating all market participants equally. protection which is a prevailing A level playing field should also be topic due to uprising cloud service provided in an ever more digital world providers. Therefore, we welcome the of financial services. Commission proposals put forward in the Digitial Finance Package. Yet, the A good example is Open Banking. As future regulatory frameworks need to Big Data was already in the past and will be technology neutral and future proof in future be the driver of many digital as the pace is high in the digital sector finance developments, PSD II was a and new technologies are emerging major step taken by the EU legislator on a constant basis. Especially, DORA in order to explore the concepts, will contribute to a safe environment address the right issues and unleash the for digital services around financial potential of financial data. Now it lies institutions. MiCA on the other hand with the customers to make use of it. is already internationally rewarded Technical interfaces will facilitate the as a standard setting framework in exchange of this data. This might help the sphere of crypto-assets. Another preparing the ground for new business priority addresses artificial intelligence models – hopefully many European HARALD in the financial sector. In this context, companies and Citizens will benefit. On we should not forget the strong the other hand, we shall not overlook WAIGLEIN interconnectedness across sectors that also other big players, especially Director General for Economic Policy, that goes hand in hand with artificial Big Tech firms possess extensively Financial Markets and Customs Duties, intelligence. Thus, the bigger picture of valuable data that should mutually Federal Ministry of Finance, Austria digital services should always be taken be readily available, at the request of into account. the customer.

Smart contracts and the ecosystem sur- Summing up, legislators and regulators rounding these should not be underes- need to closely follow technical timated in the regulatory framework as developments in digital finance and DFS – Striking a the field is rapidly evolving and risks are draw the appropriate and proportionate not yet fully assessed. In this context, conclusions at the right moment. We balance between innovative phenomena such as DeFi know it best, it’s a balancing act. should be thoroughly examined in or- fostering innovation der to understand the concepts and the technology and potentially address and a level them on European or even internation- al level as borders are almost non-exist- playing field ent in this realm while of course pre- serving the dynamic setting.

“The future of finance is digital” are the introductory remarks of the Digital Finance Strategy put forward by the The acceleration Commission in September 2020. The Covid-19 pandemic has shown that of digitalisation this is a matter of fact, nowadays more across sectors is vital than ever. Digital financial services in the upcoming played a key role to avoid even more social and economic damage across Digital Decade. the globe in the current crisis. There is no doubt that fostering digital finance will support Europe’s economic resilience and recovery. Therefore, the “Code is law” is a well-known quotation acceleration of digitalisation across ascribed to Lawrence Lessig, US sectors is vital in the upcoming Digital professor of constitutional law. In many Decade. Strengthening our strategic fields of digital finance, we see aspects autonomy in digital financial services of this doctrine. Think of Bitcoin for will support Europe’s position in example. No court, no competent the worldwide economy and avoid authority is able to enforce a rightful dependencies which in turn contributes judgement if it is not compatible with to European democracy. the code. If a private key is lost, no judge will move a bitcoin. Decentralisation, The proposed priorities in the Digital in some cases, renders lawmakers and Finance Strategy hit the bullseye. authorities stranded. But if only code Avoiding fragmentation in the Digital is law, then democracy is in danger. It Market and creating a European should be the legislator who defines financial data space in the financial the rules and authorities should have

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From my point of view, the we see non-financial service players Commission is rightly pointing at specialising in a particular leg of the some of the fundamental changes to value chain and becoming intrinsic part enable the digital European economy: of the Financial Services ecosystem. data, facilitate de migration towards With that in mind, I believe it is a modular IT architecture and the important for the European Supervisory implementation of the “same activity, Agencies to assess whether to apply a same risk, same rules” principle. more proportional approach over those activities to safeguard financial stability, Data is a core asset in the digital consumer protection, market integrity, economy. It enables companies to fair competition, and security. I believe improve their products, better serving on the use of the “same activity, same customer needs and expanding their risk, same rules” principle to take us reach to enter new sectors/markets. closer to the level playing field we seek. Our financial ecosystem is diverse, with a wide range of participants. These The Digital Finance strategy also now include non-financial companies includes measures to promote digital like tech platforms, who can leverage innovation and facilitate the adoption users’ financial and non-financial data of key technologies for the financial to innovate and enrich their financial sector such Artificial Intelligence, ISABEL products and services. We believe access block-chain and digital identification. to the data that users generate and This coincides with other related GUERREIRO agree to share should be made available initiatives such as the Data Strategy and Head of Digital Europe, across sectors, in a symmetrical fashion, the Digital Services package. We expect Banco Santander to drive innovation and ensure a level the Commission to work horizontally playing field. to address the new dynamics at work in our economy, which are so important to the future of the European Union and its citizens. Digital at the core Digital transformation I welcome and support the European of Santander’s ONE Commission proposals and hope that continues to be the they can be agreed quickly. In our Europe strategy key to success for digital world, time is of essence. European banks.

European banks are facing many si- multaneous challenges – the pro- longed pandemic, lower-for-longer We have seen the benefits of sharing of interest rates, the need to accelerate data on payments as part of the revised innovation with new players compet- Payment Services Directive, and there ing for the customer attention and is no reason why non-financial data existing profit pools, and finally the from other sectors should not follow potential cyber-security and data pro- the same example and be made widely tection risks. available, to further benefit consumers and businesses. We need to work The Digital transformation is one of towards enhancing data sharing and the critical enablers that will allow openness across and within sectors, banks to face those challenges, but to of course in compliance with data be successful we also need new rules protection and competition rules. to allow Europe to be truly competitive and lead this transformation. To accelerate the digital transformation, we must move quickly towards modular At Santander we aim to be the IT architecture, which will allow for world’s best open financial services closer collaboration with other players. platform with three strategic pillars: Our regulators could support this by the development of a digital native creating an oversight framework for consumer lending business; the launch critical third-party Cloud services of a disruptive payments company, and their providers that meets the PagoNxt; and Santander One Europe, supervisory expectations. creating scale to leverage the substantial investments made in recent years to Santander continues to make strides automate and digitalize our processes. on improving our Digital offering, innovating to surpass customers’ We welcome the Digital Finance expectations and meet their evolving Strategy launched by the European needs. We operate with customer’s Commission last year and share its interest in mind, following a robust objective to “embrace digital finance for risk framework and always observing the good of consumers and businesses”. regulatory requirements. In the market

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regulatory framework for sharing data, markets. We therefore have to be quite or financial institutions are unlikely to careful on the way the ESAP is framed. take full advantage of data analytics. The global pandemic has tested the I welcome exploratory regulatory whole industry. In addition to coping projects that allow to test innovative with huge volumes and volatility on our initiatives. In order to find the right exchanges, we have all been challenged balance between innovation and to manage a remote workforce and investor protection, these initiatives engage with clients across the globe should be limited in scope as well as facing their own struggles. Technology time, should strictly justify exemptions has been a tremendous support as to current regulations, should be we have worked to remain resilient. conducted in a transparent way – Policymaking needs to continue towards supervisors as well as the to allow the next steps. Not only wider industry – and should also be will innovation equip technology evaluated after the specified time. companies like Nasdaq to deliver top These principles should be applied for quality products and services to our instance to the digital ledger technology customers, but they will position the (DLT) pilot project. whole industry to adapt to changing business environments. BJØRN On the private investor side, digitalization is everything. Sustainable SIBBERN and inclusive growth will only happen President European Markets, if private investors can be digitally Nasdaq connected to capital markets. One reason that Nasdaq’s Nordic growth markets, First North, have been so successful is a relatively high proportion of retail participation. Smaller investors Digitalisation for have been able to be part of the growth journeys of the companies coming sustainable and to market. The online retail brokers offering services in the Nordics play a inclusive growth vital part in the financial ecosystem. It is crucial that the European market structure allows for efficient and safe participation of both larger and I appreciate and support the smaller investors. European ambitions to continuously develop the regulatory framework, enable innovation and leveraging opportunities with technology to create more inclusive, efficient and Leveraging secure markets. opportunities with There is tremendous potential to technology to create leverage data sharing technologies more inclusive, in the fight against financial crime – including money laundering, fraud efficient and secure and terrorist financing. Over the past markets. year, Nasdaq launched its Automated Investigator for AML for banks, as well as recently acquiring AML solutions provider Verafin, one of the world’s largest players that offers cloud-based, The plans for a European Single Access artificial intelligence and machine Point (ESAP), has the potential of learning tools for cross-institutional, facilitating cross-border investments multi-channel analysis to combated by allowing any investor to access financial crime. any issuer’s information in a one- stop-shop. For this, it is crucial that Verafin sends alerts to its bank the ESAP will truly provide hassle customers when unusual transactions free access for investors, at no added occur, and then facilitates data sharing cost for issuers. If on the contrary the and joint data investigations to fully access point becomes complicated scrutinize the behavior. In addition, to use for investors, and if new costs Verafin performs data analytics across are added to issuers, the ESAP project all clients’ data to deliver insights risks unfortunately deterring issuers offering a tool that significantly from using the public capital markets, improves the detection of money contrary to the policy intentions of laundering cases. There needs to be a strengthening the European capital

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Green agenda and therefore strengthen banks, but also for example with start- synergy of both efforts and promote ups and global Fintech companies. recovery of Europe. This is one element that in turn pushes towards more efficient and reliable Are there any missing points and cross-border solutions. In addition, do the DFS proposals have any refinement of risk management downsides or limitations that and preparedness to incorporate need considering? more profound interconnectedness and interdependencies in financial Obviously, it is worth stressing that any markets and emerging cyber risks into digital finance strategy and underlying the framework is simply essential. regulatory initiatives are meaningful Substantially risen cyberattacks on only if they target not just new tech financial sector institutions across the and infrastructures, but as well the EU during the pandemic is only one traditional banking, capital markets source and example. and their infrastructures to promote their competitiveness. Europe would What are the priorities in terms benefit even more if introducing new of impact and feasibility? and innovation friendly rules would MÄRTEN ROSS be at least one step ahead of private The more widely used and secure the sector initiatives and forward-looking (new) innovative solutions are, the Deputy Secretary General compared to actions of other global better. This would serve the real needs for Financial Policy and public players. of our economies and increase the External Relations, customer confidence and satisfaction Ministry of Finance, Estonia in financial services, which has to be the ultimate goal of the DFS. Furthermore, progress in single digital identification, The focus on i.e. a single solution across Europe interoperability and is critical in order to advance global competitiveness of Europe and Opportunities and broader infrastructure promote the functioning of the internal seems clearly heading market. The challenges and concerns challenges of the to right direction. about privacy and security need to be addressed to alleviate the resistance in European Digital some Member States. Finance Strategy As regards to the EU’s digital finance In that sense DFS itself is only a part initiatives, one should support novel of the real digital strategy. True, it is business models and instruments that in many respects already broader than have emerged in this digital era and the Does the European Digital most of its predecessors and this is joint efforts undertaken at the EU level Finance Strategy (DFS) identify welcome. For example, it is only logical to address the field of cryptography and the main drivers for accelerating that there is more focus on wider digital euro. the digitalisation of the EU infrastructure issues including cross- financial sector? border problems of distant on-boarding and related improvement needs on In many respects the DFS is indeed customer due diligence requirements or directed towards right priorities in potential “IBAN-discrimination” issues. enhancing competitiveness, facilitating innovation and addressing risks of However, “digitalization” of more European financial services. The traditional financial market areas focus on interoperability and broader like securities market functioning infrastructure seems clearly heading to or registry keeping frameworks right direction. Ongoing digitalisation are as important for digital agenda itself and improving the efficiency of as narrower questions. Therefore, using its opportunities by reducing forthcoming reviews of MIFID and costs and using digital transformation CSDR are as important elements of as for example artificial intelligence is the strategy. simply a must. Digital transmission goes of course Moreover, the pandemic (as one catalyst hand in hand with some challenges, for change) has clearly shown more than which in the long run might turn out to ever the importance of secure, stable be positive for both the real sector, the and efficient digital financial services private customers and businesses, but that meet customer needs. For example, also the financial sector stakeholders if instant payments are new reality even the readiness to transform and to change without regulatory action and outdated the business models is sufficiently services lose naturally their place in there. Nowadays, the traditional the market. Digital transformation banking sector is not only competing and open data enforce also European with traditional competitors, i.e. other

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and the resilience of the entire system. fully committed to this fight, which France, of course, is fully committed in will be essential to foster sound this ambitious program. digitization and competitiveness and has also announced a national On the issue of crypto-assets, which strategy for cybersecurity mobilizing will be addressed through the MiCA 1 billion euros. regulation, we hope to develop a harmonized Europe-wide framework Beyond this broad European to secure the digitization of financial strategy, it will be important to go services. The Commission’s proposal, further and pursue our reflections in currently under discussion, already complementary areas, such as open contains positive elements regarding data, artificial intelligence, or quantum provisions on crypto-asset service technologies. On this last topic, it providers, and an experimental appears indeed that the financial sector approach proposed by the Commission is the area that will be the most rapidly to allow the development of the use of affected by these technologies, with Blockchain for financial instruments. estimated benefits within 10 years.

We believe more discussion are The exponential increase in the however necessary with regard to computing power of quantum SEBASTIEN stablecoins (EMT and ART in the computers could make it possible Commission’s proposal), for which we to envisage several use cases such as RASPILLER support a very ambitious response from predictive analysis for the detection Director, French Treasury, the EU. Two priorities seem essential and prevention of fraud, optimization Ministry of the Economy, to us: preserving our sovereignty by in portfolio management, risk analysis Finance and the Recovery Plan, prohibiting all monetary creation and for liquidity management, etc. In France protecting consumers, with strong France, a national strategy in this requirements on the reserve. area has been announced recently in order to improve our expertise on The retail payment strategy is also a this technology, foster innovation and step in the right direction. It will make develop solutions in a multitude of it possible to implement numerous areas, including financial services. The European Union measures in a coordinated and phased manner, such as the improvement should offer new of cross-border payments or pan- European instant payment solutions, digital opportunities and thus meet strong expectations on these topics. in financial services and payments Cyber-attacks could lead to systemic At the end of September 2020, the European Commission presented a financial instability or new strategy for digital finance, which general disruption of includes a set of measures for the economic activity. next four years in order to grasp all the potential of digital age across the economy, by fostering competitiveness and innovation of our financial services. The pandemic, with the development The strategy comprises several of remote working, has highlighted the legislative proposals, on retail payments, importance of taking the cyber threat crypto-assets and digital operational into account in the coming years, resilience, articulated around four main and this is why we much welcome priorities: removing fragmentation in the draft DORA regulation. Cyber- the Digital Single Market, adapting attacks against highly interconnected the EU regulatory framework to international financial entities could facilitate digital innovation, promoting lead to systemic financial instability a data-driven finance and addressing or general disruption of economic the challenges and risks with digital activity. Recent attacks have illustrated transformation. the ability of attackers to intervene by using highly sophisticated methods, on After the entry into force of this an unprecedented scale. ambitious package, the European Union will offer new opportunities in Some service payments can pose financial services and digital payments, cyberrisks, as recent Target-2 while ensuring the protection of data incident made it clear. France is

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FINANCIAL DATA SPACE AND CLOUD INFRASTRUCTURE

is an early warning system for loan and has a duty to monitor and control defaults that is based on automatically the risks arising from an outsourcing evaluated economic news and which relationship. At present, the approach could improve risk management. of joint reviews of cloud service providers (pooled audits) seems to be Banking supervision seems to be the most efficient and effective way particularly suited to the use of digital for banks to gain insights into cloud technologies, because the first step in service providers’ risk management and banking supervision always involves their internal controls. That is why we analysing data. Our goal is to collect will further support the advancement and process supervisory data more of such pooled audits. quickly and easily via more flexible digital channels. But supervisors are not the only players working to provide a clear While digital innovation can certainly framework for digital finance. With promote stability, it also brings with it its Digital Operational Resilience Act new risks. That is why we as supervisors (DORA) initiative, the EU is – inter have to play a dual role here. On the alia – taking steps to forge an effective one hand, we want to enable digital European oversight framework for innovation in the financial sector, critical ICT third-party providers. We JOACHIM harnessing its potential for financial welcome stricter regulation of ICT stability. On the other hand, we have service providers, including cloud WUERMELING to keep an eye on potential risks providers, as this aims to create a level Member of the Executive Board, arising from the digital transformation. playing field for all financial services Deutsche Bundesbank It is our job to monitor all risks to providers. It is important, however, financial stability. that DORA rules are consistent with existing rules in banking regulation. Otherwise, this would lead to a further fragmentation of regulatory standards Combining innovation and overburden banks that engage in New technologies outsourcing arrangements. and stability: may not only make DORA is part of the European a supervisor’s finance more digital, Commission’s Digital Finance Package, they could also make published last year. The Digital Finance perspective on Package addresses important regulatory it more stable. issues relating to the use of innovative digital finance technologies in the financial sector, also looking at the new risks arising through the digital transformation. With this Therefore, we want to clarify our ambitious plan, Europe intends to We are all experiencing a boost to supervisory approach to the use of AI pave the way for a competitive digital digitalisation, particularly in the and machine learning technologies. financial ecosystem whilst ensuring an financial sector, due to the Covid-19 Given the “black box problem”, for up-to-date regulatory framework. crisis. However, innovation goes far instance, we have to assess the extent beyond this: I believe that we are just to which the individual bank and at the beginning, not the end, of the the supervisor can really understand digital transformation in the financial the results of AI/ML procedures. To system. Artificial intelligence, machine this end, we published a discussion learning, the cloud, distributed ledger paper on our website.1 Our goal as technology, quantum computing, big supervisors is to provide banks with data – all of these buzzwords have the balanced, differentiated and practicable potential to disrupt each and every requirements so that they can exploit business model. the potential benefits of AI/ML processes in a legally secure manner. New technologies may not only make finance more digital, they could also The same goes for the use of cloud make it more stable and more resilient. technologies. For banks, outsourcing Digital innovation can enhance the parts of the value chain can be an stability of both individual institutions important lever to increase their and of the entire financial system. competitiveness and to focus on For instance, financial institutions their core business. At the same time, 1. https://www.bundesbank.de/de/aufgaben/ bankenaufsicht/einzelaspekte/risikomanagement/ could use AI to better detect and ward every bank remains responsible for its maschinelle-lernverfahren/maschinelle- off cyberattacks. Another example outsourced processes and activities lernverfahren-598692

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resilience for financial services (DORA) regulator sees the need for increased and a revision of the Network and oversight on cloud providers or does Information Systems Security Directive it consist of unnecessary duplication? (NIS 2.0). The digitalisation of the Would there be a coordination between financial sector clearly showed that the Lead Overseer introduced in DORA all actors in the chain are interrelated and the competent national authorities and we have to look into the financial defined by NIS 2.0? ecosystem as whole. This is what we have already tried to achieve with the The Covid pandemic had imposed a GDPR, PSD2, e-IDAS and number of different social behavior framework. other initiatives that deem, among The social distancing and the transition other things, to guarantee the resilience to a completely “virtual” life have of the financial system. changed consumers behavior and business strategies. Given the new TSVETELINA While cybersecurity is essential and circumstance, we acknowledge the there is no discussion, whether we merit of the introduction of sector need more or less cybersecurity, we specific regulations or a proper “update” PENKOVA need to ensure that we put in place a of the existing regulatory framework. MEP, Committee on the Internal Market framework that is harmonised and in The importance of preserving the and Consumer Protection, line with already existing rules at both resilience of the financial sector is European Parliament EU and global level. undoubtful but how can we argue that it is more critical (for instance than health or energy) to require more or A framework that is complementary regulation? The path towards harmonised and in line with already existing Finally, the questions that come building up a rules at both EU and to mind in the current pandemic global level. situation, and given the prioritisation sound, resilient and of digitalisation in the recovery of our economy, is whether an additional harmonised financial As an example, we observe that even regulatory burden is what the industry though the DORA proposal builds on really needs? Would that bring an ecosystem - DORA the NIS Directive and the lex specialis added value or support to start ups or rule apply, number of intersections small and medium enterprises? We look and NIS 2.0 - are we between DORA and NIS 2.0 occur. forward to provide the right solutions According to the NIS 2.0 proposal to those and many other concerns in moving in the right cloud service providers should be from the forthcoming months. True, it has now on classified as “essential entities” been evident that the technological direction? and should thus be subject to both the developments are more reactive and requirements of DORA and NIS 2.0. often move much faster than the We see no clear hierarchy between regulators. The role of cloud infrastructures for DORA and NIS 2.0 for that matter. financial institutions is vital. Currently, This brings a clear issue of taxonomy in Therefore, our goal must be to find the we have seen important developments the incident reporting and overlaps in right balance in building up a sound in the regulatory area with the the requirements for the cloud service and resilient financial ecosystem in a European Commission’s proposals for providers. The question here is whether sound and timely manner. a Regulation on digital operational this redundancy is intentional, and the

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The European Commission (EC) has The strategy and the proposed been proactive, putting forward a legislative instruments seek to number of key initiatives including: address fragmentation in the existing framework and will eventually provide [i] the Digital Finance Strategy (DFS) stakeholders with regulatory certainty. – one of the pillars identified in the These proposals embrace digital Digital Finance Package published innovation and should provide more by the EC on the 24 September 2020. opportunities for FinTechs to establish Building on the FinTech Action plan, themselves in the European market. the DFS acknowledges the impact of This should increase consumer choice digital innovation on the economy and vis-à-vis the range of financial services embraces digital finance solutions, such offered, strengthening competition, as cloud computing and data sharing. It and also enhancing resilience and seeks to ensure sound practices, and cybersecurity. Of course, regulation CHRISTOPHER to enhance consumer protection and will also bring about compliance market competition; costs; however, the pros of regulation BUTTIGIEG outweigh the cons.

Chief Executive Officer Digital innovation The success of the EC’s strategy and Ad Interim Chief Officer is key in today’s world. proposals are reliant on a number of Supervision, Malta Financial factors, namely: [i] legal certainty being Services Authority (MFSA) achieved; [ii] NCAs embracing digital [ii] the Digital Markets Act (DMA) and finance in their work and initiatives; Digital Services Act (DSA) - described [iii] the uptake of market participants; by the EC as “an ambitious reform of [iv] education and awareness; and [v] Regulation of the digital space, a comprehensive set the enforcement of any legislative of new rules for all digital services, instruments promulgated. It is in this Digital Finance including , online manner that Europe can become a marketplaces and other online standard setter in the digital world. in the EU: platforms operating in the EU”,1 these proposals appear to acknowledge the challenges and widespread benefits brought about by digital solutions and set the tone for opportunities further digitisation across the EU; and

[iii] the Digital Operational Resilience Digital innovation is key in today’s Act (DORA) – a proposal seeking to world. The financial services sector harmonise ICT risk management is no exception, with various requirements across the financial commentators highlighting an ongoing services industry. It is inter alia aimed digital ‘revolution’ in this field. Whilst at strengthening the confidentiality, this inevitably creates a number of integrity and availability of data and opportunities for stakeholders, it also complements this by establishing an 1. European Commission, Press Release, Europe fit for the brings a number of challenges to the fore oversight framework on Critical ICT Digital Age: Commission proposes new rules for digital platforms, 15 December 2020, privacy, and data protection issues. Cloud Service Providers. REGULATION OF DIGITAL FINANCE IN THE EU

increasingly volatile market. They need Cloud in financial to process large volumes of data fast and break organisational silos. The time services: how effective saved processing this information allows firms to offer products at a much lower regulation can cost to their customers.

support innovation Cloud has also become an enabler for AI and machine learning (ML) technology. Banks can, for example, utilise cloud- Cloud presents important opportunities based ML models to combat fraud and for the financial sector to accelerate money laundering in a more effective innovation and improve security and way by combining transactional operational resilience at scale. and behavioural data and avoiding costly false positives. Similarly, cloud KSENIA DUXFIELD- Innovative banks are using this technology is leveraged for banks’ risk- technology to understand risk, segment management processes to determine KARYAKINA customers, track market movements, liquidity and exposure quicker, to carry Government Affairs and Public Policy, develop new instruments and ultimately out mark-to-market adjustments and for Google Cloud gain a competitive advantage in an better accounting in general.

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Finally, firms are tapping the cloud to over critical third-party providers by existing frameworks like the European develop entirely new services. Innovative financial services regulators. Supervisory Authorities’ Outsourc- firms can create experiences that closely ing Guidelines and the NIS Directive resemble the best digital ones in other - in particular in the view of the new industries. Cloud is transforming the Looking at key trends NISD2 proposal; technology ecosystem well beyond of cloud adoption • Be proportionate and fit-for-purpose, the core infrastructure, and European in finance in Europe especially through the requirements consumers stand to gain the most from and sharing a view that recognize the technological this innovation. COVID-19 accelerated on DORA. realities of evolving ICT services in many of the digital trends, and resilience the public cloud context - that are of cloud infrastructure came into full provided in a multitenant, one-to- view: we continued to support all our We welcome these efforts of the EU many environment; customers across the globe without policymakers: resilience and security are at • Maintain technology neutrality and shortfalls. the core of our technology and operations. boost innovation, which is encouraged We believe DORA could create a genuine by open market and the free flow of data; Understanding the benefits of this opportunity to enhance understanding, • Protect the availability and integrity of technology and with an objective of transparency and trust between ICT digital services and cloud customers strengthening risk mitigation and digital service providers, financial entities and privacy, whether they are subject to operational resilience of the financial regulators and ultimately stimulate DORA or not. ecosystem, European policymakers have innovation in the European finance sector. been leading global regulatory agenda. We will continue to engage with The proposal for the Digital Operational To ensure its effectiveness, the oversight the policymakers as this important Resilience Act (DORA) is an important needs to: legislation progresses and are committed step in achieving these strategic goals by • Harmonise and deduplicate require- to being a constructive voice in the introducing a direct regulatory oversight ments, including between DORA and discussion.

The picture is even broader when last years, especially in terms of breach moving up the technology stack from of confidentiality, failure of integrity of infrastructure to applications. Cloud systems and data and inability to change native applications are required to information technology. It also includes provide frequent innovations to clients security risks resulting from cyber- and ultimately to stay competitive not attacks or inadequate physical security. only with regard to traditional players but also FinTechs or BigTechs. The current approach with regard to managing ICT relies too heavily on The two challenges with regard to the principles established for outsourcing application of cloud technology are as arrangements. What is adequate for well Data security and privacy rules as a long term and stable part of a value Management of ICT (Information and chain, does not fit to cloud services that Communication Technology) and cyber can be used short term and their usage DANIEL security risks. can also be discontinued very easily. In addition, large cloud service providers Especially through GDPR the EU has will bring a high and consistent level of KAPFFER established a common standard with standards with regard to ICT risks. Given Chief Financial Officer regard to data security and privacy. their heritage, they are more used to & Chief Operating Officer, Most cloud providers provide services providing reliable, secure and extremely DekaBank from locations within the EU. However, scalable IT solutions. most contracts would still allow a data transfer to locations outside the EU, so As an important step, the EU’s digital that equivalent rules there are needed. resilience framework (“DORA”) will Cloud-competence assign third party service providers But, the major part of the EU data strategy deemed critical to an EU-supervisor determines the global is mostly about sharing data between (EBA, ESMA or EIOPA). However, different entities. The goal is an aggregated European policy makers should consider competition – let’s face pool of data that can be used for AI and going one-step further and reduce the other purposes. However, clients are only burden imposed on the financial services the challenges ahead willing to give away their data as part of firm when managing ICT risks through a service that they value and that they cloud services. otherwise cannot get access to. Therefore, Only a couple of years ago cloud it is questionable whether the data In sum, the large US firms (, technology has been a promising strategy will be able to provide significant Google and Microsoft) already dominate technology with only a few applications value. So the European market place for the cloud market. We need to make in the financial world. Since then cloud cloud services and the EU cloud rulebook sure that European financial services technology has developed to the main both intended for 2022 are helpful. firms can at least use cloud services in enabler of digitalization. It has become an adequate framework to ensure their one of the most important levers to Management of ICT have gained more competitiveness in the global landscape. decrease IT cost (30% to 40%). and more attention by regulators in the

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ADAPTING THE FINANCIAL FRAMEWORK TO DIGITALISATION

A slogan which has gained much extent to which unwarranted regulatory traction and has often been presented discrepancies remain. as the basis for the regulatory reform is “same activity, same regulation”. This In AB policy areas, like AML/CFT or suggests moving from a framework consumer protection, it is hard to find of designing requirements for entities discrepancies in the requirements with a specific licence or charter – what imposed on commercial banks as we call entity-based (EB) regulation – opposed to other providers of financial to rules that address specific activities, services. However, in areas where an EB ensuring that they apply homogenously approach is adequate, there may not be to all types of entities performing each sufficient rules that address the specific activity – what we call activity-based risks generated by big techs. This is the (AB) regulation. case in the area of operational resilience, where a comprehensive approach for FERNANDO However, achieving a level playing field big tech groups may be warranted, in a particular market is not a highest- as is currently the case for banks. RESTOY priority objective for policymakers, Moreover, there are strong arguments although it is a relevant one. In some for imposing ex ante constraints on big Chairman, policy areas, like consumer protection or techs’ practices concerning data use Financial Stability Institute (FSI) anti-money laundering and combating and different sources of discrimination the financing of terrorism (AML/CFT), across actual or potential participants in there does not seem to be a rationale the platform. Fintech regulation: (based on primary policy objectives) to discriminate across providers of a There are indeed some initiatives in how to achieve a level particular financial service. By contrast, different parts of the world (notably in in other areas, like prudential policies the US, the EU and China) which seem playing field or competition, specific EB rules are consistent with the need to develop new required. In general, this is the case EB rules for large, big tech platforms. when risks emerge not only from the In particular, in the EU the European The emergence of fintechs and big techs performance of a particular activity, but Commission proposals for a Digital constitutes a major source of disruption also from the combination of activities Markets Act and a Digital Services in the market for financial services. that entities perform. Act contain far-reaching regulatory There is already some consensus that we requirements for big techs. need a comprehensive policy approach, Therefore, regulatory discrepancies particularly for big tech platforms that across entities performing a specific offer a large variety of financial and activity may sometimes, although non-financial services – and that this not always, be justified on superior Reference: F Restoy, “Fintech regulation: how to achieve comprehensive framework should aim policy grounds. The current regulatory a level playing field”, FSI Occasional Papers, no 17, at minimising competitive distortions. framework offers mixed signals on the February 2021.

other objectives such as protection of Regulatory crossroads consumers or competition. This, in practice, means we will need pragmatic in digital finance approaches to the “same activity, same risk, same rules” principle. The EU needs vibrant and sustainable capital markets. Achieving this goal In fact, mixing “activity-based” and depends crucially on the ability of its “entity-based” rules will be necessary financial sector to continuously adapt both to promote and control innovation to faster innovation cycles and evolving in the digital era. business models, to new technological infrastructures and instruments and to Take BigTechs for instance - although fair and responsible use of digital data. their footprint is still limited in EU’s asset management and non-banking financial This challenge is recognised both by intermediation (but already relevant in RUI PERES the new CMU action plan and the the payments sector), it is wise to consider Digital Finance Strategy and will only “entity-based” rules that might deal with JORGE be met if the regulatory and supervisory possible impacts of their huge market Director, Strategic Analysis and frameworks strike a balance between power on financial stability, operational Communications Office, Portuguese ensuring a level playing field that resilience, data protection or competition, Securities Market Commission (CMVM) promotes innovation and safeguarding together with “activity-based” rules.

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On the other hand, and although This said, possible risks and the relevant regulatory sandboxes might be better “activity-based” rules are essential for differences between these two types suited for more mature firms with a proper level playing field between of innovation facilitators should innovation proposals. incumbents and newcomers, we be considered. should simultaneously ensure that we As regards risks, at least three should be clearly understand the true nature and highlighted: given the level of regulators’ implications of new proposals before We will need to keep resources required by innovation we classify them and tie them to specific a pragmatic approach facilitators, regulators’ focus might be activity rules. This is especially relevant to financial innovation diverted (and even biased) towards the when we deal with completely new regulation and selected projects, hindering a more realities emerging from the confluence supervision. comprehensive approach and strategy of Artificial Intelligence, Big Data, Cloud for innovation. Services and DLT. Additionally, regulators might also To face these challenges, regulatory From the experience and information end up prioritising innovation over sandboxes and innovation hubs might gathered in Portugal FinLab, the other objectives such as consumer prove to be useful tools both for innovation hub of the three Portuguese protection. Finally, there is a “race to regulators and innovators, by helping financial regulators (CMVM, Bank of the bottom” risk in what regards this to reduce information asymmetries Portugal and ASF), innovations hubs regulatory framework. A clearer single and regulatory costs, as several studies seem to be particularly adequate for regulatory rulebook and stronger have shown. EU-wide initiatives, such projects in seed or pre-seed phases that supervisory convergence within the EU as the DLT pilot regime for market tend to have few resources allocated for innovation facilitators might help. infrastructures are, therefore, welcome. to the regulatory framework; while

In which areas does the financial Does the DFS put forward the main framework need adapting to make it fit regulatory and supervisory changes for leveraging the new opportunities that are needed for reaping the offered by digitalisation in the asset benefits of digitalisation in the fund management sector? management and distribution area?

What is critical is to avoid keeping an The DFS is indeed an excellent initiative existing set of regulations regarding proposed by the Commission to ensure a fully new area. In particular, the the EU remains competitive within an organisation of the Pilot Regime for adapted regulatory framework and to market infrastructures based on DLT set a minimum harmonization among clearly requires the adaptation of the Member States in such a fast-developing current rules applicable to CSDs and area. For instance, regarding DORA, MTFs to facilitate decentralization, we support the minimum regulatory STEPHANE competition and lower costs for new framework set around critical ICT infrastructure players. service providers, in order for users like JANIN us to benefit from a higher safety on Head of Global On the other hand, some high-level behalf of our end clients. Regulatory Development, principles should remain the same, for instance ensuring the digital operational However, regarding supervision, on AXA Investment Managers resilience of those new players to DORA we have some concern about preserve the safety of the whole value the leading authorities which might be chain. The Pilot Regime should also the recipients of incident reports: while Digital age in allow for a wider range of eligible assets our natural competent authorities are to make that regime develop sufficiently securities regulators, considering the European asset fast and widely, thus facilitating the risks of hacking which currently exist and amortization of entry costs by new which recently hit financial regulators management: market infrastructures - to the ultimate such as the US SEC, we would favor giving benefit of end-users. that role to the dedicated information a revolution security agencies, such as ENISA – which What are the main regulatory would then share reports with securities to come? obstacles to the further digitalisation regulators as a second step. of asset management activities? In terms of EU legislative process, one key The Asset Management industry has For AXA IM, digitalization has already challenge remains ahead of us: how to always taken technological innovations started, e.g. making use of Artificial conciliate the usual pace of negotiation, on board. However, for the last Intelligence and Machine Learning. But to adoption, implementation and review of decade, the acceleration of FinTech go further, regulatory obstacles remain and EU legislation with such a fast developing has required to adapt very quickly to currently relate to DLT – while with DLT, area? We know that 20 years ago the this phenomenon to stay ahead of the we aim to reduce our costs and therefore Lamfalussy process aimed at speeding up curve, in order to reduce costs, improve those of our clients, as well as increase our that pace to adapt legislation quickly, but efficiency and possibly explore new fields efficiency, both in the settlement of assets will it be sufficient for topics such as DLT of investments. and distribution of funds. and MiCA? It is difficult to say at this stage.

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regulation has developed to respond to regulatory and supervisory direction the traditional 20th century business constantly evolving, one of the main model, which regulates based upon barriers results from some of the product, manufacturer and issuing inconsistencies from one jurisdiction to or distributing entity. This creates a another and resulting fragmentation. narrow regulatory perimeter applicable to these industries. However, a 21st Quite apart from this, there is a lack century “platform company” does not of consistent regulation of underlying need to create the underlying financial products, with some at a more product or service to become a leading advanced stage unified regulation at digital aggregator and distributor of the European level (e.g. the UCITS those products and services. This can – directive, which creates a harmonised in the case of financial services - create framework for investment funds a substantial financial marketplace to that can be sold to retail investors FRANCESCO complement a non-financial services throughout the EU using a passporting marketplace. In other words, in the mechanism), and other, substantial CECCATO connected economy, a position of areas such as mortgages remain mostly strength in one market, led by data, can regulated at the national level. Chief Executive Officer, readily be used to access another very Barclays Europe different product market. Similarly, investments and trading have been tackled effectively at the Looking forward, as the number European level, with the creation of Thoughts regarding and type of business able to access ESMA; but while such “asset-side” consumer spend data increases due regulation has been advancing, the the delivery of to Open Banking and PSD2 this is “liability-side” (borrowing and lending) likely to have further transformational has yet to achieve the same level of European financial effects on the composition of the new harmonisation. This creates a further financial ecosystem and therefore gap in safeguarding customers’ interests products in critical components of financial at the European level and in completing markets infrastructure. The increase the single market. the Digital Era in competition for consumers is to be welcome, but there is a need to address These issues are recognised by the how we collectively provide for the regulatory community. Steps such as The pace of technological change protection of consumers and clients the European Commission’s Digital continues to rise and as a result the and also to ensure a fair playing field Finance Strategy, which aims to amend impact of technology on people’s lives for all market participants. the regulatory framework to make it fit is getting greater. The pandemic has for the digital era and achieve a level clearly brought technology further Looking at the ecosystem from a playing field across entity types, will be to the forefront of our minds and is consumer perspective, it will be crucial in helping solve these challenges. accelerating changes in consumer increasingly difficult for consumers to Further, given the cross-border behaviour. understand the risk profiles of products nature of innovation, collaboration by attached to different entities and the policymakers in different jurisdictions As new operators and business models associated protection they may or may is essential. Regarding underlying emerge, it is essential to consider all not enjoy without further assistance product areas, the European of the new and different players in from regulators. Understandably, Commission recognises the continuing the financial ecosystem from the end a consumer sees products that are fragmentation of credit markets, and user’s perspective. For instance, as a interchangeable for their needs, while the Mortgage Credit Directive broader range of firms from a diverse rather than considering in detail was a good first step towards an EU- range of sectors seek to offer retail their regulatory regimes. There is a wide mortgage credit market with a and potentially wholesale financial significant risk that an industry defined high level of consumer protection, it products, there is a need to ensure that approach to regulation will fail to needs to act as a foundation and not an consumers are provided with the same recognize emerging risks posed by the end-point. level of protections, and that all those market changes noted above, and result participants who offer the same service, in customer detriment. This is all the more important in an age undertake the same activity, or expose of digital delivery of financial services. consumers to the same risk are subject In addition, a key barrier to innovation to equivalent regulatory requirements for firms is the lack of regulatory clarity on a proportionate basis. regarding how ‘new’ and ‘emerging’ technologies, such as distributed Without this, consumers will face ledger technology (DLT) and artificial an inconsistent experience, with intelligence (AI) may apply to financial the potential customer detriment sector use-cases. The current regulatory counteracting the benefits of greater frameworks across the globe were not competition and creating potential risks written with these technologies and the for market integrity and potentially also wider ecosystem in mind, and therefore financial stability. they may not be fit for purpose. Whilst the principle of technology neutrality Despite the rapid technological is important it is also essential that changes and the emergence of new regulations consider the technologies digital players, large and small, where relevant. In addition, with global

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CRYPTO-ASSETS AND STABLECOINS

broadly are experiencing a quieter but across Europe and Asia. It has formed momentous revolution. a strategic partnership with the Federal Reserve System in New York, and in International collaboration is essential the next few months it will open new to underpin technological capabilities, centres in Toronto with the Bank of ensure interoperability between Canada, London with the Bank of national systems, enhance cross-border England, Frankfurt/Paris with the payments and remittances, support Eurosystem, and Stockholm with a financial inclusion, and prevent group of Nordic central banks. The Hub geographical and social fragmentation. catalyses collaborative efforts among This is the essence of the roadmap central banks and cooperates with from the Financial Stability Board academia, financial service providers and the Committee on Payments and and the broader private sector. Market Infrastructures for enhancing cross-border payments, as endorsed Our work programme is built by G20 Finance Ministers and Central around six key themes of critical Bank Governors in October 2020 and importance to the central banking actively supported by the Bank for community: (i) suptech and regtech; International Settlements (BIS). (ii) next-generation financial market infrastructures (encompassing capital BENOÎT markets projects, foundational digital infrastructures, tokenisation of CŒURÉ assets, cross-border payments and Head of BIS Innovation Hub, Central banks payment infrastructures); (iii) central Bank for International bank digital currencies; (iv) open Settlements (BIS) need to be at finance (encompassing application the cutting edge programming interfaces in the open of technology. banking context and related dataissues); (v) cyber security; and (vi) green finance.

This work is directed towards practical Central banks and solutions rather than conceptual In the past few years, we have research. We are building a portfolio trends in digital witnessed the rise of cryptoassets and of projects across these six themes – a global regulatory discussion around typically as proofs of concept to be innovation stablecoins. Moreover, some big techs delivered to central banks. In doing have entered credit markets, either so, we are helping them to harness directly or in partnership with financial the benefits of technology while institutions. The expanded use of digital understanding its limits – and to One of the pandemic’s most long- payments brought about by Covid-19 make global financial markets safer lasting consequences has been a could fuel a rise in digital lending as as catalysts, overseers, operators and change in the way we work. We companies accumulate consumer data regulators. are experiencing, first-hand, global and enhance credit analytics. This, collaboration through technology and in turn, presents new and complex Multilateral collaboration and practical platforms. Covid-19 has also accelerated trade-offs between financial stability, thinking will be essential for building trends in digital innovation that were competition and data protection. a financial architecture that is future- already well under way. proof against a large range of shocks. Central banks will continue to The pandemic has also shown that it safeguard essential trust in money in is technology that enables our globally this rapidly changing environment. To connected world, and the provision identify these trade-offs, design sound of money, to go round. Technology regulatory responses and continue to has been indispensable in helping fulfil effectively their mission to deliver to mitigate the economic and social monetary and financial stability, central impact of the Covid-19 crisis by banks need to be at the cutting edge of enabling economic activity to continue technology. at arm’s length and partially overcome social distancing protocols. Consumers It is for these reasons that the BIS has in many countries have stepped up their established its Innovation Hub (www. use of contactless payments, and as bisih.org) to spearhead the central bricks-and-mortar stores temporarily bank response to digital innovation. closed, e-commerce activity surged. Reflecting the global nature of With the rise of “decentralised innovation and technology, the BIS finance” (DeFi), financial services more Innovation Hub already has centres

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credible stability anchor. Crypto-tokens bank money, while money in the form have no intrinsic value, and there is of cash enjoys enduring popularity as a usually no reliable issuer that is legally means of payment for the public. obligated to ensure that tokens will remain stable in value or to guarantee For this reason, Bundesbank experts that tokens can be exchanged back into are exploring ways to technically bridge cash or book money. In addition, many the space between DLT networks and crypto-tokens involve comparably existing payment systems in a way low processing capacities, relatively that would allow DLT-based trade costly money transfers, and consume to be settled in central bank money. huge amounts of energy in the most Moreover, the Eurosystem is currently prominent examples, making them examining the risks and rewards of an economically and environmentally central banks issuing their own digital inefficient proposition as a means of currencies, or CBDCs. There needs payment so far. to be a clear understanding of the potential implications of launching For crypto-tokens to maximise their a digital euro for matters including potential as a payment instrument, financial stability and monetary policy they will need to be stable in value and effectiveness before any such decision safe to use. Stablecoins may fit the bill, can be made. BURKHARD given that they stabilise their value for example by pegging it to, and backing The potential downsides of CBDC, such BALZ it by, a currency issued by a central as structural disintermediation of the Member of the Executive Board, bank. There are several conceivable banking system, have to be manageable Deutsche Bundesbank ways in which stablecoins can be legally and outweighed by positive effects such structured, and the European Union’s as efficiency gains or the facilitation of Markets in Crypto-Assets Regulation new business applications. Therefore, (MiCA) is a new piece of legislation we will have to pay close attention to designed to regulate their issuance in how any digital euro is designed. Are crypto-tokens the EU. MiCA aims to provide clarity and certainty for crypto-asset issuers the future of money? and providers, while establishing sufficient safeguards for the buyers of such coins, for example in the form of capital requirements for issuers, well- For more than a decade now, defined investor rights and stringent distributed ledger technology (DLT) supervision. has facilitated the transfer of crypto- tokens across decentralised digital networks using cryptographic methods. DLT transfers take place in a clear and transparent manner without the need While DLT offers a for intermediaries, so the technology promises to be disruptive. This could wealth of potential, potentially speed up confirmations and current crypto-tokens reconciliation processes in the financial are still a niche sector and even eliminate some steps in the process chain altogether. phenomenon in the payment space. As a result, DLT may be of value in particular complex labour-sharing processes like securities settlement, though cross-border payments may benefit as well. Given that DLT can also I believe that in a market economy, be used to programme payment flows offering innovative payment solutions and incorporate payment processing to the general public should be a primary into delivery processes, it is mainly task of the private sector. Nowadays, the regarded as a promising basis for many vast majority of payment transactions applications in what has been dubbed between non-banks are settled in the Fourth Industrial Revolution. commercial bank money. Stablecoins issued by a private commercial bank While DLT offers a wealth of potential, could therefore be one way forward to the crypto-tokens currently available in satisfy the demand for crypto-tokens as the market are a niche phenomenon in a programmable payment medium in the payment space. Indeed, the chief the financial sector and real economy. purpose they serve is as a means of However, central bank money will speculation, largely because of their continue to play an important role in huge swings in value against official payments in the future, just as it does currencies like the euro. One key today. Recipients of large payments are reason for this instability is the lack of a likely to prefer settlement in central

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Even so, crypto assets could deliver in the stablecoin area. This heralds many benefits. They could increase the possibility of such instruments efficiency, as DLT offers a way to record becoming more widely used, notably as key information in a safe, immutable a means of payment.This would come format and can make that information with additional challenges and risks that widely accessible.It could also increase need to be addressed. the efficiency of payments, by reducing cost, increasing speed, security and The European Commission in September user-friendliness.It could enhance 2020 adopted a proposal for a regulation competition in payment markets, also by on markets in crypto assets (MiCA). It encouraging incumbents to improve. creates a new bespoke framework for crypto assets that currently fall outside However, there are also challenges. EU financial services legislation. MiCA Price volatility undermines their utility also sets more stringent regulation and MARCEL HAAG as a means of payment, exchange or supervision of stablecoins. This will store of value. However, some crypto allow crypto asset markets and related Director, Horizontal Policies, assets – so-called “stablecoins” – address private sector initiatives to develop on a DG for Financial Stability, this by stabilising their value against safe and sound foundation. Financial Services and Capital Markets an underlying pool of assets. If this is Union, European Commission credible and effective, they are more As these markets will grow, it remains likely to be used for payments.This could to be seen how they contribute to be particularly promising for cross- more efficient payment arrangements. Crypto assets – border payments, notably remittances, Stablecoins could potentially become a where there is indeed margin for widespread digital means of payment. As reaping the benefits improvement. set out in MICA, they should therefore be subject to the same rules as other while addressing digital means of payment, so as to ensure MiCA will allow markets a high level of consumer protection the risks and related private and a sound retail payments market. In initiatives to develop parallel, the Retail payments strategy on a safe and sound will foster the development of instant The ongoing digital transformation foundation. payment solutions, in a pan-European of the financial system brings along fashion, which will further improve the with it innovative classes of assets or efficiency of cross-border payments in products relying on new technologies. Beyond price volatility, there are also the EU and beyond. One of these are crypto assets built on important operational challenges distributed ledger technologies (DLT). related to e.g. the ability to scale up DLT.A key challenge, however, relates The market for crypto-assets is very small to the lack of certainty about the rules compared to the market for traditional that apply, as many crypto assets are financial assets. It has historically been likely to fall outside existing financial prone to leverage, operational risks services legislation. and high volatility. While stressing the 1. See e.g. the 2018 joint warning of the European potential of DLT, many authorities have While for all these reasons, the market Supervisory authorities on the risks for consumers of buying virtual currencies. https://www.eba.europa. therefore issued warnings about the for crypto assets has remained small, eu/esas-warn-consumers-of-risks-in-buying-virtual- 1 risks related to certain crypto-assets. the market is developing rapidly notably currencies

inclusion for people that do not have Delivering on bank accounts, or are underbanked, or consumers’ access to a currency that is stable. For new forms of digital money such payment needs in as stablecoins to be widely used for retail payments, convertibility into fiat the digital age currency and maintain a stable value is essential to ensure consumer trust. Central Bank Digital Currencies Conversely, crypto-assets like Bitcoin (CBDCs) and stablecoins backed 1:1 are predominantly held as assets, and by fiat currencies, are an evolution of given their volatility are not used for money brought about by changes in retail payments in a significant way. commerce and technology. Both of these financial instruments have the potential While stablecoins and CBDCs raise ROELAND VAN to be used for global commerce, much questions about future forms and like other fiat currencies, and can help underlying technology of digital money, DER STAPPEN minimize the inefficiencies in dealing we know that the future of payments Head of Regulatory Affairs, with cash and cross-border retail is digital and mobile. However, we VISA Europe payments. They can also foster financial should not only think about the future

192 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net CRYPTO-ASSETS AND STABLECOINS of money, but we should equally remain When considering the potential benefits Regulators must continue to promote focused on what consumers want and of new technologies in a retail payment the use of international standards need when they pay in a digital age. context, it is important to consider what to enable technical interoperability, resilience looks like in a digital age. whereas international alignment around Above all consumers have come to expect regulatory principles for stablecoins or trust and security with payments. That CBDCs will allow systems to connect requires advanced risk management We should not only across different jurisdictions. More capabilities and investments in fraud think about the future broadly, we believe that open and prevention and anti-money laundering of money, but we interoperable payment networks can control mechanisms by any issuer of should equally remain enhance both innovation and resilience digital currencies. In case of a CBDC, focused on what across payment flows. consumer expectations will be no different, and the solution should be to consumers want and Finally, stablecoins and CBDCs will form work with private intermediaries that need when they pay in part of a broader digital retail payment have expertise in this area and can help a digital age. mix with multiple payment networks and manage security of transactions. payment service providers continuously looking to address consumer needs. Security also means that consumers For retail payment transactions it means We believe that making good use know what happens when something the ability to securely process and digital currencies can contribute to the goes wrong with a retail payment. authorise tens of thousands transactions development of new forms of commerce Stablecoins and CBDCs should have in milli-seconds. It also means and popularize digital payments. an equivalent consumer protection payment network uptime, and that is standard as e-money if used for retail why we continue to make significant Above all, it has a chance to create payment purposes, following the investments in resilience of our network greater consumer choice for paying and principle of same service, same rules. to achieve 6 9s or higher availability, or accepting payments. This will also ensure consumers can use differently put no more than 32 seconds them with confidence. of downtime per year.

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CROSS-BORDER PAYMENTS GLOBAL ROADMAP

of issues is by far not new but have features, be operationalized in a way recently been given a strong political that will eventually fix the frictions. impetus in view of materializing The endorsement of targets by the significant progress. G20, in the last quarter of 2021, will be hence essential, as will be the ongoing The work done last year under the monitoring of their implementation aegis of the G20 is the first global and over the following years. comprehensive initiative to firmly improving cross-border payments. The Central banks have to play an important ambitious roadmap agreed in October role in this setting. As overseers of 2020 indeed aims at addressing all the payments infrastructures, they will various pain points mentioned above, have to contribute to the design from all the perspectives at stake, within and implementation of the revised a delimited time-frame, under the close frameworks that will result from the DENIS BEAU scrutiny of the FSB and, ultimately, of need to increase the convergence of the G20. This decisive policy step in the regulatory and supervisory approaches First Deputy Governor, landscape of payments, which implies between jurisdictions. As operators, Banque de France not only public authorities but also and their support to solutions designed foremost the private sector, is highly to inter-connect payments system, promising. However much will depend wherever needed and possible, will be Taking the cross- on our collective willingness and ability essential, as will be a number of targeted to deliver. measures including for instance the border payments extension of operating hours; some However much more forward-looking initiatives, such roadmap forward will depend on our as the potential issuance of central collective willingness bank digital currency in the context of and ability to deliver. cross-border payments could also be Cross-border payments, which sit at considered. And as catalyst, they will the heart of international trade and have to stimulate and create a conducive economic activity, have been for long It is in this regard pivotal that the environment for innovative solutions, facing a number of shortcomings that implementation of this roadmap which may encompass new platforms or hamper their efficiency, in terms of cost, remains overtime tied to the initial some forms of appropriately designed delay, transparency and accessibility. ambition. This stress the critical digital payments. These frictions encompass a wider importance of targets, mostly array of aspects, from fragmented data quantitative, that will be set - in terms All in all, the G20 roadmap offers standards, lack of interoperability, of price, delay, transparency and a unique collective opportunity to complexities in meeting compliance accessibility – as part of the roadmap. prepare and improve the future of requirements, data protection purposes Indeed, this will help ensure that cross-border payments. Its success or outdated legacy technology the various “building blocks” of a relies on the steady commitment of all platforms. This multi-dimensional set response, whatever their nature and stakeholders.

actions by public authorities and private Building the cross- actors in a broad range of areas to remove the frictions that have held back the devel- border payments opment of better cross border payments. ecosystem for the The Committee on Payments and Mar- 21st century ket Infrastructures (CPMI), chaired by Sir (Deputy Governor, ), led the development of the The payments landscape has changed 19 building blocks, arranged into five dramatically in recent years. Domestic focus areas, which form the basis of the payment systems have improved, and roadmap. Four of these focus areas seek the use of cash has declined in many to enhance the existing payments ecosys- jurisdictions, but cross-border payments tem, while the fifth is more exploratory TARA RICE are still largely perceived to be slow, in nature and covers emerging payment expensive, opaque and for certain user infrastructures and arrangements. Head, Secretariat of CPMI, segments unavailable. Bank for International The focus areas are as follows: Settlements (BIS) As a result, in late 2020, the G20 endorsed a roadmap to enhance cross-border pay- a. Commit to a joint public and private ments. It lays out a comprehensive set of sector vision to enhance cross-border

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payments: Focus on driving meaningful, practices: Focus on promoting the arise if over time they are advanced and coordinated change at the global level adoption of common message formats, implemented in a coordinated manner. over a sustained period of time among including conversion and mapping stakeholders from the public and from legacy formats to ISO 20022 and Achieving change in all of these areas is private sector. common protocols for data exchange. a challenging objective. While all of these b. Coordinate on regulatory, supervisory This could mitigate the friction around building blocks feature concrete actions and oversight frameworks: Focus on fragmented and truncated data. and key milestones, the problem needs to advancing consistent international e. Explore the potential role of new payment be tackled comprehensively. rules and standards without infrastructures and arrangements: Ex- compromising individual jurisdictional plore the potential that new multilat- Absent a coordinated and sustained discretion or lowering standards. eral cross-border payment platforms, initiative, supported by both the public b. Improve existing payment infrastructures central bank digital currencies (CB- and the private sector, we will not see the and arrangements to support the require- DCs) and so called global “stablecoins” improvements we seek. ments of the cross-border payments mar- could offer for enhancing cross-border ket: Focus on technical and operational payments. Only a cross-border payments ecosystem improvements to existing domestic that can keep pace with the way we live and international payment infrastruc- Each of the building blocks individually and transact is fit for the 21st century. The tures that cross-border payments de- has the ability to bring notable benefits CPMI is taking a leading role in shaping pend upon. to cross-border payments. However, due the future of cross-border payments. d. Increase data quality and straight through to their interdependencies, the most processing by enhancing data and market significant enhancements are likely to

Key to the Roadmap’s success is the up multilateral systems with cross- involvement of market forces, enabling a currency settlement, which would be long‑term, joint private and public sector especially useful for countries that have commitment. Moreover, to the extent strong economic ties with one another. possible, we need to leverage existing In Europe, the instant payment system infrastructures and arrangements so as TIPS is experimenting in these areas. to reduce the sunk costs of innovation. Enhancing private-public cooperation Industry-led initiatives targeting oper- and existing systems are two of the focus ational frameworks (e.g., message for- areas of the Roadmap. mat) may help to streamline transaction chains. Turning to possible actions, the responsibility to meet end users’ needs Changes in the payments industry and requirements lies primarily in the are giving rise to new risks that must GIUSEPPE hands of payment system providers be managed in order to safeguard (PSPs) rather than those of public financial stability and the public’s trust authorities. Services could be developed in money. The greater dependence GRANDE to enable individuals and businesses to on technical service providers and the Deputy Head of Market make payments through high concentration of the supply of and Payment Systems Oversight, and PCs, for example, or better track such services are matters of concern. Banca d’Italia them along the transaction chain, Companies have to recognize third-party combine them with other services and risk and the different responsibilities settle disputes easily. of the outsourcer and the outsourcee. Competitive distortions due to the Cross-border presence of a few large players have to Enhance access to be countered and data privacy and cyber payments: more back end, deepen security must be ensured. interlinking, simplify access, less practices and These policy efforts do not equate to an compliance, manage increase in regulation. There is room for compliance costs lowering compliance costs by tackling new risks. disparities resulting from inconsistent regimes or from duplicative compliance The G20 Roadmap on cross-border The PSPs’ ability to improve services checks. This is also one of the focus areas payments can greatly benefit the public also depends on the availability of of the Roadmap. More importantly, an and the world economy. Cross-border ‘back’ end processes. Criteria to open and inclusive payment ecosystem, payments are the cornerstone of the extend such processes to non-bank with a level playing field, strengthens international mobility of goods, services, PSPs are being considered in several market discipline and is conducive to capital and people. Yet, for too many jurisdictions in order to promote growth, thereby reducing the need for individuals and businesses they are innovation and competition, reduce public intervention. still costly, slow and less secure, if they the risk of single points of failure and are even available. This has been well ultimately strengthen financial stability. Nonetheless, central banks and other documented by the FSB, in coordination Payments across borders can also be authorities will continue to monitor old with the CPMI. The Roadmap is a high- boosted by adopting new structural and emerging risks, to improve oversight level and flexible plan to enhance the approaches, such as establishing links criteria and tools and to be ready to act. global payments ecosystem. between domestic systems or setting

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Core to CLS’s purpose is to mitigate Building Block 9 of the FSB Roadmap – foreign exchange (FX) settlement facilitating increased adoption of PvP). risk, the risk that one party to an FX Key questions on operating model, transaction will pay the currency it account type, settlement finality, and sold but not receive the currency it applicable standards remain, and a bought. CLS continually seeks to add flexible and agile way of thinking will currencies to its settlement system be required to answer those questions. (CLSSettlement), and is in the process New technology on its own will not be of onboarding the Chilean peso as its able to address them. 19th currency. Specific to access, as a general rule Despite recent reports suggesting CLS believes it is important to assess FX settlement risk is on the rise1, the trade-off between participant CLS’s ability to expand its payment- accessibility and the potential changes MARC BAYLE versus-payment (PvP) protection to to the risk profile of the ecosystem. new currencies and improve direct However, CLS believes there is merit in DE JESSÉ access to CLSSettlement will remain ensuring that, from a legal perspective, limited unless there are changes to the following categories of low risk non- Chief Executive Officer, the regulatory regimes applied to bank participants will have the ability CLS Group systemically important infrastructures to directly participate in systemically like CLS. important FMIs: No quick fix – 1) supranational institutions and “Technology is multilateral development banks; Addressing frictions only one part of 2) foreign systemically important FMIs the complicated and their operators; in cross-border equation” 3) sovereign wealth funds. Depending on the jurisdiction, changes to payments existing regulations and legislation, Few remaining currencies can meet including the EU’s Settlement CLS’s currency onboarding standards, Finality Directive, may be required to The Financial Stability Board’s (FSB) which derive from the Committee on accomplish this goal. Cross-Border Payments Roadmap Payments and Market Infrastructures’ rightly focuses on improvements to and the International Organization While the use of new technology existing payment infrastructures and of Securities Commissions’ Principles may help address current frictions, arrangements. Such improvements are for Financial Market Infrastructures, technology is only one part of the needed to address current frictions that other applicable regulations, and CLS’s complicated equation to achieve a limit access, increase costs, and leave own standards for CLSSettlement. faster, cheaper, more transparent, and risks unmitigated. Principle 1, legal basis, and Principle 8, more inclusive global payment system. settlement finality, have presented the Removing these frictions involves care- largest obstacles to onboarding new ful consideration of the regulatory, legal, currencies to CLSSettlement. and operational changes required – many of which cannot be readily addressed by As a result, CLS has started to formalize 1. BIS: “BIS Quarterly Review – International banking and financial market developments”, specifically Bech simply adopting a new technology or its views around a new, separate solution and Holden: “FX Settlement Risk Remains Significant” shifting to a new type of infrastructure. for non-CLS currencies (in support of (December 2019).

payments to its customers across the Cross-border globe. It might therefore surprise some to hear that we are big supporters of the payments: recent policy initiatives.

welcoming the new The payment industry has always been at the forefront of technological and political impetus societal changes. It has had to adapt to new consumer behaviours and needs. The industry is continuously Under the Saudi Arabian leadership of innovating to make the payment the G20, the FSB and CPMI embarked process as seamless, efficient and secure on an ambitious work programme as possible. Today, we are seeing a lot of to improve the efficiency of cross- collaboration across the industry. One border payments. Last month, EU good example is the Western Union PETER BUCHER finance ministers adopted important platform. More and more FinTech Chief Executive Officer, Conclusions to improve the retail companies come to us to use our Western Union International payments market in the EU. Western payment platform to access our global Bank GmbH Union is one of the world’s leading network and agents to be present in all provider offering efficient cross-border parts of the world.

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The regulatory and supervisory commu- digital payment solutions. This brings should importantly find ways to nity needs to be part of this collaborative efficiency and helps to reduce costs. incorporate offline customers so that approach. This is where we believe the Nonetheless, digital payments are not these too profit from the new rules. CPMI work is of critical importance. in themselves the solution for making • The commitment to encourage, not The CPMI sets out a number of impor- cross-border payments more efficient. hamper the appetite of industry tant building blocks that, if implement- to invest and innovate in the ed, would make a big difference: aligning Many customers, not least in remote safety, security and efficiency of regulatory and supervisory approaches, and rural communities that require payments. Differences in national promoting the interoperability of pay- the necessary investment in digital implementation of AML, data ment infrastructures and contributing infrastructure or banking network, still privacy and consumer protection to standard setting on data exchange. rely heavily on cash. are creating barriers to scaling up While local rules, regulations and con- business solutions across the EU and sumer protection requirements need to How can the EU contribute to the in- internationally. ensure that payments remain safe and ternational agenda? We welcome the • The commitment by the ECB, Euro- secure, they should not unduly fragment Retail Payments Roadmap as a con- pean Commission and the National the ability of the industry to deliver structive way forward. It rightly identi- Central Banks to have clarity on the cross-border payments or stifle innova- fies a number of important actions: real-world applications of the CBDCs tion in the industry, nor should it favour including Digital Euro and the options one payment solution over another. • The move to a harmonized KYC for public-private collaboration when and e-onboarding framework will embarking on those new projects. If we look at our business today, contribute to cost-efficient and more customers are increasingly opting for effective compliance. Such initiative

experiences and expectations. The 19 border payments market under the diverse building blocks lay a strong same set of rules which create a level foundation for progress in the global playing field, this has the potential to payments ecosystem. enhance cooperation and change the competitive dynamics of the market. Despite the heterogeneity of the building New approaches will benefit from more blocks, one overarching objective efficient compliance frameworks while is a desire to reduce the high costs from a competition perspective both associated with cross-border payments. old and new solutions should obviously This challenge is multi-facetted, be subject to the same rules. although one clear outstanding issue is the cost of compliance and associated Beyond their roles as regulator or risks. Providers of cross border payment overseer, central banks also have a services need to comply with several critical role to play as providers of ULRICH sets of rules and regulations while, at liquidity and operators of payment the same time, mitigating legal risk systems. With regard to the latter, it BINDSEIL resulting from a lack of awareness or a should be mentioned that the ECB, in misunderstanding of the way laws and collaboration with Sveriges Riksbank Director General, DG Market regulations are applied. Compliance and the Banca d’Italia, has started to Infrastructure & Payments, costs are, eventually, charged to analyse how TARGET Instant Payment European Central Bank (ECB) end users while de-risking (i.e. the Settlement (TIPS, the Eurosystem pan- withdrawal of providers from the cross- European service that settles payments border payments market) means less in central bank money around the clock The G20 cross- competition, which in turn translates in real time) could support efficient into more market power for the payment transactions across different border roadmap – remaining providers, increasing further currencies. Ideally, payments would fees charged to end users. The G20’s have an efficient and competitive FX The foundations of a work acknowledges the importance of conversion layer and minimise costs for improving the efficiency of compliance participants and ultimately end users. future-proof global and reducing its associated risks, which The usage of TIPS by both Sveriges is why five out of the 19 building blocks Riksbank and the Eurosystem provides payments ecosystem are in this area. This is where making a great opportunity to explore this. improvements will be important for It will also foster our understanding both existing and new arrangements of all the practical challenges we face The G20 cross-border payments and providers. when aiming to implement concrete roadmap encompasses a variety of innovative solutions. actions through 19 building blocks The G20’s work also recognises the in an attempt to address the various importance of competition. It supports International cooperation will also be challenges related to cross-border the use of a variety of approaches to key to shaping the future ecosystem payments. The diversity of measures address the technical issues involved for central bank digital currencies, under consideration is also a result of in processing cross-border payments, which may offer consumers and firms a the different types of end users of cross- such as improving traditional payment further option for making cross-border border payments, who face different rails and correspondent banking. In payments, thus strengthening further challenges and have broadly different addition, if new players enter the cross- competition and efficiency.

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EU RETAIL PAYMENT INITIATIVES

contactless credit and debit cards. In a that are fit for global competition. In a recently conducted survey on payment market economy, offering such payment behaviour in Germany, the Bundesbank solutions to the public should be one found that the share of transactions of the private sector’s primary tasks. settled in cash has fallen from 74% to Consequently, the European Payments 60% compared to the last survey as of Initiative was launched by a group of 2017. This shift is unlikely to be reversed 20 major euro area banks as well as two once the pandemic is over. large European acquirers. The initiative is seeking to develop a unified card and In light of these developments, we digital wallet that can be used across need to ask ourselves whether the Europe, and potentially beyond. It means of payment currently available offers a real opportunity to reshape the adequately meet the needs of consumers payments landscape, providing a pan- in the digital age. Unfortunately, the European payment solution that is fast, BURKHARD instruments offered by EU payment secure, cheap and widely accepted. service providers are in danger of falling BALZ short of the needs of payers and payees That said, the private sector is not alike. The EU payment system is still alone. European authorities are pulling Member of the Executive Board, highly fragmented. Most payment together, too, so that they can provide Deutsche Bundesbank solutions are still developed around the environment and conditions for the domestic ecosystems, with little or no private sector to innovate and thrive. acceptance beyond national borders. Legislators, central banks, financial Securing the future of regulators and competition authorities Unsurprisingly, none of the many are setting up the appropriate framework European payments national solutions available are big for a resilient, innovative, diverse and enough in terms of reach or user numbers competitive payments landscape to to compete on an equal footing with serve the evolving needs of European Payments are the backbone of global players like major card networks people and businesses. our economies. This backbone is or bigtech platforms from China and the undergoing a dramatic transformation, United States. This increases the risk The Eurosystem has a particular part to driven by the digital revolution and its that these firms evolve into increasingly play in this, such that payment systems impact on the demand for new forms of dominant market players in domestic can rely on its infrastructure. The payment and the provision of innovative markets as well, raising questions about Eurosystem needs to act as a catalyst, payment services. Consumers want competition, privacy, financial stability being at the cutting edge of technology quick, convenient, secure and cheap and even monetary sovereignty. and providing state-of-the-art payment payment methods – around the clock infrastructure that reflect our changing and with solutions covering cross- The European Union cannot afford to economies. This includes exploring the border payments, too. We can see that be a bystander to these trends. It is high potential benefits, risks and operational the use of cash is waning. The COVID time to advance European initiatives and challenges of issuing a digital euro. 19 pandemic has boosted the use of develop innovative payment solutions

In the wholesale segment, the advances A European in FMI integration in the last years have been significant. The Eurosystem has strategy for played a prominent role by developing retail payments and operating Target2, the real-time gross settlement (RTGS) system for large value payments in euros, and TARGET2- The global covid pandemic has generated Securities (T2S), the securities settlement an unprecedented economic shock that platform which allows the adhered CSDs has impacted the global economy, in to settle securities and cash in central general, and the European economy, bank money. in particular. Against this backdrop, speeding up the process towards the In the retail segment however, the results Capital Market Union (CMU) is a useful are mixed. The Single Euro Payment tool to foster economic recovery. One of Area (SEPA) initiative has successfully JUAN AYUSO the main initiatives of the CMU Action increased the harmonization of, in Director General Operations, Plan is the pan-European integration particular, credit transfers and direct Markets and Payment Systems, of the financial market infrastructures debits, allowing European citizens to Banco de España (FMIs), including securities market make cross border payments as easily infrastructures and payment systems. and efficiently as they can do within their

198 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net EU RETAIL PAYMENT INITIATIVES home countries. There is however still the pan-European reach of instant and security, European brand and work to do regarding the point-of-sale payments), an active engagement as a governance, and global acceptance, with (be it physical or virtual for e-commerce catalyst of private efforts that fit with the a focus on a full deployment of instant transactions), where the user experience overall vision of the Eurosystem seems payments, where Europe is a global is still fragmented. The domestic card more appropiate. reference, and the enhancement of based and e-commerce solutions that cross-border payments. exist in a few countries might show a good degree of efficiency but lack pan- The Eurosystem is actively Among the private initiatives well European reach, whereas those solutions working towards the aligned whit these objectives, it is worth that work across Europe are usually improvement of retail highlighting the European Payment managed by global companies whose payments in euro. Initiative (EPI), led by major European strategies may not always be aligned banks, perhaps the most promising ini- with the European users’ needs. tiative to achieve these objectives, even The first and main goal of the strategy though other potential solutions seeking The Eurosystem is actively working defined by the Eurosystem for retail to meet them are of course welcome. towards the improvement of retail payments, fully aligned with the payments in euro, but its role is European Commission, is to support Advancing on these objectives in necessarily different from that played payment solutions that fulfil five cooperation with the private sector is of in wholesale payments. While some key objectives: pan-European reach the essence at the current juncture, to operational role can still be played (e.g. and seamless customer experience, the benefit of European citizens and the the deployment of TIPS to promote convenience and low cost, safety European economic recovery.

the payments sector. Benefitting payments market. Wide acceptance of from significant network economies, a means of payment not denominated they challenge established financial in euro could impair the transmission services providers. Moreover, with the of monetary policy in the euro area. emergence of crypto-assets (including Hence, the issuance of a digital euro stablecoins) they may soon be offering could support European economic payment solutions based on encryption sovereignty and financial stability. and blockchain technology. In 2020, a group of 16 European banks Innovation and digitalisation will launched the European Payment continue to change the way payment Initiative project with a view to offering services are provided: old channels and a pan-European payment solution by traditional payment instruments are 2022. The Commission welcomes this increasingly abandoned; this will lead initiative aimed at completing a single MARIA to new ways of initiating payments, European payments market. Other such as via “wearables” (watches, glasses, promising market-driven initiatives have etc.). The Covid-19 pandemic has emerged recently, aimed at designing VELENTZA reinforced the shift to digital payments common infrastructures, increasing Director Financial Services, and confirmed the importance of safe cooperation and interoperability DG Competition, and convenient (including contactless) between domestic payment solutions. European Commission payments for remote and face-to-face Synergies between private and public transactions. However, cash remains initiatives will be key in supporting the means used for a majority of retail the recovery from the current crisis payments in the EU; the principle that in a balanced and cohesive way across Towards a and coins are a legal the EU. tender is enshrined in the EU Treaty. competitive and Citizens and businesses in Europe should benefit from a broad range innovative European Public and private of high-quality payment solutions, players will shape supported by a competitive, innovative payments market jointly the future payments market and based on safe, payments landscape efficient and accessible infrastructures. – and support a The Commission, beyond its specific Digital innovation is radically reshaping policy agenda in the payments sector the provision of financial services. The cohesive recovery. follows those initiatives, which are retail payments sector is at the forefront supporting the objectives of creating an of this trend; the pace and scale of Public and private sectors have economy that works for people and a technological change requires specific complementary roles to play in the Europe fit for the digital age. and targeted policy measures. future payments landscape. More and more central banks around the world, Most importantly, competition Over the last years, the act of paying including the European Central Bank, enforcement complements policy has become less visible, increasingly are looking into the possibility of initiatives, hence supporting the dematerialised and disintermediated. issuing central bank digital currencies digital transformation of finance and In addition, large tech companies and there are tangible prospects of promoting a level playing field. (“BigTechs”) have become active in further significant changes in the retail

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payments, and indeed the increased use trust through increased transparency; of digital apps for all kind of payments. protection of our EU autonomy. While fundamental needs related to payments have not changed – it is still Firstly, we should be proud of the and always will be about transferring pioneering role that the EU has played money in an easy and secure manner – in opening competition in the retail the solutions for retail consumers are payment space with the second Payment more and more diverse and creative. Services Directive (PSD2). This approach can be an inspiration for further open Private stakeholders continue to finance initiatives related to payments, compete to provide better solutions and even beyond in the broader financial for businesses and consumers. As Vice- services space. The ‘same business, same Chair of the ECON committee in the risk, same rules’ principle and reciprocal European Parliament, my role is to access to relevant data will ensure a level STÉPHANIE ensure this productive competition playing field across providers, and that does not lead to a race to the bottom entities outside of the traditional remit YON-COURTIN and respects the core principles of our of financial services, including BigTechs, European regulatory values. are not unduly getting the lion’s share. MEP, Vice-Chair, Committee on Economic Secondly, consumers should be and Monetary Affairs, Fair competition, empowered to challenge their payment European Parliament increased trust providers on the quality of their through increased services and associated charges, thanks transparency, to clear disclosure on how much and protection of our for what they pay. This will build trust Retail payment overtime. Only a coherent EU approach EU autonomy. on the payments rulebook and on its strategy: enforcement, involving all relevant The recent European Commission supervisors and stakeholders, will three pillars Retail Payments Strategy provides a rebuild the trust severely eroded by the strong basis for the crucial discussions Wirecard scandal. for the future in the coming years on adapting our EU rulebook on payments, Thirdly, our eyes should remain wide including the wider policy landscape open to the challenges to our European One year after the world went to related to distribution of financial autonomy linked to payments, lockdown following the emerging products, financial reporting, financial alongside the opportunities they bring. spread of COVID-19, all domains of innovation, audit, post-trading, Anti- The EU is leading the way in creating our lives have been shaken to the core. Money Laundering and Countering the first Digital Operational Resilience The payment landscape is no exception, Terrorism Financing. framework, also applicable to payment as the pandemic accelerated existing infrastructures. Similarly, the European consumer trends, such as contactless We should anchor our actions going Payments Initiative (EPI) is a key payments, digital consumer-to- forward in three pillars: fair competition milestone to preserve the independence consumer and consumer-to-business on the open finance field; increased of our foreign policy decisions.

solutions could thus shape the European The retail payments market in a way that does not serve the interests of European payments strategy stakeholders.

in Europe To overcome the challenges of digitalisation in the payments market, Digitalisation and increasing global the Eurosystem has re-launched a retail competition in the payments area payments strategy. Three of the goals could put sovereignty of the European are: 1) the development of pan-European retail payments market at risk. The payment solutions at the point-of- digitalisation trend has accelerated interaction, 2) the full roll-out of with the COVID-19 pandemic where instant payments in Europe, and 3) the the use of cashless payment methods improvement of cross-border payments has risen. Cards continue to be the beyond the euro area and the EU. FIONA VAN most used electronic means to pay in Europe, however, a significant share Firstly, it is essential that pan-European ECHELPOEL of card transactions are covered under payment solutions for retail payments Deputy Director General, international brands. Additionally, at the point-of-interaction (POI), DG Market Infrastructure BigTechs with a large customer base including the physical point-of-sale & Payments, European that can be leveraged for retail payment and in the mobile and e-commerce Central Bank (ECB) services are entering the market. The space, are developed under European dependency on non-European payment governance. In 2019, the Eurosystem

200 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net EU RETAIL PAYMENT INITIATIVES called for collaboration between service went live in 2018. However, for party. Moreover, the settlement of European stakeholders and devised five instant payments to become the “new instant payments in automated clearing objectives that any private initiative normal”, interconnection between houses (ACHs) will move from TARGET2 needs to meet: pan-European reach market participants is needed. To tackle to TIPS. and customer experience, convenience this issue, the European Central Bank and cost efficiency, safety and security, has put in place a set of measures to be Thirdly, cross-border payments beyond European identity and governance, implemented in TIPS by the end of 2021. the euro area and the EU should be and, in the long-run, global reach. improved. In this vein, the ECB and Currently, a few market initiatives Sveriges Riksbank are exploring if cross- seek to end the fragmentation in the To overcome the currency payments between euro and European payments’ ecosystem with challenges of the Swedish krona can be settled in TIPS. pan-European solutions. digitalisation in the In parallel to the retail strategy, the payments market, Eurosystem is exploring the issuance of Secondly, instant payments should be the Eurosystem has a digital euro to respond to the evolving deployed fully in Europe so European needs of European consumers. citizens can send or receive money in re-launched a retail real time, as easily as text messages payments strategy. A digital euro could be an option to or emails. The first steps have been ensure that citizens have access to a safe successfully deployed. The SEPA instant By then, all payment service providers in form of digital money, alongside cash. credit transfer (SCT Inst) scheme was TARGET2 that adhere to the SCT Inst To avoid any negative impact in the launched in 2017 and the TARGET scheme will become reachable in TIPS, financial sector, the design of a digital Instant Payment Settlement (TIPS) either as participant or as reachable euro would need to be further assessed.

business. Over the last decade, payments The second challenge is that despite have benefitted from unprecedented recent progress, the retail payments technological innovation. Consumer market in Europe is still very fragmented expectations are also changing, making along national borders, with many speed, convenience and ubiquity the new payments solutions being purely expected normal. Increasingly, the speed national. of retail payments can be measured in seconds, and households and companies The Commission’s recently adopted expect to be able to make payments at Retail Payments Strategy seeks to address any time of any day. these challenges by supporting the roll- out of instant payments in the EU and EU legislation has promoted innovation the emergence of European payment and competition in retail payments. solutions, ensuring a sound, competitive In this regard, the second Payments and innovative retail payments market MARCEL services Directive (PSD2) was a game and a high level of consumer protection. changer. It has been instrumental in The Commission’s Strategy is a long- opening up the banking ecosystem and term policy framework to support the HAAG fuelling the development of innovative future development of retail payments in Director, Horizontal Policies, payment services by FinTech firms. the EU and to exploit the opportunities DG for Financial Stability, that digitalisation offers. Financial Services and Capital As digitalisation progresses, the pay- Markets Union, ments ecosystem becomes increasingly With its Strategy, the European European Commission complex, with many actors - regulated Commission is showing the way towards or non-regulated - intervening in the the achievement of a customer-centric, payments chain. It is important to en- modern, competitive and innovative sure that regulation remains well-cali- payments ecosystem. Europe is, and Shaping the brated and that it adequately covers all must remain a role model in payments actors and services that might carry risks integration. payments landscape to the financial system. All relevant play- ers should be subject to adequate super- The Strategy requires extensive work and of the future: vision and oversight. collaboration between all stakeholders, public and private. The Commission is the Commission’s EU regulators are faced with two already in the process of implementing important challenges: The first is that a its strategy, with work being underway Retail Payments significant share of payments in Europe on several of the initiatives announced effectively depends on international in the strategy, such as instant payments, Strategy players, such as international card cash, digital euro, SEPA enforcement etc. schemes and, increasingly, of large technology companies. It is crucial, for A public consultation on instant The European payments industry the EU’s open strategic autonomy, to payments will, for example, be soon is facing dynamic innovation and reduce this dependency and to support launched. Some ambitious initiatives continued disruption of its traditional the emergence of European champions announced in the strategy, like the value chain and service propositions. in the payments sector. This will increase review of PSD2, will be presented at a Payments are a constantly evolving competition and choice for end-users. later stage.

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physical central bank notes can all be physical (card) and digital form, based attributed to the changing consumer on state-of-the-art technologies and needs resulting from the ongoing under a strong common brand will pandemic. secure the role of banks in the retail payments landscape of the future In my home country of Germany, we while ensuring that European interests have experienced shifts in consumer in sovereignty, standards and data behavior and expectations even more protection regulations are protected. acutely than many of our European neighbors. As an example, our national Long term, the success of EPI will depend card scheme Girocard (already one on a variety of key factors. Notably, EPI of the largest in Europe), has seen an would not be a true European champion annual increase of over 20% in the if it were not able to compete across number of transactions in 2020 alone Europe. Also critically important is a JOACHIM and of those, the share of contactless sustainable business model that allows transactions rose from 39% to over 60% EPI to innovate and stay competitive SCHMALZL during the same period. long after it has entered the market. Of course, we must also ensure that lessons Executive Member of the Board, Of course, dominant international learned in various national solutions Deutscher Sparkassen- und payment solutions such as the ICS, are reflected in EPI and that strong and Giroverband (DSGV) GAFA, and BATX have also benefited sensible migration plans are in place from these shifts in consumer habits. where needed. As a result, the overall equation and The way forward: the fundamental need for a competitive Lastly, we must recognize that the European payments champion has been goal of creating a European payments the role of further reinforced. champion — that is key to the successful implementation of the European Retail European Banks Payments Strategy — cannot be realized We must recognize by European Banks and Acquirers and acquirers that the goal of alone. Therefore, support from the creating a European European Commission, the European in the future of payments champion Central Bank, various other EU (and cannot be realized by national) regulators, and central banks digital payments will be a necessary factor in “leveling the European Banks and playing field”. Acquirers alone. Around the globe, the COVID-19 The imbalance between global and pandemic has effected significant shifts In the European Payments Initiative local models has limited the ability in the payments industry as a whole. (EPI), we have set ourselves the task of European players to innovate and Irregular - but foreseeable - increases of developing a portfolio of retail reinvest in their solutions. Initiatives in E-/M- commerce transactions, payment products for consumers and (such as EPI) are hence needed in order increased use of contactless payment merchants that can compete with to effectively compete in a globalized methods at the Point of Sale (PoS), international rivals on various fronts payments industry currently dominated and an accelerated shift to acceptance such as simplicity and user experience, by an oligopoly of international and use of digital payments methods security, and availability. Best-in-class payments service providers. coupled with a decrease in the use of European payment products, both in

Policymakers as well as the industry are Building a working on several solutions to offer European consumers, businesses, and competitive merchants’ access to better services and better prices. Fundamentally, this landscape for is grounded in the understanding that all market players deserve more choice, payments and that any forward-looking payments market should have competition at in Europe its heart.

A new and dramatically different era for The creation of a pan-European scheme the European retail payments space has is therefore a step on the right direction. begun. Every choice the EU takes now Initiatives such as the European will help determine Europe’s influence Payments Initiative (EPI) are focused JUAN ORTI and position in the global payments on encouraging real competition to Country Manager Spain, Head market of tomorrow. the dominant schemes – whether from of Consumer Spain and BeNeLux, FinTech’s, European-led initiatives or Europe Board Director, It is vital that we get it right from alternative models such as American American Express the start. Express and Diners.

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The development of pan-European only up to 12 months outside their developments into Open Banking/ solutions is no doubt important, but we home member state. Such a restriction Finance/Data could lead to inconsistent believe there are also other paths the puts non-bank PSPs at a disadvantage customer experiences that differ across EU could – and should – consider, to vis-à-vis banks when offering personal products and providers, and cause delays increase competition even further. loans and credit cards. to financial institutions updating and enhancing their external APIs. Not least, At the top of that list must be the definition of “payment account” addressing the shortcomings of PSD2. Any forward- still needs to be further detailed and The changes to the open access rules, looking payments clarified, as the overly broad contours of for instance, combined with other market should have the definition in current EU regulations onerous regulatory requirements, have competition at have led to a divergence in views and made it even harder for alternative and its heart. implementation across the EU. innovative fintech players to enter this space and compete with the dominant Ultimately, if we work on these different four-party schemes. The much talked about move from Open workstreams in parallel, together we Banking to Open Finance is another can empower European consumers, Similarly, the current restrictions in essential part of the puzzle. To make businesses, merchants, and payment place regarding the passporting of a swift and seamless transition to this service providers with different choices, credit services are an obstacle to the broader scope, we first must ensure that and we can achieve a truly innovative single market. PSD2 stipulates that PIs Open Banking is fully implemented. and competitive payments market. can issue credit on a passported basis Without API standardization, further

solutions is European or even co-owned environment and given the progress of by Europeans. At the same time, the competitor solutions, this looks more European regulator has created the than ever challenging and requires a basis for instant payments, but no major strong concertation between the public development took place in the retail and private sector in Europe. payments space because the alignment of critical mass on one solution Priorities have to be set out in line with necessary for the rapid successful roll market expectations, so that the private out in the market, did not happen. sector can deliver, but the support of the public sector will be needed since While this situation clearly offers some the effort will be anyhow immense. A potential opportunities, it is important collective effort appears as the only way to understand that Europe has to catch how to turn around the continuous shift up in terms of payments solutions. of Europe into increasing dependency MARTINA The reason why many international in cards, wallets, payment standards solutions from different players develop and related technologies, while being so strongly in Europe is because we have internationally inexistent. WEIMERT no European reply, but only national Chief Executive Officer, or local solutions lost in more or less This support seems not only necessary EPI Interim Company SE relevant specificities. for the overarching principles or long- lasting objectives but should reflect also in the detailed lay out and set-up of a Are we able Creating only a level European solution. In exchange of his playing field and support, the European regulator should to align in regulated approaches have control over the realization of which we usually these objectives in order to obtain clear European retail deploy in Europe, will benefits for the European consumers, market players and its economy in payments? very unlikely suffice. terms of digitization, innovation and efficiency. Creating only a level playing This situation entails consequences: field and regulated approaches which The pandemic has led to a strong payments innovation is always a long- we usually deploy in Europe, will very increase for contactless and e-commerce term investment and will require a unlikely suffice to create the needed transactions in Europe, including substantial shift of parameters known conditions for success. through cross-border e-commerce. until now, meaning that Europe will Europe seems more than ever ready have to deliver its our own innovation, The longer we wait, the more difficult for digitization. Besides this push, we investing more into technologies, and it will become, if not impossible. Lack witness since a couple of years the achieving efficiency which are in line of support, nationalism, or believing in development of strong international with our overall European market size. vain that solutions at the national level wallet solutions and constantly could be more efficient and competitive evolving new technologies as the main Ultimately “catching up“ with the in the long run compared to European- market drivers. All these solutions are payment giants will require massive wide innovation and leveraging continuously enriched and numerous investments and an outstanding collectively our scale, are the biggest value-added services appear including persistence in the implementation enemies to this evolution. now also financing. But none of these efforts. In the current economic

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banks, domestic market infrastructures, coordinated action from public and service providers and vendors. It’s private sectors. In the private sector, the a complex web of interconnected SWIFT community has so far taken an systems, standards and practices that evolutionary approach, its gpi initiative evolved slowly and often in isolation, building on existing standards and and that now work together. protocols to provide transaction tracking and other modernisations. Another Many small differences across the system welcome development, already well in terms of data and data formats lead in hand, is the industry’s convergence to automation breaks, loss of data and on a common modern data standard delay. In many cases, these legacy data across all the major components of formats were optimised to minimise size the ecosystem, embracing both public and processing complexity, constrained and private sector. ISO 20022, which is by the technology of the day. However, already the de facto choice for new or DAVID the environment for payments has refreshed market infrastructures, from become much more demanding, November 2022 will also be adopted for WATSON with customers expecting real-time cross-border payments. experiences, and regulation demanding Chief Strategy Officer, SWIFT complex sanctions screening and Consistent shared data end-to-end, AML measures. between customers, banks, MIs and service providers, addresses today’s Cross-border fragmentation and its inherent Finding the right risks, enabling higher automation payments evolution: balance will require rates, more effective compliance coordinated action processing, and richer contextual common standards from public and data benefiting payment system users. private sectors. For cross-border flows, SWIFT will & public/private deploy new technology to ensure banks can move at their own pace to cooperation As highlighted in CPMI’s recent adopt ISO 20022, while maintaining report, the overall system needs to community interoperability and be modernised to address new needs. ensuring the integrity of payment The world of cross-border payments But this poses a dilemma: reform too data. Public sector implementers can is changing. While there have been slowly and risk disruption from new accelerate the realisation of these developments over many years technology or models, at least for major benefits, by cooperating to harmonise and through many generations of corridors; reform too quickly and risk local implementations with their technology the market continues to fracturing the existing system, which international peers. Regulators can evolve. Viewed as an ecosystem, cross- provides unparalleled access in terms also help by taking advantage of the border business involves not only the of markets, currencies and accounts. convergence of transaction data models payer and payee but correspondent Finding the right balance will require to harmonize AML/CFT standards.

The Covid-19 pandemic has brought fundamentals. Payments have their into sharp relief the importance of own “Maslow’s hierarchy”. At the base digital payments to our markets, as of the pyramid is resilience, and security the adoption of contactless payments – the food, air, water, and security in and e-commerce has increased. The the Maslow we know. Without that security and resilience of the payments the foundation is unstable, the risk infrastructure has also been critical to to credibility and financial stability maintaining confidence and credibility, manifest. The reliability of digital and therefore to supporting business payments over the last year must not and economic recovery. be undervalued; the shift to digital of businesses and consumers which While European regulation has arguably in turn has strengthened economic contributed to the most competitive and resilience cannot be understated. This innovative retail payments market in base of the pyramid should be a primary CHARLOTTE the world, it is poised for more change focus for all policy makers, setting clear in light of a further uptake of new and standards and expectations for the HOGG efficient digital payment solutions, digital world we are moving into. open banking achieving its full poten- Executive Vice President tial, alongside a potential introduction Openness and access comes next – the and Chief Executive Officer, of a digital euro. Looking forward, we love and belonging of Maslow. There VISA Europe believe the future of payments is open. is a big difference between open and Europe should promote open and inter- closed-loop payment networks. Open operable payment systems as this drives networks are clear and transparent The future of both innovation and resilience. about their rules and all participants who meet those rules can join them. payments is open As we move into this next phase, it’s They have governance structures that important to stay grounded in the push towards inclusion, recognizing the

204 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net EU RETAIL PAYMENT INITIATIVES positive externalities for all that come ulatory requirements. All are important. So what’s at the top – where do from that. None imply single platforms or single payments realise self-esteem? My points of connection. Interoperability answer is through serving consumer In our transition from a member avoids creating the single points of fail- and business needs, use case by use case. association owned by 441 banks to a ure that are so inherently damaging to Enabling consumer choice. Ensuring commercial organization, we have for the fundamentals. competition and level playing fields. example become more accessible to EU Offering different values for different FinTech players and have supported types of transactions. For example, their growth beyond domestic markets. Europe should speed in one case, consumer protection Thus open networks enable greater promote open and in others, different form factors in yet a consumer choice and competition. interoperable payment third. This is where innovation comes systems as this drives into playing, building off consumer Openness is also about interoperabil- both innovation trust and resilience, gaining access to ity.0Definitions are important here. open and interoperable systems. Technical interoperability means the and resilience. ability to facilitate payment transac- In a time of rapid change, we must tions between different applications To give a Visa example; in 2020 create the environment for innovation, and infrastructure to enable straight our payments push platform Visa enabling European citizens to through processing. Network interop- Direct completed nearly 3.5 billion benefit from the record levels of erability, the ability for multiple parties transactions involving 16 card-based entrepreneurship we see. But we must to connect through a network that fa- networks, 65 domestic ACH schemes, 7 never compromise on the security and cilitates payment transactions. Regula- faster payment schemes, and 5 payment resilience that makes this all possible tory interoperability the ability to con- gateways. This is our “network of and maintains the trust so vital to nect payment systems across different networks” strategy in action and a great our economies. jurisdictions governed by different reg- interoperability story.

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Latest Eurofi policy notes and contributions from public and private representatives on a selection of key policy topics

ECONOMIC AND STABILITY CHALLENGES Covid crisis : impacts and responses Economic and Monetary Union Monetary policy impacts International role of the euro Financial stability Indebtedness EU financial sovereignty

FINANCIAL POLICIES CMU 2.0 Asset Management framework Securities trading and post-trading Relaunching securitisation in the EU Banking Union Brexit & Third-country arrangements CEE region funding challenges

NEW TRENDS ESG and sustainability Sustainability disclosure challenges Digitalisation Artificial Intelligence Cloud services Crypto-assets and payments Operational resilience

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 205 7

ESG AND SUSTAINABLE FINANCE

ISSUES AT STAKE

The need for more sustainable growth is becoming more evident with the increase of climate-related natural disasters and also the Covid pandemic, which questions globalised economic value chains and demonstrates the impact that the economy may have on biodiversity. The financial sector, the economy and the society as a whole need to mitigate the likely consequences of such emerging risks. In addition the importance of going beyond Environmental challenges by addressing also Social and Governance ones is increasing.

Transitioning the economy towards this new objective however requires unprecedented efforts to develop alternative sources of energy, reduce the consumption of natural resources and develop a fairer economy. One key contribution to drive those necessary changes is redirecting a higher volume of savings and financing from resource intensive processes towards more sustainable ones. Setting clear and common definitions of what is “sustainable” for companies, investors and policymakers is also essential, as well as facilitating the elaboration and distribution of the related information. Defining dedicated risk-assessment and mitigation approaches is also key.

A great number of initiatives are underway at domestic, regional and global levels to address these pressing issues and the EU is in a leading position in this regard. However, reducing the cost of producing the relevant information, facilitating its sharing and achieving a sufficient level of coordination and harmonisation of the related ESG standards globally is necessary in order to obtain sufficient impact. ESG GLOBAL AND EU STANDARDS CONVERGENCE...... 208

Hester M. Peirce - U.S. Securities and Exchange Commission / Carmine Di Noia - Commissione Nazionale per le Società e la Borsa / Katharine Braddick - HM Treasury / Anne Finucane - Bank of America Europe / Natalie Westerbarkey - Fidelity International / Jessica Ground - Capital Group / Kay Swinburne - KPMG in the UK / Daniel Hanna - Standard Chartered Bank

EU SUSTAINABLE FINANCE TAXONOMY...... 216

Paul Tang - European Parliament / Carlos San Basilio - Ministry of Economy and Digitalization, Spain / Jean-Paul Servais - Financial Services and Markets Authority, / Marcel Haag - European Commission / Hideaki Takase - MUFG Bank ltd / Adriana Pierelli - BNY Mellon / Rami Feghali - PricewaterhouseCoopers Audit / Oliver Collin - Invesco

CLIMATE-RISK IMPLICATIONS...... 222

Sylvie Goulard - Banque de France / Francois-Louis Michaud - European Banking Authority / Willem Evers - De Nederlandsche Bank / Åsa Larson - Finansinspektionen / Emilie Mazzacurati - Moody’s ESG Solutions Group / Alan Smith - HSBC Holdings plc / John Scott - Zurich Insurance Company Ltd / Gianluca Cantalupi - Credit Suisse International ESG AND SUSTAINABLE FINANCE

ESG GLOBAL AND EU STANDARDS CONVERGENCE

Some are urging us to closely align our is rooted in investor-oriented financial rules with our European friends who materiality and principles-based long have been working on devising a requirements to accommodate the comprehensive set of ESG disclosure wide variety of issuers. metrics. Others would like to see us rely on standards developed and governed The European concept of “double by an international body, such as materiality” has no analogue in our the work being contemplated by the regulatory scheme and the addition of International Financial Reporting specific ESG metrics, responsive to the Standards Foundation. Indeed, there is wide-ranging interests of a broad set of mounting pressure to embrace a single “stakeholders,” would mark a departure global set of metrics, which would from these fundamental aspects of our facilitate international capital flows disclosure framework. The strength of and issuers’ reporting obligations. our capital markets can be traced in part to our investor-focused disclosure rules and I worry about the implications a stakeholder-focused disclosure regime would have. Such a regime would The result of global likely expand the jurisdictional reach of the Commission, impose new costs HESTER reliance on a centrally on public companies, decrease the M. PEIRCE determined set attractiveness of our capital markets, of metrics could distort the allocation of capital, and Commissioner, U.S. Securities and undermine the role of shareholders in Exchange Commission (SEC) undermine the very corporate governance. people-centered objectives of the ESG Let us rethink the path we are taking before it is too late. movement. Rethinking global The views represented herein are my own views and not necessarily those of the U.S. ESG metrics Securities and Exchange Commission or At first glance, everything sounds my fellow Commissioners. good—common metrics demonstrating a joint commitment to a better, cleaner, Many advocates behind the global wellgoverned society. Common environmental, social, and governance disclosure metrics, however, will drive movement argue that prosperity alone and homogenize capital allocation is not a sufficient measure of society’s decisions. A single set of metrics will progress, a position that I believe is constrain decisionmaking and impede unassailable. The challenge we face creative thinking. Unlike financial in addressing the ever-increasing accounting, which lends itself to a number of issues underlying E, S, and common set of comparable metrics, G is daunting. The task before us is ESG factors, which continue to evolve, to find a way to bring about lasting, are complex and not readily comparable positive change to our countries on a across issuers and industries. The range of issues without sacrificing in result of global reliance on a centrally the process the very means by which determined set of metrics could so many lives have been enriched and undermine the very people-centered bettered. Accordingly, a shared desire objectives of the ESG movement by to address these and other societal displacing the insights of the people problems should compel us to rethink making and consuming products and our prescriptive approach to ESG and services. instead find ways to encourage our most precious resource—our people—to Hampering the ability of the markets devise solutions to the climate-related to collect, process, disseminate, and and other challenges our societies face. respond to price signals by boxing them in with preset, government- In the United States, the idea of articulated metrics will stifle the enlisting the securities laws to achieve people’s innovation that otherwise ESG objectives is gaining traction would address the many challenges among activists and policy elites with of our age. Moreover, converging a particular emphasis on requiring standards would be antithetical to our disclosure of specific ESG metrics. existing disclosure framework, which

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issues requiring companies to be to be or lack of, non-financial information sustainable in order to receive funding. could also have an impact on the supply This is a strategy that puts a heavy chain entities in case the top-chain responsibility on us. EU has a very company requests all the suppliers to strong commitment and our job is to disclose their ESG data. Not providing enforce EU ESG regulations but also to this could lead a cut off even here. put in place, in my view, a surveillance on any unintended side effect that has Related to this, if we think about to be reported back to EU to fine tune production district, whose typical the framework. feature is to be built up on many specialized micro and small companies, Much more is needed. Transparency then we can have – and in Italy we do and standardization must be the have many textile, mechanics, furniture core of our strategy, i.e. data. Data districts – wide regions where the published by companies, and lately, as success of the general strategy, if not remarked by ESMA, ratings published accompanied by deemed disclosure, on companies. Beneath these needs can be potentially disruptive due to the there is also the need of consistency effect either on the funding (being cut and comparability in sustainability off by cheap one) and on the revenues reporting drawn up with different (being cut off by supply chain). CARMINE standards. It’s so impelling that this is the way on which are working the We need to manage the possible DI NOIA standard setters of the non–financial unintended consequences that ESG Commissioner, information, (CDP), Climate Disclosure strategy may have more negative Commissione Nazionale Standards Board (CDSB), Global immediate effects on people and per le Società e la Borsa Reporting Initiative (GRI), International communities than positive future Integrated Reporting Council (IIRC) e effects on the environment. Sustainability Accounting Standards Board (SASB) and on which both IFRS Foundation and EU, by means of EFRAG and ESMA, are moving. A sustainable ESG The priority now must be a clever strategy to avoid proportional regime for disclosing non–financial information. Disclosure unsustainable has a cost; so many companies simply do not disclose their ESG situation. consequences If investors and lenders became more demanding on ‘green’ and ‘sustainability’, a side effect could quickly arise: a company that does not Financial markets do love heterogeneity. Corporate Governance last decade’s debate has been centred on the idea of cultural and gender diversity. Modern finance theory itself is grounded on the The priority must be principle of diversification: Markowitz’s portfolio selection framework is based a clever proportional on the research of uncorrelated assets. regime for disclosing In order to valorise heterogeneity non–financial (of contents), however, we need homogeneity (of forms). information.

A single shared language must be spoken within a boardroom; agreed measures of risk/returns must drive disclose ESG information can be cut off every portfolio selection. by financial market or, at least, by cheap funding. Obviously this is the aim of The same holds for corporate the strategy in the background, but the information: specificity of context must size of the company ‘matters’; while big be conveyed through standardized companies can afford big investments and comparable languages. This is in transition and in reporting, SMEs particularly true with regards to the have to decide whether to invest emerging wave of ESG information. in transition in sustainability or in disclosure or in which mix of these, The biggest challenge for our because the cost of disclosure could be generation, with Covid-19, is climate not light. This need of proportionality change and, attached to this, the related becomes more urgent the more we social inequality and human rights approach standardization and ratings violations. We decided to tackle these and reports are issued. Moreover, poor,

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Whilst private sector convergence disclosure obligations across the around the TCFD is clear, voluntary economy, and to join us in supporting action in the private sector has most the proposed IFRS SSB, with a view to likely progressed this cause as far as it seeking to adopt future SSB standards can, to the point where public sector when appropriate. co-ordination is now needed to ensure consistent, comparable and reliable Crucially, standards from the IFRS SSB disclosure. With that in mind, last year will be delivered through a building the UK became the first country in the blocks approach, allowing individual world to announce our intention to jurisdictions and regions to supplement make TCFD aligned disclosures fully baseline international standards mandatory across the economy by with additional domestic corporate 2025. Of course, the EU’s ambition on disclosure requirements that capture sustainable finance has also been world- wider sustainability impacts. This is leading, marked by an unrelenting important given the SSB will develop focus on aligning the economy with standards on information relevant to the objectives. One investors on enterprise value creation foundational element of this is the in the short, medium and long-term. on-going review of the Non-Financial Reporting Directive (NFRD) which The UK fully supports this building KATHARINE is seeking to significantly strengthen blocks approach, it promotes corporate sustainability reporting in international convergence on a global BRADDICK the EU. baseline, without constraining the Director General, ambition of individual jurisdictions Financial Services, or regions. This will be an important HM Treasury consideration for the EU, as it explores establishment of a European sustainability reporting standard- Global baseline setting body. With that in mind, standards are the IOSCO and the IFRS Foundation are only way to deliver progressing the establishment of an The case for expert multi-stakeholder committee truly consistent to help the SSB co-ordinate with global corporate and comparable reporting requirements on wider sustainability sustainability impacts. sustainability reporting across The EU’s long-standing commitment reporting standards jurisdictions to promoting international standards, and leadership and expertise on sus- tainability disclosure, places it in a unique position to both inform and in- Investors, governments, civil society tegrate common baseline international and citizens are demanding better Nevertheless, although jurisdictional reporting standards. At the same time, information from companies about sustainability disclosure regimes – EU leadership – including through social and environmental performance being developed in the EU, UK and the International Platform on Sustain- and impacts, but the reliability and the elsewhere - are an important lever for able Finance - is needed to promote quality of reporting is often lacking. improving the quality and quantity cross-jurisdictional convergence on Today there is significant global variation of reporting, so too are common sustainability reporting matters that in the information on sustainability international standards. Such global stretch beyond this baseline. impacts that many stakeholders want baseline standards, built from the now corporates to disclose. However, established TCFD, are the only way to in the case of financial markets – deliver truly consistent and comparable which by their nature are inherently sustainability reporting across international – there is an acute need jurisdictions. Whilst a few months ago for global comparability. this might have seemed impossible, today’s geopolitical context makes this Consistent corporate disclosure of sus- not just feasible, but increasingly likely tainability-related information relevant to happen at pace. for enterprise value is foundational to investors managing short, medium and The IFRS Foundation are rapidly long-term sustainability risks. Volun- advancing the establishment of tary sustainability metrics, frameworks a Sustainability Standards Board and standards in this area have prolif- (SSB) under their remit, in close erated in recent years, most notably collaboration with IOSCO, FSB and through the Taskforce on Climate-re- other international organisations, lated Financial Disclosures (TCFD) rec- with preparatory work on the ommendations. Today, the TCFD has development of standards underway. become the pre-eminent framework Ahead of COP 26, the UK government for climate-related reporting on enter- is calling on countries to announce prise value. their intention to implement TCFD

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a role and responsibility to address Government programs, including these issues (stakeholder capitalism); statutes and regulations, can be and 3) an increased understanding – important drivers of change. Often, validated by BofA Global Research government defaults to “sticks” – -- that companies that manage ESG regulation or restrictions if economic well perform better over time. This, in concerns don’t take the desired actions. turn, helps prompt investors to direct But the private sector is leading in capital toward companies with strong many instances, and the public sector ESG characteristics. can encourage accumulation of private sector participants through incentives. However, we need effective principles Incentives, combined with regulations, of governance to ensure companies have worked very effectively. In the US, are really integrating ESG into their for example, renewable tax credits have operations. Stewardship, accountabili- driven significant scale-up of wind and ty, and transparency are the principles solar investments, making them cost companies should follow. Stakehold- effective today. ers are seeking greater transparency around ESG alongside the transparency In Europe, the EU has taken the lead in financial reporting that companies on the fight against climate change, ANNE already provide. However, the current sustaining and even increasing the ESG reporting ecosystem is complex, pace throughout the pandemic. Europe with ratings organizations and stand- is committed to addressing climate FINUCANE ards setters offering different and change and driving toward a low- Vice Chairman, sometimes contradictory performance carbon, sustainable future. This is what Bank of America and Chairman, metrics and assessments. Companies the EU Green Deal demonstrates: a Bank of America Europe and their stakeholders may struggle to fully-fledged and purpose-driven plan know which evaluations matter. for Europe to reach its climate neutrality goal. But the Green Deal might consider including incentives to further stimulate private sector engagement and allow a green economic recovery as The ESG agenda needs To make real well as a just transition. global actionable progress, especially The US is once again at the same table in addressing climate as the EU and the rest of the world, commitments change, we need increasing the focus on the ESG agenda. To make real progress, especially in global, actionable addressing climate change, we need commitments and global, actionable commitments and For some years now, we have seen an true private-public true private-public collaboration increased focus from the private sector and cooperation. in addressing society’s most pressing collaboration and issues. Now, the ESG agenda has real cooperation. momentum, and collaboration is key. It is vital that companies across industries work together to achieve the United Nations Sustainable Development Goals (SDGs). Bank of America therefore supports straightforward, global standards for Even before the pandemic, there was ESG disclosure, so that companies can an understanding that it would take demonstrate long-term sustainability the creativity, innovation, energy and update their progress, alongside and resources of the private sector to their financial reporting, in Annual address the major needs of society, as Reports and other filings. We worked broadly reflected in the SDGs. with global accounting firms Deloitte, EY, KPMG, and PwC, together with Companies have responsibilities to the World Economic Forum, to help all their stakeholders – shareholders, develop common metrics drawn from clients, employees, and partners in the most prominent and established the communities where they operate. standard-setters. More than 70 There is an increasing expectation companies have now signed on to this that companies should integrate effort, and that number is growing. ESG considerations and impact into The work is contributing to a broader their core purpose, strategy and movement toward a global, regulator- operations. This is being driven by approved standard for ESG disclosures. three big dynamics: 1) widespread The involvement of private sector understanding and agreement that companies in this movement is critical. there are large, systemic global issues that we must address urgently; 2) the Private sector action should take growing belief that corporations have place alongside the public sector.

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ESG policies provide guidance for asset to regional needs. IOSCO’s urgent call owners, managers and corporates on for globally consistent, comparable the definition of sustainable economic and reliability disclosure standards activities and their application in in February 2021 and commitment practice. It is imperative that ESG towards working with the IFRS standards converge at international to develop an SSB - Sustainability level so to prevent regulatory arbitrage Standards Board - is highly encouraging across global jurisdictions, as capital to achieve global convergence. flows are international, and corporates operate across global supply chains. The EU’s efforts to establish a dialogue through the International Platform At the heart of the success lies an on Sustainable Finance (IPSF) could improved and standardised approach be the critical path towards achieving to corporate disclosure. In the EU, global convergence of ESG standards corporate transparency is driven by a and already includes major countries in revised EU Non-Financial Reporting the Americas and Asia Pacific. Hence, Directive (NFRD), which is expected asset managers welcomed that the to result in more comparable and United Kingdom joint the IPSF at the meaningful disclosures. Consequently, beginning of 2021 and encourage also investors may have better quality data the United States becoming a member, NATALIE in future when engaging with the as they are indispensable in successfully investee companies on sustainable achieving the global convergence WESTERBARKEY corporate governance. However, of ESG standards. COP26 this year Director & Head of EU Public Policy, investors are already valuing corporates will also represent a key opportunity Fidelity International on both their financial and non- to align international sustainable financial performance today, since the finance policies. EU’s Sustainable Finance Disclosure Regulation (SFDR) entered into force in Most importantly, in the interest of March 2021. investor protection - both retail and Globally consistent institutional investors - international convergence of ESG standards ESG policies are including eco-labels for financial products will be vital. Ideally these in indispensable for It is imperative future will be built on global, not just on regional policy initiatives such as international finance that ESG standards the EU Taxonomy, corporate disclosure converge at and SFDR ESG product classification. international level. Hence, international ESG policy convergence will ultimately benefit the Undoubtedly, sustainable finance end investor. is accelerating as investor demand is rising. In order to meet the demand, asset managers and Therefore, it is essential that corporates financial institutions are increasingly swiftly disclose non-financial data incorporating ESG criteria into the based on international frameworks investment and distribution process. existing today, developed already by In parallel, corporates are working to SASB, the Sustainability Accounting provide greater transparency through Standards Board, and the FSB’s TCFD, non-financial reporting. Fidelitythe Financial Stability Board‘s Task International developed an in-house Force on Climate-related Financial proprietary ESG rating tool launched in Disclosures created in December 2015. 2019, evaluating its investee companies EU sustainable policy initiatives ideally on ESG metrics. This approach is a key would build on these frameworks and building block for enhanced corporate develop them further as envisaged engagement on non-financial factors through the double materiality concept with investee companies, and in embedded in the future, revised response to investor client demand EU NFRD. as well as policy expectations. Recent data evidence confirms a correlation Likewise, it is welcomed that EFRAG, between financial and non-financial the European Financial Reporting factors, as companies with robust ESG Advisory Group, aims to ensure scores have on average suffered less that IFRS - International Financial financial loss and outperformed. Reporting Standards - takes into account European needs. Consequently, To continue the journey from here, the investor community is hopeful the work of policy makers in the area that globally consistent minimum of sustainable finance is indispensable sustainable reporting standards are for the success of the financial sector developed by policy makers and and corporates to transition towards a existing frameworks applied today by greener financial system and economy. the corporate community, responsive

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of environmental reporting with a The EU’s Non-Financial Reporting focus on climate change-related risks. Directive (NFRD) currently has one human capital reporting requirement, What is the state of Human on diversity. But the fact that individual Capital reporting? member states have added in additional requirements such as board diversity, In the last year, Capital Group invested distribution of employees in terms of over 4,000 hours of analysts’ time age, gender and pay indicates more is in building our bottom-up ESG needed. frameworks. These frameworks give us an excellent understanding of which What we’d like to see issues matter most to the companies in which we’re invested. This in turn Companies are reporting more on a builds our understanding of the impact voluntary basis but much more can be that companies have on their local done to encourage more disclosure of communities, the broader economy the following: and the market as a whole. This level of detailed analysis reveals just how much 1. Total workforce cost an issue of unique importance, human 2. Employee turnover JESSICA capital is. 3. Comprehensive workforce demographic data (EEO-1 Today, there is little or uneven equivalent in the US) GROUND reporting on even the simplest human 4. Total cost and hours of employee Global Head of ESG, capital indicators. training provided Capital Group 5. Gender pay gap reporting More and more of the value of 6. Monitoring of internal engagement companies, and hence the savings of and workplace culture people, is represented by intangible assets such as software, brands What is also crucial is that this Why reporting and data, all of which is driven and information and these disclosures apply sustained by human innovation. Yet globally. Indeed, global consistency is a on human capital while an investor can find out exactly key factor in allowing investors to make how much is invested in research valuable comparisons across regions matters and development or the cost of new and can help companies draw financing equipment, finding out how much has from a wider range of investors. been invested in workforce training is much more difficult. We believe these six metrics would put The events of 2020, including the “S” on equal footing as other types of impact of Covid-19 on social imbalances environmental and governance metrics. and the murder of George Floyd have It is widely acknowledged that we face a very firmly put the “S” back into ESG. climate emergency, let’s not wait for the However, apart from media headlines It is widely next human emergency before we start bringing social considerations into the reporting on human capital. spotlight, little has been said about acknowledged that what this might look like for company we face a climate reporting. emergency… ESG reporting today

ESG-related disclosures by issuers are largely made on a voluntary basis. In the What is missing from current absence of a mandatory ESG disclosure requirements? framework, companies exercise their own discretion in determining which Last year, the Securities Exchange ESG risks and opportunities are Commission (SEC) acknowledged material to their business and which the importance of human capital but to disclose to investors. The result has stopped short of providing specific been a lack of consistency, quality and reporting requirements. They called comparability of ESG data, which is of for companies to disclose the number limited value to investors. of employees and a description of its human capital resources if material to Companies are making progress the business as a whole. on environmental and governance reporting. Indeed, they have been Training, recruitment, safety, engage- providing governance reporting in one ment and mention of objectives are all form or another since the first corporate voluntary. This coupled with US Gen- came into being. The Financial Stability erally Accepted Accounting Practices Board’s Taskforce on Climate-related (GAAP) requirements means that even Financial Disclosures (TCFD) has calculating what the average employee helped make progress on a major aspect earns is difficult.

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standards board, building on existing In order to comply with this rapidly frameworks. So, there is progress, but growing body of regulation, firms need there is still a long way to go. data that are not only comprehensive and consistent, but also reliable. A fundamental difference is whether It is notable that the Technical we are talking about climate change, Expert Group’s recommendations environmental risks more widely or to the Commission on the Green the full set of ESG factors. The UN Bond Standard include mandatory Sustainable Development Goals, the verification by an external accredited recommendations of the Taskforce on verifier, of both the bond’s framework Climate-related Financial Disclosures, and its allocation reports – how the EU Taxonomy Regulation and proceeds have been used. There is no Sustainability Accounting Standards similar requirement yet for external Board (SASB) framework focus on assurance on corporate reporting different aspects. They are also a mix that sits outside the audited financial of definitions, metrics and reporting statements. A few companies are standards, as are the various industry voluntarily seeking such assurance, initiatives. Other jurisdictions are but until this becomes commonplace, entering the debate but are indicating users have to trust the veracity of the they intend to write their own detailed disclosures made. KAY requirements, which may make convergence challenging. The journey to convergence will not SWINBURNE be easy. The more detailed standards Chair of KPMG’s EMA FS Regulatory and rules become in one jurisdiction, Insight Centre (RIC) and Partner, the more difficult it may be for KPMG in the UK others to converge with them. This Throughout the tension is playing out within the EU as regards the detailed Level 2 rules convergence under the Taxonomy Regulation. The journey, a balance 30-page Level 1 Regulation is already needs to be struck supplemented by 500 pages on two of Defining ESG: the six environmental objectives with between detail perhaps 1,000 more pages to come. the journey to and flexibility. And the debate on defining S – social – has still to come. Throughout the convergence convergence journey, a balance needs to be struck between detail and flexibility.

Around the globe, the focus is largely In order for financial firms and on corporate reporting and rules for institutional investors to measure their listed firms. The EU financial services ESG exposures, they need data from industry is at present alone in also the companies and projects they fund, being subject to specific ESG FS insure or invest in, including other regulation. Those rules currently fall financial firms and products. Without on benchmarks providers and the buy- mandatory and consistent definitions, side (asset owners and managers). They metrics and reporting, it is difficult require disclosures at both company and for firms to obtain the data they need, product levels. The fact that these FS let alone verify their accuracy. Listed disclosures are different and additional corporates are responding by improving to corporate reporting can be confused. their ESG reporting and credentials, And more product rules are on their but there are still many data gaps, a lack way: the Green Bond Standard and EU of consistency and differences across Eco-label for retail products. asset types. The EU supervisory authorities have Individual jurisdictions are taking set our clear expectations that banks different approaches to sustainable and insurers should incorporate ESG finance regulation. Some governments risks into their overall risk frameworks have developed over-arching strategies. and stress testing. The UK PRA led the Some regulators have adopted specific way on this and the US Federal Reserve requirements, while others have, to Bank has recently indicated similar date, tended to leave it to market expectations. EU regulation is expected forces. Given global concerns about in this area, too. The European the diverse range of sustainability Commission’s renewed Sustainable standards, standard setters have joined Finance Strategy includes proposals forces to strive for consistency in that climate and environmental corporate reporting, including recent risks should be fully managed and confirmation by the IFRS Foundation integrated into financial institutions’ Trustees of their intent to establish operations, and that social risks should a global sustainability reporting be considered where relevant.

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www.sc.com/en/insights/zeronomics/) Climate-related Financial Disclosures. shows 81% of senior managers of However, the quality and consistency companies want standardised, globally of broader sustainability data is consistent measurement and reporting often poor, non-comparable and standards and believe these would help inconsistently disclosed. accelerate their net-zero journey. Internationally, we are seeing frag- Reporting frameworks are a critical tool mentation undermine progress. The in unlocking investment in the fight proliferation of taxonomies for exam- against climate change and the delivery ple prevents interoperability, increases of sustainable development globally. the compliance burden on companies Yet we know that access to capital operating across multiple markets, and remains a key barrier. The financing ultimately prevents global sustaina- required to keep global warming to an ble capital mobility. The Internation- increase of just 1.5 ˚C may be as high al Platform on Sustainable Finance as USD8 trillion annually, and the UN has great promise in bringing about estimates that the funding gap to reach convergence. the Sustainable Development Goals (SDGs) by 2030 is USD2.5 trillion a year. Finally, as we emerge from the Covid DANIEL As policymakers consider how best to crisis with constrained resources, we enable sustainable or climate finance need to recognise that impact matters through reporting frameworks, we as much as volume; indeed ‘where’ may HANNA encourage progress in three areas. be more important than ‘how much’. A Global Head, dollar invested can have a significantly Sustainable Finance, First, greater focus on transition. Many different outcome depending on Standard Chartered Bank of the frameworks put in place are where and how it is deployed. As our backward facing, yet we are united in first sustainable finance impact report the goal of enabling the transition to (https://av.sc.com/corp-en/content/ low-carbon, which implies we are not docs/Sustainable-Finance-Impact- where we want to be. Taxonomies, Report-Sept2020.pdf) highlighted, in this context, give a clear view of financing a solar project in India will Improving ‘green’ or, in the EU’s case, ‘net-zero help avoid more than seven times the aligned’ exposures, but that is not the CO2 from a similar-sized project in sustainability same as understanding a company’s France given the current sources of direction of travel and progress against power on those countries’ grids. This reporting to catalyse those targets. Given the planet’s finite is why we are proud that out of our resources, we also encourage moving USD3.9 billion of verified sustainable private finance the wider economy to reporting on financing, 91% is in emerging markets a ‘double materiality’ basis to help in and 86 per cent is in some of the world’s investment decision making, though least developed nations. financial materiality will take longer It has been a challenging year. The to establish. With the right frameworks put in place, growth in sustainable finance and the with the EU leading on this important momentum to ‘build back better’ in agenda, we can ensure that we meet the response to the Coronavirus pandemic next global crisis – the climate crisis – are small positives but are important head on. ones that can set us on the path to a We need to more environmentally and socially sustainable world. recognise that impact matters as Complementary to this growth, we much as volume; are seeing the steady and inexorable shift from the consideration of indeed ‘where’ may environmental, social and governance be more important (ESG) issues as reputational matters to a than ‘how much’. reflection of a company’s performance. This is an important driver of capital inflows to ‘sustainable’, ‘ESG’ or ‘climate’ activities. It also raises the bar on the volume of information that Second, international consistency the financial sector needs from its and the avoidance of fragmentation. clients in identifying the underlying More effort is required to increase, economic activity, and that it needs to improve and harmonise data and provide to investors on the extent to disclosures from all sectors of the which their investment has enabled economy, in particular from emerging sustainable outcomes. markets which are the most at risk from climate change but also represent The drive for more information is not the biggest investment opportunities. just coming from the financial sector. Information is improving thanks to Our ‘Zeronomics’ report (https:// initiatives such as the Task Force on

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EU SUSTAINABLE FINANCE TAXONOMY

consumers will face an inconsistent regarding how ‘new’ and ‘emerging’ experience, with the potential customer technologies, such as distributed detriment counteracting the benefits ledger technology (DLT) and artificial of greater competition and creating intelligence (AI) may apply to financial potential risks for market integrity and sector use-cases. The current regulatory potentially also financial stability. frameworks across the globe were not written with these technologies and the Despite the rapid technological changes wider ecosystem in mind, and therefore and the emergence of new digital they may not be fit for purpose. Whilst players, large and small, regulation the principle of technology neutrality has developed to respond to the is important it is also essential that traditional 20th century business model, regulations consider the technologies which regulates based upon product, where relevant. In addition, with manufacturer and issuing or distributing global regulatory and supervisory entity. This creates a narrow regulatory direction constantly evolving, one of the perimeter applicable to these industries. main barriers results from some of the However, a 21st century “platform inconsistencies from one jurisdiction to company” does not need to create the another and resulting fragmentation. underlying financial product or service to become a leading digital aggregator Quite apart from this, there is a lack PAUL TANG and distributor of those products of consistent regulation of underlying MEP, Committee on Economic and services. This can – in the case of products, with some at a more advanced and Monetary Affairs, financial services - create a substantial stage unified regulation at the European European Parliament financial marketplace to complement a level (e.g. the UCITS directive, which non-financial services marketplace. In creates a harmonised framework for other words, in the connected economy, investment funds that can be sold to a position of strength in one market, led retail investors throughout the EU using by data, can readily be used to access a passporting mechanism), and other, another very different product market. substantial areas such as mortgages The EUs remain mostly regulated at the national Looking forward, as the number level. Similarly, investments and sustainable finance and type of business able to access trading have been tackled effectively at consumer spend data increases due the European level, with the creation agenda, a first step to Open Banking and PSD2 this is of ESMA; but while such “asset-side” likely to have further transformational regulation has been advancing, the of many effects on the composition of the new “liability-side” (borrowing and lending) financial ecosystem and therefore has yet to achieve the same level of critical components of financial harmonisation. This creates a further markets infrastructure. The increase gap in safeguarding customers’ interests The pace of technological change in competition for consumers is to be at the European level and in completing continues to rise and as a result the welcome, but there is a need to address the single market. impact of technology on people’s lives how we collectively provide for the is getting greater. The pandemic has protection of consumers and clients These issues are recognised by the clearly brought technology further and also to ensure a fair playing field regulatory community. Steps such as to the forefront of our minds and is for all market participants. Looking the European Commission’s Digital accelerating changes in consumer at the ecosystem from a consumer Finance Strategy, which aims to amend behaviour. perspective, it will be increasingly the regulatory framework to make it fit difficult for consumers to understand for the digital era and achieve a level As new operators and business models the risk profiles of products attached playing field across entity types, will be emerge, it is essential to consider all to different entities and the associated crucial in helping solve these challenges. of the new and different players in protection they may or may not enjoy Further, given the cross-border the financial ecosystem from the end without further assistance from nature of innovation, collaboration by user’s perspective. For instance, as a regulators. Understandably, a consumer policymakers in different jurisdictions broader range of firms from a diverse sees products that are interchangeable is essential. Regarding underlying range of sectors seek to offer retail for their needs, rather than considering product areas, the European and potentially wholesale financial in detail their regulatory regimes. There Commission recognises the continuing products, there is a need to ensure that is a significant risk that an industry fragmentation of credit markets, and consumers are provided with the same defined approach to regulation will fail while the Mortgage Credit Directive was level of protections, and that all those to recognize emerging risks posed by the a good first step towards an EU-wide participants who offer the same service, market changes noted above, and result mortgage credit market with a high level undertake the same activity, or expose in customer detriment. of consumer protection, it needs to act consumers to the same risk are subject as a foundation and not an end-point. to equivalent regulatory requirements In addition, a key barrier to innovation This is all the more important in an age on a proportionate basis. Without this, for firms is the lack of regulatory clarity of digital delivery of financial services.

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a climate disaster strike. The Covid-19 activities contributing substantially pandemic will eventually subside, but to climate change mitigation or the climate crisis is here to stay. adaptation, is a very important step in this process. Furthermore, a common The green recovery will not happen EU database of Taxonomy reports would just by accident. And showing goodwill ease transparency and comparability, when it comes to promoting a transition while avoiding duplication of data to a green and sustainable economy collection efforts. won´t be enough either. We need to find the right incentives in order to In this regard, I think it is fair to direct investments to green activities acknowledge that the Commission and start thinking more from a long- is trying its best to come up with term perspective. Such a paradigm innovative solutions in order to create shift in economics requires not only a single market for data by connecting significant investment from both the existing databases through digital EU and the national public sector, but means. And, why not, maybe it is also also from the private sector. Even more the right time to take advantage of the importantly, it must be based on a new latest technology, such as Distributed programming language, that maps the Ledger Technologies, to provide a single way things are and that encourages point of access to information relevant CARLOS people to effect change in the world. to investors and companies. Eventually, As we all know, language is action, and progress in this area will naturally spill SAN BASILIO the EU Taxonomy will become the new over to the workstreams on taxonomy Secretary of the Treasury, programming language of the green of “brown” and “social” activities, which Ministry of Economy economy that is yet to come. would enhance comparability and and Digitalization, Spain reliability of ESG data.

Technical discussions on the EU taxonomy and political discussions on We need to find the broadness of the transition category that recognizes companies’ efforts to EU Taxonomy: the right incentives invest in becoming carbon neutral, are in order to direct not only inevitable, but a fundamental the programming investments to green aspect of democratic law-making. As long as we have a clear sense of direction language of the activities and start and the necessary political goodwill, it thinking more from a is entirely possible for this project to European green deal long-term perspective. succeed.

«The EU Taxonomy as the catalyst for the green economic rebound» From this perspective, it is clear that Taxonomy is not only about organizing We are still in the fighting phase of the and classifying. Which industries COVID-19 crisis, but fortunately, the should qualify for support? Should end is in sight, thanks to the progress investments go exclusively to self- in the roll-out of COVID-19 vaccines evidently green sectors or also to firms across the EU and the selfless sacrifices in carbon-intensive sectors trying to made by the frontline corona-warriors clean up? How can stakeholders be and by all the companies and workers brought together to formulate a vision who have borne such a disproportionate for the future and how can such a share of the burden. vision be implemented? In the public arena, where stakeholders often have As we are starting to see the light at very different incentives, this can be the end of the tunnel, it is becoming particularly challenging. We need ever more evident that the economic therefore to also consider that the key recovery will be green, or it won´t concern for many companies, regions be at all. This conclusion derives and cities is the ‘fairness’ portion of the not only from the fact that the ‘fair and green’ transition. European and national public support schemes will be financing to a large As we create this new language, we extent environmentally and socially must work with all stakeholders to sustainable economic activities. Indeed, ensure a just transition where nobody is a fair transition to a green economy left behind and that the EU Taxonomy is not a mere policy choice nor an is workable and dynamic, responding experiment designed in a laboratory. We to changes in technology, scientific just need to look at the crisis wrought evidence, new activities and data. The by the coronavirus as an early warner of upcoming Delegated Act establishing what could potentially happen should the screening criteria for economic

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tor, is not only an important enabler for therefore important to limit undue scaling up sustainable investment but fragmentation, e.g. via the International also a powerful tool to protect investors Platform on Sustainable Finance. from greenwashing. Indeed, by stating what economic activities are sustaina- For national authorities, the entry in ble from an environmental perspective force of disclosure requirements based and requiring manufacturers to disclose on the Taxonomy Regulation will in their pre-contractual documentation entail the evaluation of environmental the share of the portfolio invested in information published by regulated such activities, the Taxonomy Regula- entities. Moreover, market participants tion offers an easily readable and com- and financial advisers will have to parable indicator of a product’s level take into account the sustainability of greenness. preferences of their consumers, and regulators will then have to ascertain JEAN-PAUL that the proposed products adequately The EU cannot reflect investors’ ESG concerns. In this SERVAIS achieve the green respect, it will be of crucial importance for financial market participants to have Chairman, Financial Services transition alone, and hence global access to standardised ESG information and Markets Authority, from investee companies. Belgium (FSMA) cooperation is key. It is therefore to be welcomed that However, it still faces many challenges the EU is working on a review of the The sustainability to ensure its effective implementation. NFRD, in order to enhance the delivery In order to provide accurate information of high-quality sustainability related taxonomy: on the products, the information about reporting by corporates. This will the sustainability of activities should facilitate the gathering of information an additional be easily accessible for all financial by financial market participants when market participants, and tools should developing, managing and marketing tool against exist to measure the environmental their products. performance of activities carried out greenwashing by companies. It will also be essential In the face of the need for a global to take account of proportionality in response to climate change, the ultimate the implementation, especially in the goal should be to foster coherence and The Regulation on the establishment current economic situation. consistency between the EU and global of a framework to facilitate sustaina- sustainability reporting. In this respect, ble investment (the “Taxonomy Regu- The EU cannot achieve the green it is encouraging that the EU is open to lation”) is an important part of the EU transition alone, and hence global working with global initiatives such as sustainable finance plan drawn up by cooperation is key. Taxonomies, if the initiative of the IFRS Foundation, the European Commission. The Tax- developed in isolation, might lead to which aims, in close cooperation onomy Regulation, together with the greater fragmentation of practices with IOSCO, to develop new global Regulation on sustainability-related and could inhibit the growth of global standards for sustainability disclosures disclosures in the financial services sec- sustainable finance markets. It is by companies.

place credible and usable tools and Sustainable finance: frameworks.The EU Taxonomy will play a key role.It provides investors a finance agenda with a robust and evidence-based tool to identify opportunities for green for the transition investments in line with our 2050 environmental target.The Taxonomy Sustainable finance is key to mobilising Regulation adopted in June provides the massive investments needed to meet for a general framework that will be the objectives of the Paris Agreement further refined through the adoption of and the UN 2030 Agenda on sustainable delegated acts specifying the technical development goals (SDGs). In the EU, in criteria for an economic activity to be particular, sustainable finance is vital to included in the EU Taxonomy. It will reach our targets under the European be expanded and updated as technology Green Deal, our strategic growth agenda and research evolve. MARCEL for a climate-neutral Europe by 2050.The pandemic has not altered this necessity: The first delegated act, defining HAAG the recovery needs to support the Green activities that substantially contribute Director, Horizontal Policies, Deal and to catalyse the green transition. to the objectives of climate change DG for Financial Stability, mitigation and adaptation, will be Financial Services and Capital To mobilise private investors,regulators adopted in April 2021 and enter into Markets Union, European Commission need to set the targets,provide clarity force at the beginning of 2022. A second on the direction of travel, and put in delegated act defining activities that

218 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net EU SUSTAINABLE FINANCE TAXONOMY make a substantial contribution to the The legislative proposal of the revision enable civil society organisations to hold other four environmental objectives, of the NFRD, to be adopted by the companies accountable for their social namely protection of water resources, Commission in April 2021, is critical and environmental impacts (inside-out). biodiversity and ecosystems, circular to the success of the sustainable economy and prevention of pollution, finance agenda. The Commission is assessing the will be elaborated once the Platform EFRAG’s recently issued recommenda- submits its technical input in autumn. tions on sustainability reporting stand- Sustainable finance is key ards.Currently,standards represent the Furthermore, a separate delegated to mobilise the massive best solution to address the lack of rel- act will specify the taxonomy-related investments needed to evance and comparability of the non-fi- disclosures by which companies falling meet the objectives of the nancial information,as well as to ensure under the scope of the Non-Financial Paris Agreement and the consistency with other pieces of sus- Reporting Directive (NFRD) will have tainable finance legislation,such as the to disclose their key performance European Green Deal. Sustainable Finance Disclosure Regula- indicators, i.e. share of turnover and tion and the EU Taxonomy.However,we capital expenditure, in respect of By improving the environmental, social recognise the importance of applying sustainable economic activities. This and governance (ESG) information proportionate sustainability reporting delegated act is planned to be adopted in that companies report, it will enable requirements to SMEs:we are consider- Q2 2021 building on the technical advice investors and assets managers to better ing a simplified non-financial reporting submitted by the European Supervisory understand the sustainability related standard for smaller companies to be ap- Authorities (ESAs) on 1 March. risks to the entity (outside-in), and will plied probably on a voluntary basis.

In October 2020, the new Prime Minister Taxonomies are essential tools to help of Japan Mr Suga declared that by 2050, put in place a framework for ensuring Japan will aim to reduce greenhouse gas we all speak the same language about emissions to net-zero and to realise a the economic activities which are carbon-neutral society. This declaration playing a role in the path to net zero. is a defining moment for Japan’s future They assist in driving the economic energy and climate policies, and the shift necessary to reach the ambitious government is developing additional goals we set ourselves. We know from policies to achieve this target. Japan various studies that this will require wants to cut significant investment in renewables, by 26% between 2013 and 2030. Other but equally important is the necessity major economies are working towards of a significant transition from high- similar ambitious targets. emitting sectors to more sustainable and energy efficient solutions. To HIDEAKI reduce financial risk arising, the process We encourage of reducing GHG emissions over time regional policy needs to be managed in a steady and TAKASE reliable manner. President and Chief Executive Officer, makers to bring MUFG Bank ltd their expertise on taxonomies together, Many banks are in the process of developing their own taxonomies with with the aim to the purpose of supporting clients and Taxonomies design common, facilitating the conversation about globally consistent transition paths. Multiple taxonomy and the road to principles. frameworks complicate for banks active in multi jurisdictions. The market decarbonization perception of the current EU Taxonomy These global emissions reduction is that it could give an increased focus on commitments require a balancing act transition and avoid cliff-edges. In this The financial sector is making an between energy security, economic perspective, we welcome the EU’s views unprecedented shift to support efficiency, environmental protection that taxonomies need to be dynamic the transition to a low carbon and safety. We need a whole economy and not a static framework, as well as economy. Environmental and social transition in which each stakeholder is take into consideration transition. considerations have been part of playing an important part. financial decision-making for some Financial transactions and decision- time now but as a result of geopolitical, In order to understand what the overall making, in particular for large banks, are societal and market developments, this transition pathway will look like, we need global in nature. Whilst we appreciate shift has accelerated at a rapid speed. to rely on consistent and comprehensive the challenges a single, uniform global data and policy frameworks. Not only taxonomy would bring given regional Net zero commitments from will these measure success, they will transition paths, we encourage regional stakeholders across the public and help financial institutions and central policy makers to bring their expertise private sector are becoming more banks assess the risks related to the on taxonomies together, with the aim concrete, painting a clearer picture of pathway, while at the same time seize to design common, globally consistent the shape and speed with which the opportunities to enhance and potentially principles. energy transition will take place. even accelerate the transition.

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challenges inherent in the sustainable By its nature – as a piece of European finance agenda, and in the creation legislation, and as it can be based of a taxonomy of environmentally only on judgments that have a high sustainable economic activities. degree of certainty and of consensus – the taxonomy will be authoritative, A first major challenge is the compatibility foundational, but limited. with the price system. Prices serve as strong signals guiding investment and In order to meet the challenge identified economic activity. The data derived from by Bianca Jagger, we shall need to go the taxonomy will also serve as a strong beyond the taxonomy. signal identifying investments that are sustainable and that will maintain their We shall need other, more diverse, value in the long term. types of data, as well as complementary frameworks that can cater for different ADRIANA It is critical that these two mechanisms and uncertain judgments as to what are complement, and do not counteract, the best transitional paths. And we shall PIERELLI each other. There is in other words need a financial system that uses and a need for public authorities to have creates different types of data, and that Regional Executive Southern Europe, a coherent approach across different facilitates those different paths. Managing Director Global Client areas of public policy (including energy, Management, BNY Mellon emissions, and transport policy). This creates requirements and opportunities. Implementing It is critical that Key requirements include better access these two mechanisms by investors to more, and more reliable, the taxonomy – complement, and granular source data on companies and do not counteract, securities, as well as more efficient, and challenges and each other. more effective, capital markets that can channel savings into diverse forms opportunities of innovative investment. We need, in A second major challenge relates to the short, progress on the revision to the design of the taxonomy. A short and Non-Financial Reporting Directive, “Reforming our financial system in such simple taxonomy will contain limited the European Single Access Point, and a way that it not only creates wealth, information and will give clear and all other items set out in the Capital but that it creates wealth, worth having: strong signals only for a limited area of Markets Union Action Plan. that is the challenge we now face” – economic activity. Bianca Jagger (European Commission Opportunities lie in digital innovation Open Hearing on Sustainable Finance, A broader and more complex taxonomy that can help make sense of, and derive 17 July 2017) will contain more information, covering insight from, disparate data from diverse broader areas of economic activity, but sources and allow tracing of proceeds Since Bianca Jagger spoke those words, at the cost of clarity and simplicity. from ESG issuance. They lie in the almost four years have passed. enormous pent-up demand for green and The world is a complex place and sustainable investment products. And This is not a complaint. In the managing the transition to a more they lie in public sector actions such as intervening four years much serious and sustainable economic system is highly the Next Generation EU issuance which substantive work has been done. This complex, with often a need for difficult can help create the foundation for liquid remark is rather a reflection of the major judgments as to the best transition path. and efficient European capital markets.

for the two climate related objectives. Unlocking the Financial companies will have similar European taxonomy requirements. The taxonomy can play a pivotal potential role in the European environmental transition provided it is properly and The European taxonomy is a granular swiftly implemented. It can indeed fill set of criteria that needs to be met in two important gaps that are currently order to qualify an economic activity preventing a quicker transition of as sustainable. It is essentially a tool the European economy towards a that will have multiple usages. The sustainable economy. most important one will certainly be the requirement for non-financial First the extent and the timeline of companies, under the scope of the the industrial transformation that is RAMI NFRD, to disclose their share of revenue, required at an individual company level capex and opex that is aligned with is usually still unknown. While the FEGHALI the taxonomy, starting from January taxonomy does not directly address this Partner, PricewaterhouseCoopers Audit 2022 and based on 2021 information issue, which is a matter of regulation

220 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net EU SUSTAINABLE FINANCE TAXONOMY of the real economy, its does address it There are however three important dimensions of sustainability such as the indirectly by requiring to disclose the issues to be addressed in order to social impact. It must be put in context. alignment with a granular sustainable achieve a proper implementation The completion of the taxonomy on target, creating the market incentive to of the taxonomy. First, public the remaining dimensions would also converge to this target. authorities should plan a progressive help in building a meaningful picture. implementation, the disclosure of a Lastly, the SME shouldn’t not be Second, the absence of ESG standardized, single alignment number can create excluded, they are part of the journey reliable and comparable data that can be an illusion of certainty, while most and should be supported on embarking shared with all users, hinders the ability companies will only be able to produce on this journey. to measure performance, analyze risk estimates in 2022. in a consistent way and take informed The taxonomy is not a perfect tool, but decisions on the direction of travel. The Supervisory bodies and companies it is a tool that we can build on. Both Non-Financial Reporting Standard will need to recognize the underlying public and private sectors should create address this; however, the taxonomy uncertainty and be transparent about the conditions of a swift, controlled disclosure requirements can be it, to avoid expectation gaps and what and large adoption of the taxonomy. It considered, de facto, as a first building could become a taxonomy washing. can be the catalyst of the necessary and block of an ESG reporting standard. It Second the taxonomy is currently one urgent transformation of our economies will be mandatory, granular, directly sided, it shows what is sustainable and its operational implementation will linked to underlying industrial activities today but doesn’t say much about also secure the consistency between and its implementation will require the remaining dimensions of the ESG European policy choices and the significant investments that need to transition: the targets, when these reporting standards that will prevail. be leveraged. targets will be reached and the other

Commissions’ 2019-24 priorities that companies from being part of the included the realisation that “Europe solution. Failure to nurture companies needs a new growth strategy that will in transition could cause them to wither transform the Union into a modern, before sending up new shoots and lead to resource efficient and competitive Europe dependent on imports to achieve economy”. However, the real prize isn’t its goal. If policy rewards companies intra-European, it’s global. through the transition phase we will grant our existing enterprises access European environmental legislation is to cheaper capital as they change and not new. For years, Europe has been a hence fund more innovation and create first mover in safety standards and best the products, services and refreshed practices that have become global stand- jobs to achieve EU prosperity and its ards. However, the European Green climate goals. Deal marks a more dynamic approach OLIVER COLLIN and the Taxonomy has the potential to This idea of creating a pathway isn’t new. become the means by which the market Europe has 2030 climate goals as well as Fund Manager, will administer the carrot or the stick to the goal of climate neutrality by 2050, European Equities, companies. Winners will be those seen which recognises the need for transition Invesco to solve the environmental crisis and plans such as hybrid autos ahead of full the losers will be those thought to be electric, coal to gas electricity generation the cause. and blue hydrogen ahead of green being Climate Change viable. We must further embrace this approach and reward companies for is a generational Failure to nurture becoming less bad, not just those that companies in transition are good. By focusing on transition, we opportunity for could cause them to will incentivise European companies to wither before sending allocate their existing cashflow towards Europe up new shoots. green innovation as opposed to being forced into ever larger dividend yields.

The Covid health crisis of 2020 created Europe has grand ambitions and a once a synchronised economic depression. Combined these elements create the in a generational opportunity to steal Europe’s response was the creation of foundations for success. European a march on other continents. Most of a €750bn European Recovery Fund. companies that exhibit strong alignment the tools in place to achieve success, However, rather than just deploy the with the Taxonomy will see their cost however failure to promote our existing capital, Member States chose to focus of capital fall compared with those companies in the transition phase could on a Green Recovery, with a significant that don’t. endanger our goals, including those proportion of the funds to address the beyond climate change. With small existential threat of climate change The goal of climate neutrality requires adjustments to the current agenda and the protection of the environment. significant investment and innovation. Europe has the potential to achieve In practice, this means EU spending is However, the proposed technical Net Zero and in doing so become the being guided by the newly developed screening criteria under the Taxonomy Silicon Valley of Green Tech including Sustainable Taxonomy. The EU fails to reward transition. This risks the vibrancy, jobs and innovation that Recovery Plan is interlocked with the excluding our existing stock of European comes with it.

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CLIMATE-RISK IMPLICATIONS

carbon economy, and which countries, and finally, unveiling the main obstacles to regions or firms may win or lose from the a robust assessment of these risks in terms diffusion of such technologies. of modelling challenges and data gaps. Sig- nificant challenges remain. First, financial Accounting for ESG risks also calls for institutions need adequate information to better identifying how specific events that differentiate dynamically when assessing were traditionally not or only poorly as- counter parties and geographies. They sessed by financial agents such as rating need, for instance, to be able to assess fu- agencies could have material financial im- ture vulnerability and not only existing vul- pact. For instance, firms that do not respect nerability. Corporate disclosure such as the basic social or environmental standards will TCFD at the global level and the revision of lose clients and could face costly lawsuits non-financial reporting directive in the EU with adverse impacts on market valuation are critical steps. and credit rating. In addition, accounting SYLVIE GOULARD for climate-related and ESG risks might Second, as climate change has barely call for integrating them into macroeco- started to materialize, climate change- Second Deputy Governor, nomic and financial models. For instance, related risks are not historical but modelled Banque de France the low-carbon transition could have sig- events meaning that using traditional nificant impacts not only on GDP, but also methods reliant on historical data is on other macroeconomic and financial impossible. Accordingly, the stress testing Climate risks, variables such as the rate of interest or the exercise is a starting point for building price of assets. The transition’s impacts will more appropriate models. new risks? also exhibit significant sectorial differences and strong distributional effects. These re- Third, any modelled projection over such quire that assumptions in models, such as long-term horizon needs to be considered “Climate change is a source of risks that is indicating the incidence of a carbon price carefully. This means questioning the fundamentally different from the financial or the use of proceeds of a carbon tax, be traditional use of supervisory stress-test risks investors and financial regulators made explicit. tools. Quantitative analyses need to be are used to managing” (Bolton et al, 2020) complemented with an assessment of the Assessing them calls for new risk models In order to size climate-related financial strategic resilience of supervised entities based forward-looking analysis fed with risks, the Banque de France and the French against climate change. original data. Assessment of physical supervisory authority (ACPR) have run a risks requires very granular geographical pioneering stress-testing exercise involving Finally, the climate challenge is collective analysis of potentially extreme climate banks and insurers. Launched in July 2020, and global. Being successful alone is an events, as well as specific hypotheses the objectives are threefold: i) assessing illusion. Cooperation should prevail, regarding how impacts in one place could over a long-term horizon the impact on between actors and across borders. The cascade to downstream activities and financial stability of disorderly transition political changes in the US as well as locations. Assessment of transition risks pathways as well as a ‘hot house world’ sce- the coming COP 26 represent a great calls for developing scenarios of sectorial nario, relying on NGFS reference scenarios; opportunity to make collective progress, adjustments at granular level, foreseeing ii) understanding the strategic and mitiga- improve risk assessment and mitigation, in which technologies might prevail in a low- tion reactions of financial institutions; iii) particular through a better disclosure.

term, time horizons. Financial firms Building a regulatory cannot ignore these risks. Neither can they underestimate the role they can and supervisory play in facilitating a transition towards a framework enhanced more sustainable environment. for ESG risks Traditional risk assessment tools and metrics were not developed to cater for the specificities of ESG risks in the first In recent years, the financial sector and place. Challenges related to data and policy-makers have stepped up their methodologies are many. Nonetheless, efforts to tackle risks stemming from financial institutions need to build their environmental, social and governance long-term risk, strategic and operational factors. These, and climate-related decision-making processes to embed risks in particular – raise considerable ESG considerations. The banking FRANCOIS- challenges: their far-reaching impact, regulatory and supervisory framework is irreversibility, and dependency on actively adapting to integrate ESG factors LOUIS MICHAUD short-term actions have the potential to and risks into disclosure, prudential Executive Director, European Banking materialize into financial risks at many rules and supervisory practices, at the Authority (EBA) levels and over multiple, including long- global, European, and national levels.

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The EBA is actively contributing to methodological aspects and data Addressing ESG risks requires a this, in Basel discussions, but also by requirements. While climate risk stress long-term forward-looking strategic directly supporting the EU Commission test and scenario analyses differ from approach. The ambitious EU sustainable work, building on the EU taxonomy. It solvency stress test in terms of objectives finance agenda paves the way for the has started embedding ESG risks into and framework, they can provide development of such an approach, the European regulatory framework valuable information to financial firms bringing together scientific evidence, by following a sequence whereby key institutions for their own assessments of societal expectations, public policies, metrics and disclosure1 are available to vulnerabilities and the identification of and sound and risk-based prudential support strategy and risk management.2 remediating actions. standards that take into account the Enhanced transparency and disclosures impact of ESG factors and facilitate of simple and comparable metrics meeting expectations around financing informing on institutions’ strategies, The EBA is developing the transition to a carbon neutral such as a Green Asset Ratio, should key metrics to support economy. Data and methodologies will allow to gradually get to a better picture the disclosure and keep improving. Some first tools have of the current situation and on the management of ESG recently been developed and we can now way forward. risks. start implementing them. In spring 2021 the EBA will publish the findings of its 2020 pilot exercise on Stabilizing the referential and its metrics 1. See EBA press release (https://www.eba.europa.eu/eba- climate risk. The outcome of the pilot is of the essence if financial firms are launches-public-consultation-draft-technical-standards- pillar-3-disclosures-esg-risks). exercise represents the starting point to integrate ESG considerations into 2. See EBA Discussion Paper (https://www.eba.europa. for a more comprehensive discussion on business strategies, risk management eu/sites/default/documents/files/document_library/ how to embed climate risk in the stress and governance. Any adjustments to Publications/Discussions/2021/Discussion Paper on management and supervision of ESG risks for credit test framework in the coming years prudential treatment will come later, institutions and investment firms/935496/2020-11-02 and will support the EBA in shaping based on appropriate evidence. ESG Discussion Paper.pdf).

supervisory regulations, methodologies First, whereas a forward-looking and examinations. In a broader context, approach is key, there is an obvious and leveraging our role as central bank, uncertainty related to the size and timing DNB aims to fuel the public debate by of climate risks. Second, historical data contributing facts and insights about are of very little use in making climate the energy transition and its effects on risk projections. Third, we lack expertise the economy. and experience in translating climate risks to financial institutions’ financial DNB’s approach on the integration of risks. Furthermore, physical climate climate-related risks in our supervisory risks are subject to sizeable geographical practice currently focuses on Data differences, making it hard to generalize and disclosure, Risk management, the impact of these risks. Fifth, there is and Governance and strategy – which a clear interrelation between climate- follows the framework of the Taskforce risks and other environmental risks (eg WILLEM EVERS on Climate-related Financial Disclosure. biodiversity loss), which may amplify Taking a look at where we are at their impact on financial risks. This Head of Department, integrating climate-related risks in the interaction further complicates the Supervisory Policy, regulatory framework, notable good design of risk differentials. Finally, De Nederlandsche Bank news is that the need for embedding the time horizon for climate-related (financial) risks related to climate change risks tends to be longer than time in the prudential regulatory framework horizons traditionally applied to Climate-risk is widely recognized. prudential standards. implications for the Encouraged by the expanding Network So, what is the way forward? Identifying for Greening the Financial System, and mitigating climate risks will EU financial sector there’s a growing number of standard require taking a fresh and perhaps non- setters and regulators taking a seri- traditional look at our regulatory toolkit. ous look at the effects climate change As the future is not in the data yet, it may Climate-risks are high on the agenda of will have on our societies at large and be worthwhile exploring tools designed the financial sector and its policymakers. how the risks stemming from these for non-cyclical and long-term events, As central bank and prudential developments should be dealt with such as concentration limits and/or supervisor, De Nederlandsche Bank within the financial industry. Howev- targeted risk buffers, along with climate (DNB) is committed to contribute to er, amending a prudential framework stress testing and scenario analysis. sustainable prosperity. We are convinced typically requires quantitative evidence that sustainable economic growth is – which is, as of yet, lacking. Collect- Having said that, financial market players only possible when we avoid harmful ing such quantitative evidence is ham- should not wait for all the regulations, effects on the environment. pered by some specific characteristics conditions and perfect data sets to be of climate-related risks, which makes in place before they can have impact. DNB’s sustainable finance strategy for its it challenging to adequately reflect They, too, have a social responsibility to supervisory tasks focuses on integrating their impact in a prudential regulato- support a sustainable economy. sustainability-related risks in our ry framework.

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of the impact of the risk and also the of time in complex ecological and uncertainty of how this risk can spread social systems. It is, as we all know, very to other areas of the financial sector and difficult to predict the future. Longer to society. Not to mention the challenge time horizons increase the uncertainty in determining the size…. This is a fairly and the elements of genuine new risk area and there is a lot we do uncertainty, where risks are particularly not know yet. difficult to translate into probabilities, are significant. There is a lot of published information on sustainability and also the way When uncertain, it is important to work insurers and other financial companies along the lines of scenario analysis. Such provide this information to consumers, analyses can help to illuminate and to investors and to supervisors. In accept uncertainty. It can also increase many cases, companies use different the ability to handle unexpected ÅSA types of voluntary standards and outcomes. frameworks that do specify what and LARSON how information should be compiled One way to calculate transition risk in and published. financial companies is to analyse how Executive director, compatible the exposures are with Finansinspektionen This is in itself a challenge since it makes national or global climate goals. A it difficult to assess how companies particularly relevant climate scenario is are financially affected by various that of the limited global heating. Climate risks sustainability factors. We also still have different disclosure requirements We see that more and more investors seen from a in different regions in the world. request information on the extent to which companies’ operations in supervisory Climate risk - a forward-looking perspective are compatible with objectives of the Paris what’s in it for perspective Agreement and how they are affected by a supervisor? the Paris Agreement’s commitment to limit the global warming. One problem in defining specificities That means that a potential client, an of climate and other ESG related risks investor or a researcher looking for My contribution to the panel will be is to differentiate and untangle climate information will find different data and about the importance of data, in order risks from other types of risks handled answers depending on where he or she to measure, compare and understand by each financial institute. is situated. the risks related to sustainability and climate changes. I will also give a few So I’d say that the specificities for these Climate changes and the transition to examples of activities and tools in this types of risks are all about challenges – in a low-carbon economy include many risk area my authority (the Swedish the timeframe of the risks, uncertainty and major changes over a long period FSA) has initiated.

Climate risk combines the character- pressures – unsustainable natural istics of a black swan event - hard to resources consumption, water stress, predict, highly disruptive - with the in- biodiversity loss, and their ripple effects evitability of a systemic shift that we all -- point to existential threats to human know will happen. called societies that our financial system does this tension between the ineluctability not yet know how to fully process. of climate change and the limited abili- ty of financial markets to anticipate and These characteristics of climate change integrate long-term factors the “Trage- will mold the shape and features of dy of the Horizon.” risk assessment tools. Maps become an essential asset, as climate risk is Climate risk is also defined by dynamic fundamentally geospatial. To assess uncertainty: the future will be what their risk, lenders and investors need to we make of it, through our collective understand the spatial distribution of policy and economic decisions. Yet their portfolio – a challenge for many EMILIE some of the changes underway may not institutions. Climate risk assessments be reversible, bringing another layer of should be forward-looking and as MAZZACURATI uncertainty. granular as the science will allow; Global Head of Climate Solutions, yet that granularity may still not be Moody’s ESG Solutions Group Melting ice sheet and sea level rise, enough to inform investments and risk for example, may already be beyond mitigation as global climate models the reach of policy intervention, perform best at the regional scale. The true costs of while scientists are still working to understand the physics of the processes Pervasive and multifaceted, climate climate change underway. The physical changes, risk should be be mainstreamed combined with broader environmental and integrated into established risk

224 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net CLIMATE-RISK IMPLICATIONS management tools and models. To bridge light on the progress and limitations due to data limitations, raising the the knowledge gap between disciplines, of the exercise. With adequate location specter of potentially flawed decision there will need to be collaboration and sector data, financial institutions making. The discrepancy comes from a between economists, financial modelers can readily identify core exposure in lack of historical data on economic and and climate scientists. their portfolios. financial weather-related losses, as well as the limitations of climate models Financial institutions should embrace in predicting non-linear changes, and the complexity of climate impacts on The costs of the difficulty of modeling second and economies and financial systems and physical risk third order impacts on human and be ready to work with a range of models are grossly ecological systems. to understand impacts across asset underestimated classes, sectors and geographies. They due to data Addressing these fundamental data also need to recognize and understand and modeling limitations is a critical the assumptions, limitations, and limitations. to incorporating the true costs of uncertainties of the models. climate change in financial and While the costs of transition risk are economic decisions. Early efforts to assess climate risks in fairly well understood, the costs of bank and investment portfolios shed physical risk are grossly underestimated

Clients must be central and supported generating them to ensure that this along the entire journey to the Net is the case; Zero world, through advice in building credible transition pathway plans and Conduct and treating all customers via the provision of financing to enable fairly must be a top priority for EU them to be executed; Financial Sector firms. Climate conduct programmes must be in place from Communities of all stakeholders, the outset with the overarching goal in particular the vulnerable and to protect the climate vulnerable and marginalised should be engaged, prevent “green-lining” exclusion in consulted and considered to ensure the credit decisions; Sector plays its role in a just transition so that the Green New Deal works Contracts need to fully capture and for all; comply with the legal requirements ALAN of climate change now enshrined Culture and capabilities need to be in legislation across the EU. As nurtured and enhanced to build Nationally Determined Contributions SMITH financial sector firms with the right get encoded into laws and regulations, Senior Advisor climate skills and mind-sets essential they need to be embedded into Climate and ESG Risk, to ensuring that economies are built contractual relationships. HSBC Holdings plc back better for a sustainable future and that green jobs of worth and dignity are Finally, Communication must be trans- created in support of the low carbon parent and ongoing to all stakeholders The 8Cs economy; - the Board, investors, regulators, em- ployees, NGOs, civil society. of effective The 8Cs of climate As financial sector firms across the EU climate risk risk management will make real their climate commitments, be essential to EU the context in which they execute management Financial Sector being them will evolve and it is essential effective in supporting to be communicating transparently and constructively at all stages to all Climate Risk is the defining risk the transition to the interested parties. The ultimate goal management challenge and strategic low carbon economy. of addressing climate change is to keep opportunity for the EU Financial average global warming to no more Sector for the generation to come. The Calculations underpinning climate than 1.5 ºC by 2050. Sector has the responsibility to play measurement must be robust. Climate a leadership role in supporting the is the ultimate big data area and the To achieve that, many of the necessary transition to the low carbon economy calculations for scenarios, climate risk foundational actions need to be put in and society by 2050. models and warming potential must be place and commenced over the decade developed with rigour to inform data- which has just started, through to 2030. This will require that the boards, driven decisions; To be successful, we must get The 8Cs executives, regulators and investors of Climate Risk right. in financial sector firms are effective Controls need to strong around climate at the 8Cs of Climate Risk – Clients; data, disclosures and risk identification. Communities; Culture and Capabilities; Given all that is at stake, decisions must Calculations; Controls; Conduct; be evidence based and strong controls Contracts; and Communication. must underpin all the processes

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 225 ESG AND SUSTAINABLE FINANCE

are coming from scientists, climate solvency in the short-term. There are activists, civil society and increasingly also challenges with standardizing the finance sector. This is driving forward-looking metrics and the lack climate related ‘transition risks’ as the of data on which to base quantitative global economy transforms, moving assessments of climate change risks. This towards a net zero global economy. New requires using different quantitative and low-carbon technologies are changing qualitative tools, data and metrics to investor preferences and consumer monitor and assess exposure to physical, sentiment. All of which requires new transition and liability risks. policy frameworks to influence supply and demand of low carbon products / Lessons learned services and successfully deliver the EU Green Deal. The insurance industry has a long history of analyzing natural catastrophe JOHN SCOTT This transformation comes with risks risks and is addressing the complex on a shorter time frame than the task of building long-term climate Head of Sustainability Risk, physical risks of climate change. The science simulations into these models. Zurich Insurance Company Ltd economic and societal impact of the Zurich proposes analytical and risk “just” transition will be felt sooner management tools such as climate risk than many might expect. The public advisory services to clients to better ESG & climate-risk: and private sectors must act now and understand the impacts of climate focus on developing strategies that change on their physical assets and implications for the build resilience and adapt to climate supply chains. change. Only then will they be able to financial sector and take steps that drive the low-carbon EU policy priorities transition while managing the risks and EU policy opportunities that come with it. Policymakers should enact legislation Changes in climate risk assessment to continue raising awareness around and disclosure protection, infrastructure, information Despite the pandemic crisis, gaps for citizens and businesses and to environmental risks dominate the risk The Taskforce for Climate related build adaptation and resilience through landscape according to the WEF Global Financial Disclosure (TCFD) framework sustainable investments, sound and Risks Report, for which Zurich is a for climate risk disclosure is now widely adequate risk management tools and strategic partner, with 4 out of the 5 top accepted and in some jurisdictions is metrics. Public-private partnerships will risks being environmental. now mandated for financial services be required to accelerate the delivery of companies. critical policies supporting the transition The most common perception of to a net-zero economy. climate change risks is the ‘physical risks’ Discussion and consultation are (melting polar ice caps, sea level rise, ongoing to better assess and disclose The EU Green Deal and Climate retreating glaciers and changes in severe climate risks. Key issues are about the Adaptation Strategy is an important weather patterns). Demands for rapid assumptions inherent in long-term first step in this, as will be the ongoing reductions in greenhouse gas emissions scenario-based analyses, or stress tests EIOPA work on ESG considerations in aligned with the Paris Agreement and the implications for capital and pricing and underwriting.

environmental, social and financial Putting ESG front consequences, before acting. Hence, the need to be forward-looking, proactive and centre for our and brave.

business and risk At CS, we have committed to setting management strategy Science Based Targets within the next 24 months for achieving net zero emissions from our operations, supply chain & Regulations and internal risk financing activities no later than 2050. management frameworks of banks have We have developed sector-specific Client often played catch up to cover risks Energy Transition Frameworks (CETFs) after they manifested themselves, for which identify priority sectors/industries example, the introduction of liquidity and set out a methodology to categorize coverage requirements after the 08- clients that operate in these sectors GIANLUCA 09 crisis. It is difficult to set guidelines according to their energy transition and internal constraints without a clear readiness. In this way, we aim to actively CANTALUPI historical example of what can go wrong. encourage clients to transition along the Managing Director and Global CETF scale over time and support them Head of Reputational, Sustainability This is where ESG themes, and in through financing and advisory services. and Climate Risk, Credit Suisse particular climate risk, are breaking new International ground. We cannot afford to witness To advance framework developments multiple events with catastrophic across the ESG spectrum, we participated

226 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net CLIMATE-RISK IMPLICATIONS in many industry-wide initiatives, perspective when managing the bank’s treatment for green investments while including, the Equator Principles, the client risks. ESG factors are currently ensuring that requirements remain risk- PACTA project1, and the Task Force for considered mainly based on qualitative sensitive. Capital needs to be sized based Nature-Related Financial Disclosures criteria, but we are adding more on a forward view, while existing models (TNFD). structured KPIs, leveraging internal & tend to look back. Forward-looking third-party data. Credit decisions should stress testing is the key tool to obtain Key concepts such as reporting be taken with full consideration of ESG insights and explore risks to inform greenhouse gas emissions, disclosing matters, especially for clients in sensitive business strategy. Unfortunately, models biodiversity-related aspects and sectors & countries. are still at an early development stage, reporting D&I statistics, are increasingly and data is scarce. becoming standard. However, there is a need for more transparency and There is a need for Our ambition is to become a standardization on an international level more transparency and Sustainability leader. However, the to make approaches more comparable standardization on an financial system can only facilitate the and to minimize greenwashing, while international level to transition - governments must also increasing the availability of reliable make approaches more play their part by charging the cost of pollution at source. Together, we share data. This should not come at the comparable and to expense of flexibility required to the responsibility to protect the planet recognise emerging risks. minimize greenwashing… and drive towards sustainable prosperity.

At CS, we have aligned Reputational, Looking ahead, we see merits in Sustainability, Credit and Compliance exploring mechanisms in the prudential processes to develop a more holistic framework to provide a preferential 1. Paris Agreement Capital Transition Assessment

LATEST REGULATORY UPDATE WWW.EUROFI.NET

Policy notes written by the Eurofi Secretariat on recent regulatory developments and macroeconomic trends impacting the EU financial sector, including implications of the Covid-19 crisis

www.eurofi.net

EUROFI REGULATORY UPDATE APRIL 2021

INSIDE

RESPONSES TO THE COVID CRISIS EU BANKING AND CAPITAL MARKET FRAMEWORK ENHANCEMENTS ESG AND DIGITAL FINANCE POLICY DEVELOPMENTS

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 227 INDEX OF CONTRIBUTORS

228 | VIEWS | The EUROFI Magazine | April 2021 | eurofi.net NAME INSTITUTION PAGE

PUBLIC AUTHORITIES

Ashley Ian Alder Securities and Futures Commission, Hong Kong 26

Nathalie Aufauvre Banque de France 155

Juan Ayuso Banco de España 198

Burkhard Balz Deutsche Bundesbank 191, 198

Ugo Bassi European Commission 139

Denis Beau Banque de France 89, 194

John Berrigan European Commission 74, 79

Ulrich Bindseil European Central Bank 197

Katharine Braddick HM Treasury 78, 210

Peter Braumüller European Insurance and Occupational Pensions Authority 123

Rodrigo Buenaventura Spanish Securities and Exchange Commission 130

Christopher P. Buttigieg Malta Financial Services Authority 184

Per Callesen Danmarks Nationalbank 92

José Manuel Campa European Banking Authority 71, 106

Natasha Cazenave Autorité des Marchés Financiers 140, 165

Mário Centeno Banco de Portugal 18

Gorazd Čibej Insurance Supervision Agency, Slovenia 117

Benoît Coeuré Bank for International Settlements 190

Alberto Corinti Italian Insurance Supervisory Authority 124

Margarida Corrêa de Aguiar Portuguese Insurance and Pension Funds 115 Supervisory Authority

Declan Costello European Commission 43

Gerry Cross Central Bank of Ireland 64

Paulina Dejmek Hack European Commission 171

Nausicaa Delfas Financial Conduct Authority 62

Carmine Di Noia Commissione Nazionale per le Società e la Borsa 209

Jonathan Dixon International Association of Insurance Supervisors 122

Valdis Dombrovskis European Commission 20

Luís Máximo dos Santos Banco de Portugal 88

Helmut Ettl Austrian Financial Market Authority 110

Willem Evers De Nederlandsche Bank 223

Markus Ferber European Parliament 42, 136

Jonás Fernández Alvares European Parliament 90

Edouard Fernandez-Bollo European Central Bank 86

Elisa Ferreira European Commission 24

Gabriela Figueiredo Dias Portuguese Securities Market Commission 138

Luis Garicano European Parliament 104

Sylvie Goulard Banque de France 222

Giuseppe Grande Bance d’Italia 195

Frank Grund Federal Financial Supervisory Authority, Germany 116

Marcel Haag European Commission 176, 192, 201, 218

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PUBLIC AUTHORITIES

Gottfried Haber Oesterreichische Nationalbank 98

Pablo Hernández de Cos Banco de España 33

Werner Hoyer European Investment Bank 32

Alexandra Jour-Schroeder European Commission 68

Elke Kallenbach Federal Ministry of Finance, Germany 150

Othmar Karas European Parliament 97

Mārtiņš Kazāks Bank of Latvia 45

Elke König Single Resolution Board 108

Gert-Jan Koopman European Commission 37

Jörg Kukies Federal Ministry of Finance, Germany 36

Dominique Laboureix Autorité de Contrôle Prudentiel et de Résolution 114, 170

Asa Larson Swedish Financial Supervisory Authority 224

João Leão Ministry of Finance, Portugal 16

Klaus Löber European Securities and Markets Authority 154

Pedro Marques European Parliament 68

Francesco Mazzaferro European Systemic Risk Board 52, 61

Mairead McGuinness European Commission 22

Martin Merlin European Commission 110

Jochen Metzger Deutsche Bundesbank 154, 158

Jean-Louis Michaud European Banking Authority 222

Emmanuel Moulin Ministry of the Economy, Finance and the Recovery Plan, 35 France

Ricardo Mourinho Felix European Investment Bank 39

Mario Nava European Commission 150

João Nuno Mendes Ministry of Finance, Portugal 131

Robert Ophèle Autorité des Marchés Financiers 60

Fausto Parente European Insurance and Occupational Pensions Authority 148, 170

Hester M. Peirce US Securities and Exchange Commission 208

Tsvetelina Penkova European Parliament 183

Rui Peres Jorge Portuguese Securities Market Commission 186

Marcus Pleyer Federal Ministry of Finance, Germany 69

Sébastien Raspiller Ministry of the Economy, Finance and the Recovery Plan, 102, 151, 181 France

Klaus Regling European Stability Mechanism 30

Fernando Restoy Financial Stability Institute 186

Tara Rice Committee on Payments and Market Infrastructures 194

Hélder Rosalino Banco de Portugal 162

Märten Ross Ministry of Finance, Estonia 180

Verena Ross European Securities and Markets Authority 80, 141, 164

Rimantas Šadžius European Court of Auditors 135

Carlos San Basilio Ministry of Economy and Digitalization, Spain 217

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PUBLIC AUTHORITIES

Ana Paula Serra Banco de Portugal 96

Jean-Paul Servais Financial Services and Markets Authority, Belgium 218

Luigi Federico Signorini Banca d’Italia 63, 96

Andrej Sircelj Ministry of Finance, Slovenia 31

Ralph Strauch European Stability Mechanism 54

Paul Tang European Parliament 216

Irene Tinagli European Parliament 38

Hanzo van Beusekom Dutch Authority for the Financial Markets 164

Laurent Van Burik Commission de Surveillance du Secteur Financier 140

Fiona Van Echelpoel European Central Bank 200

Laura van Geest Dutch Authority for the Financial Markets 132

Boštjan Vasle Bank of Slovenia 91

Maria Velentza European Commission 109, 199

Boris Vujčić Croatian National Bank 44, 53

Harald Waiglein Federal Ministry of Finance, Austria 34, 177

Klaus Wiedner European Commission 93

Justin Wray European Insurance and Occupational Pensions Authority 116

Joachim Wuermeling Deutsche Bundesbank 182

Stéphanie Yon-Courtin European Parliament 146, 200

Ante Žigman Croatian Financial Services Supervisory Agency 146

INDUSTRY REPRESENTATIVES

Mireille Aubry Covéa 118

Alban Aucoin Crédit Agricole Group 100

Alexander Batchvarov Bank of America 172

Marc Bayle CLS Group 196

Nicholas Bean Bloomberg Trading Facility Limited 166

Francisco Bejar Iberclear 161

Stefen Berger Citadel 166

Jacques Beyssade Groupe BPCE 112

Thomas Book Deutsche Börse AG 133

Philippe Bordenave BNP Paribas 98

Haroun Boucheta BNP Paribas Securities Services 156

Stéphane Boujnah Euronext Paris 81

Niels Brab Deutsche Börse Group 158

Sylvain Broyer S&P Global Ratings Europe Ltd. 48

Peter Bucher Western Union International Bank GmbH 196

Gianluca Cantalupi Credit Suisse International 226

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INDUSTRY REPRESENTATIVES

Francesco Ceccato Barclays Europe 188

Oliver Collin Invesco 221

Joanna Cound Blackrock 65

Timothy Cuddihy The Depository Trust & Clearing Corporation 67

Alban de Mailly Nesle AXA Global P&C 120

Alex Dockx J.P. Morgan 160

Andreas Dombret Oliver Wyman 58

Ksenia Duxfield-Karyakina Google Cloud 184

Christian Edelmann Oliver Wyman 142

Matthew Elderfield Nordea Bank Abp 70

Guillaume Eliet Euroclear S.A. 159

Nathalie Esnault Crédit Agricole Corporate and Investment Bank 172

Rami Feghali PricewaterhouseCoopers Audit 220

Santiago Fernández de Lis Banco Bilbao Vizcaya Argentaria 95

Anne Finucane Bank of America 211

Denis Gepp Federated Hermes – International 66

Jesús González Nieto-Márquez Bolsas y Mercados Españoles 152

Vittorio Grilli J.P. Morgan 40

Jessica Ground Capital Group 213

Jordi Gual CaixaBank 55

Isabel Guerreiro Banco Santander 178

Daniel Hanna Standard Chartered 215

Pierre Heilbronn European Bank for Reconstruction and Development 46

Philippe Heim La Banque Postale 105

Charlotte Hogg VISA Europe 204

Stéphane Janin AXA IM 187

Simon Janin Amundi 148

Daniel Kapffer DekaBank 185

Xavier Larnaudie-Eiffel CNP Assurances 57

Diony Lebot Société Générale 94

Jean Lemierre BNP Paribas 87

Daniel Maguire LSEG 156

Daniel Mayston BlackRock 167

Emilie Mazzacurati Moody’s ESG Solutions Group 224

Bernard Mensah Bank of America 75

Hannes Mösenbacher Raiffeisen Bank International AG 70

Keiichiro Nakamura SMBC Bank International 83

Juan Orti American Express 202

Stefanie Ott Swiss Re Management Ltd 125

Adriana Pierelli BNY Mellon 220

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INDUSTRY REPRESENTATIVES

Nicolas Rivard Euronext 168

Markus Ronner UBS 76

Cyril Roux Groupama 49

Gianluca Sanmartino Generali 119

Karl-Peter Schackmann-Fallis Deutscher Sparkassen- und Giroverband 111

Thomas Schindler Allianz Global Investors GmbH 142

Joachim Schmalzl Deutscher Sparkassen- und Giroverband 202

John Scott Zurich Insurance Company Ltd 226

Bjørn Sibbern Nasdaq 179

Antonio Simões Grupo Santander 106

Stefan Simon Deutsche Bank AG 104

Alan Smith HSBC Holdings plc 225

Aylin Somersan Coqui Allianz SE 118

Bernard Spalt Erste Group Bank AG 134

Christian Staub Fidelity International 147

Kay Swinburne KPMG in the UK 214

Hideaki Takase MUFG Bank ltd 219

Patrick Thomson J.P. Morgan Asset Management 82

Shinsuke Toda Mizuho Financial Group, Inc. / Mizuho Bank, Ltd. 77

Roeland Van der Stappen VISA Europe 192

Diederik Van Wassenaer ING Group 112

Fernando Vicario Bank of America Europe 103

James von Moltke Deutsche Bank AG 99

David Watson SWIFT 205

Swen Werner State Street Bank and Trust 160

Natalie Westerbarkey Fidelity International 212

Alastair Wilson Moody’s 56

Laurent Zylberberg Caisse des Dépôts 47

OTHER STAKEHOLDERS

Maria Luís Albuquerque 144

Jean-Marie Andrès EUROFI 7

Jean-Jacques Bonnaud EUROFI 126

Didier Cahen EUROFI 7

Jacques de Larosière EUROFI 10

Guillaume Prache Better Finance 145

Marc Truchet EUROFI 7

Martina Weimert EPI Interim Company SE 203

David Wright EUROFI 9

eurofi.net | April 2021 | The EUROFI Magazine | VIEWS | 233

ABOUT EUROFI

The European think tank dedicated to financial services

• A platform for exchanges between the financial services industry and the public authorities • Topics addressed include the latest developments in financial regulation and supervision and the macroeconomic and industry trends affecting the financial sector • A process organised around 2 major international yearly events, supported by extensive research and consultation among the public and private sectors

OUR OBJECTIVES OUR EVENTS AND MEETINGS

Eurofi was created in 2000 with the aim to contribute to the Eurofi organizes annually two major international events strengthening and integration of European financial markets. (the High Level Seminar in April and the Financial Forum in September) for open and in-depth discussions about the latest Our objective is to improve the common understanding among developments in financial regulation and the possible implications the public and private sectors of the trends and risks affecting of on-going macro-economic and industry trends. These events the financial sector and facilitate the identification of areas of assemble a wide range of private sector representatives, EU and improvement that may be addressed through regulatory or international public decision makers and representatives of the market-led actions. civil society.

OUR APPROACH More than 900 participants on average have attended these events over the last few years, with a balanced representation We work in a general interest perspective for the improvement between the public and private sectors. All European countries of the overall financial market, using an analytical and fact-based are represented as well as several other G20 countries (US, approach that considers the impacts of regulations and trends for Japan...) and international organisations. The logistics of these all concerned stakeholders. We also endeavour to approach issues events are handled by Virginie Denis and her team. These events in a holistic perspective including all relevant implications from a take place just before the informal meetings of the Ministers macro-economic, risk, efficiency and user standpoint. of Finance of the EU (Ecofin) in the country of the EU Council Presidency. Eurofi has also organized similar events in parallel We organise our work mainly around two-yearly international with G20 Presidency meetings. events gathering the main stakeholders concerned by financial regulation and macro-economic issues for informal debates. In addition, Eurofi organizes on an ad hoc basis some meetings Research conducted by the Eurofi team and contributions from and workshops on specific topics depending on the regulatory a wide range of private and public sector participants allow us agenda. to structure effective debates and offer extensive input. The result of discussions, once analysed and summarized, provides OUR RESEARCH ACTIVITIES AND PUBLICATIONS a comprehensive account of the latest thinking on financial regulation and helps to identify pending issues that merit further Eurofi conducts extensive research on the main topics on the action or assessment. European and global regulatory agenda, recent macro-economic and monetary developments affecting the financial sector and This process combining analytical rigour, diverse inputs and significant industry trends (technology, sustainable finance...). informal interaction has proved over time to be an effective way Three main documents are published every 6 months on the of moving the regulatory debate forward in an objective and occasion of the annual events, as well as a number of research open manner. notes on key topics such as the Banking Union, the Capital Markets Union, the EMU, vulnerabilities in the financial sector, OUR ORGANISATION AND MEMBERSHIP sustainable finance.... These documents are widely distributed in the market and to the public sector and are also publicly available Eurofi works on a membership basis and comprises a diverse on our website www.eurofi.net : range of more than 65 European and international firms, • Regulatory update: background notes and policy papers on the covering all sectors of the financial services industry and all steps latest developments in financial regulation of the value chain: banks, insurance companies, asset managers, • Views Magazine: over 190 contributions on current regulatory stock exchanges, market infrastructures, service providers... The topics and trends from a wide and diversified group of European members support the activities of Eurofi both financially and in and international public and private sector representatives terms of content. • Summary of discussions: report providing a detailed and structured account of the different views expressed by public The association is chaired by David Wright who succeeded and private sector representatives during the sessions of Jacques de Larosière, Honorary Chairman, in 2016. Its day-to- the conference on on-going trends, regulatory initiatives day activities are conducted by Didier Cahen (Secretary General), underway and how to improve the functioning of the EU Jean-Marie Andres and Marc Truchet (Senior Fellows). financial market. EUROFI MEMBERS

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